With its 2010 budget, the federal government’s primary focus is the continuation of economic stimulus measures that were the centerpiece of last year’s budgets, although there are measures affecting employment insurance and stock-based compensation rules.
Other highlights from the budget of interest to HR managers include:
•upcoming consultations on Canada’s retirement system
•the treatment of “purely cosmetic” procedures for purposes of the Medical Expense Tax Credit
•improvements to the Registered Disability Savings Plan rules
•a reduction in the inclusion rates for U.S. Social Security Benefits
•an update regarding the treatment of foreign investment entities and non-resident trusts.
The budget reaffirms previously-announced economic stimulus measures amounting to $19 billion for fiscal year 2010-2011. These measures include personal income tax relief ($3.2 billion); enhanced EI and training benefits ($4 billion); infrastructure spending ($7.7 billion); research, development and education ($1.9 billion); and economic adjustment and regional support ($2.2 billion).
Although the infrastructure spending simply reflects the remaining stimulus funding that was not spent in fiscal 2009-2010, it is beneficial to Canadian businesses and workers, and will provide a source of long-term assets, many with inflation-linked revenues for pension plans to invest in.
Rate freeze and changes to rate-setting procedures: EI premium rates will remain frozen at $1.73 per $100 of insurable earnings for fiscal 2010-2011. After 2011, premiums will be set by the Canada Employment Insurance Financing Board on a cost-recovery basis, with annual changes limited to 15 percent.
Extension of the work-sharing program: This program, which provides EI benefits to workers who are willing to accept a reduced work week, is extended. Existing or recently-terminated work-sharing agreements will be extended by an additional 26 weeks, to a maximum of 78 weeks. Qualifying criteria for new work-sharing agreements will be made more flexible, and access to EI parental and sickness benefits will be improved for military families. EI spending in 2010-2011 is expected to continue at a rate of $6 billion higher than in 2008-2009.
Extended benefits for Canadian Forces members: Members of the Canadian Forces whose military requirements have made them defer their parental leave will have their EI eligibility period extended by 52 weeks. Individuals who have lost a family member as a result of military service will have access to EI sickness benefits.
Support for victims of crime: Funding is provided to facilitate access to EI sickness benefits for eligible workers who have lost a family member as a result of crime.
Current rules enable an employee holding an employer-granted stock option either to exercise the option and receive the stock or to receive a cash payment in lieu of the option gains (tandem stock options). If the plan is properly designed, the employee may claim a stock option deduction in either case, but the employer is only entitled to a deduction for a cash payment. The budget proposes that the stock option deduction will be available to an employee only where:
•an employee acquires securities of the employer upon exercising a stock option; or
•the employer makes a cash payment in lieu of issuing securities and agrees to forego a deduction for the cash payment.
The budget clarifies the withholding tax obligations for stock-based compensation of employers and reduces the taxation risk for employees who hold devalued shares of an employer following the exercise of an employer-granted stock option.
Beginning in 2011, where an employee receives a security of an employer as an employment benefit, tax on the value of the employment benefit must be withheld currently and remitted by the employer. This proposal corresponds to the U.S. withholding tax requirements.
Currently, where an employee acquires shares of an employer on exercise of an employer-granted stock option, the market value of the shares at the time of acquisition is a taxable employment benefit. Subject to certain conditions, the current rules allow an employee to elect to defer an income inclusion of up to $100,000 of the taxable benefit until disposition of the shares of a publicly-traded company. Changes in the market value of the shares following acquisition are treated as capital gains or losses. However, if an employee elects to defer recognition of the employment income benefit and later disposes of the shares when the value of the shares has dropped significantly, the disposition proceeds may not be sufficient to pay the employee’s tax liability. To address this, the budget proposes to immediately repeal the employee’s option to defer the tax.
The budget also announces a long-awaited relief measure for employees who have a deferred tax liability under the current rules, where the deferred tax liability now exceeds the market value of the shares. The budget proposes to allow these individuals to elect to pay a special tax equal to the proceeds from the disposition of the shares. This election will be available for dispositions of such shares before or after 2010. Individuals who disposed of these shares before 2010 must make their elections on or before the due date for filing their 2010 tax returns. Individuals who have not yet disposed of these shares must do so before 2015 in order to make the special election.
Finally, the budget announces that rules for stock options will be clarified to provide that disposition of rights under a stock option agreement to a non-arms-length person will trigger a taxable employment benefit.
Retirement income system
The budget announces that the federal government will undertake public consultations on how to improve Canada’s retirement system starting in March 2010. The results of these consultations will be discussed when the federal and provincial finance ministers meet in May 2010.
While the Budget reiterates the federal government’s commitment to increasing the pension surplus threshold in the Income Tax Act from 10 per cent to 25 per cent, the Notice of Ways and Means Motion accompanying the budget does not contain provisions giving effect to this measure.
Medical Expense Tax Credit eligibility
The METC provides assistance for Canadians with above-average medical and disability-related expenses. The budget proposes that expenses incurred after March 4, 2010, for purely cosmetic procedures will not be eligible for the METC.
The Canada Revenue Agency has implied that a Private Health Services Plan (PHSP) can only cover those expenses which are eligible for the METC. This interpretation has been subject to debate. Under the budget proposals, to the extent that plan sponsors restrict benefits to those that are METC-eligible, cosmetic procedures would no longer be eligible for coverage under a traditional PHSP or through a health spending account.
Registered Disability Savings Plans
RDSPs were introduced in 2007 as a savings vehicle to help parents and others provide for a child with a severe disability. Currently, RDSPs attract Canada Disability Savings (CDS) grants of up to $3,500 annually and CDS bonds are available up to $1,000, to a lifetime limit of $20,000. However, these amounts cannot currently be carried forward if unused. The Budget proposes a 10-year carry forward of CDS grant and bond entitlements, recognizing that families of children with disabilities may not be able to contribute regularly to those plans. The carry forward will be available starting in 2011.
The budget also proposes to allow funds in the Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF) of a deceased individual to be transferred tax-free to the RDSP of a financially dependent child or grandchild, up to the limit of available RDSP contribution room.
Reduction of U.S. Social Security benefits inclusion rates
The budget proposes to reduce the inclusion rate for certain Canadian residents receiving benefits under social security legislation in the United States (excluding unemployment benefits). The proportion of U.S. Social Security benefits required to be included in income will be reduced from 85 per cent to 50 per cent. This applies to Canadian residents who commenced receipt of Social Security benefits prior to Jan. 1, 1996, and in respect of benefits received on or after Jan. 1, 2010.
Foreign investment entities and non-resident trusts
The budget proposes further consultations regarding the tax treatment of foreign investment entities and non-resident trusts. It reiterates the government’s stated intention that entities such as pension funds and registered charities be exempted from any taxes applicable to non-resident trusts and that the rules will not apply to bona fide commercial trusts.
Action steps for HR managers
There are no measures in the budget that would have a direct impact on employer-sponsored pension and other benefit programs. Employers may want to consider participating in the federal government’s upcoming public consultations on ways to improve Canada’s retirement system.
Employers offering stock-based compensation programs should consult with their advisors and take action as necessary to ensure compliance with the new tax rules announced in the Budget. Employers may also wish to inform employees who may be liable for deferred tax on optioned securities of the new election options announced in the Budget.
Ian Genno and James Pierlot are senior consultants in Towers Watson’s Toronto office. This article was developed with the help of several colleagues at Towers Watson. You can reach Ian and James at Ian.Genno@TowersWatson.com and James.Pierlot@TowersWatson.com.