With its 2010 budget, the federal government’s primary focus was the continuation of economic stimulus measures that were the centrepiece of last year’s budgets, although there were measures affecting employment insurance and stock-based compensation rules.
Other highlights from the budget of interest to HR managers included:
• 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 United States social security benefits.
• An update regarding the treatment of foreign investment entities and non-resident trusts.
The budget reaffirmed previously announced economic stimulus measures amounting to $19 billion for the fiscal year 2010-2011. These measures included 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 reflected 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 would remain frozen at $1.73 per $100 of insurable earnings for fiscal 2010-2011. After 2011, premiums would be set by the Canada Employment Insurance Financing Board on a cost-recovery basis, with annual changes limited to 15 per cent.
Extension of the work-sharing program: This program, which provides EI benefits to workers who are willing to accept a reduced workweek, was extended. Existing or recently terminated work-sharing agreements would be extended by an additional 26 weeks, to a maximum of 78 weeks. Qualifying criteria for new work-sharing agreements would also be made more flexible. EI spending in 2010-2011 was expected to continue at a rate of $6 billion more 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 would have their EI eligibility period extended by 52 weeks. Individuals who have lost a family member as a result of military service would have access to EI sickness benefits.
Support for victims of crime: Funding was 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 to either exercise the option and receive the stock or 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 proposed the stock option deduction would be available to an employee only if:
• an employee acquired securities of the employer upon exercising a stock option
• an employer made a cash payment in lieu of issuing securities and agreed to forego a deduction for the cash payment.
The budget clarified the withholding tax obligations for stock-based compensation of employers and reduced the taxation risk for employees who hold devalued shares of an employer following the exercise of an employer-granted stock option.
Beginning in 2011, if an employee received a security of an employer as an employment benefit, tax on the value of the employment benefit would have to be withheld currently and remitted by the employer. This proposal corresponded to U.S. withholding tax requirements.
Currently, if an employee acquires shares of an employer through 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 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 proposed to immediately repeal an employee’s option to defer the tax.
The budget also announced 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 proposed to allow these individuals to elect to pay a special tax equal to the proceeds from the disposition of the shares. This option would be available for dispositions of such shares before or after 2010.
Individuals who disposed of these shares before 2010 would have to make their choice on or before the due date for filing their 2010 tax returns. Individuals who have not yet disposed of these shares would have to do so before 2015 in order to make the special election.
Finally, the budget announced rules for stock options would be clarified to provide disposition of rights under a stock option agreement to a non-arms-length person would trigger a taxable employment benefit.
Retirement income system
The budget announced 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 reiterated the federal government’s commitment to increasing the pension surplus threshold in the Income Tax Act from 10 to 25 per cent, the Notice of Ways and Means Motion accompanying the budget did not contain provisions giving effect to this measure.
Medical Expense Tax Credit eligibility
The Medical Expense Tax Credit (METC) eligibility provides assistance to Canadians with above-average medical and disability-related expenses. The budget proposed expenses incurred after March 4, 2010, for purely cosmetic procedures would not be eligible for the METC.
The Canada Revenue Agency has implied a Private Health Services Plan (PHSP) can only cover those expenses that are eligible for the METC. This interpretation has been subject to debate. Under the budget proposals, to the extent 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
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 up to $1,000 are available, to a lifetime limit of $20,000. However, these amounts cannot be carried forward if unused.
The budget proposed a 10-year carry forward of CDS grant and bond entitlements, recognizing 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 proposed 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.
Social security benefits inclusion rates
The budget proposed to reduce the inclusion rate for certain Canadian residents receiving benefits under social security legislation in the U.S. (excluding unemployment benefits). The proportion of U.S. social security benefits required to be included in income will be reduced from 85 to 50 per cent. This would apply 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 proposed further consultations regarding the tax treatment of foreign investment entities and non-resident trusts. It reiterated 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 the rules would 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 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 options announced in the budget.
Ian Genno and James Pierlot are senior consultants at 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.