When handed a lemon..

WHAT DO YOU DO WITH A LEMON?
A commentary on the defective taxable benefit legislation
Inherited by the Conservative Government
Elected in February 2006
By Victor Drummond ©
March 2008


To say that the Conservative minority government inherited a lemon -- when they took office in February 2006 – is a masterpiece of understatement.

It seems a hidden defect in the Income Tax Act; taxable benefit legislation did not become apparent during the Hi-tech stock market boom years 1985 through 2000.

There was fierce competition in the communications industry for key personnel in the fiber-optics field where anyone who could pack more communications channels and/or achieve higher transmission speed could capture a major chunk of the lucrative telecommunications market.

Corporations in the fiber-optics field, such as JDS Fitel – later JDS Uniphase, (JDSU), grew from an ordinary home garage operation to become a multi-billion dollar corporation in about 15 years.

The phenomenal number of new corporations that sprang up – and began to compete for the scarce top rated personnel – created a serious tug-of-war for these people. American corporations competed with Canadian corporations and -- on both sides of the USA Canadian border -- corporations were raiding each others talent pool.

One strategy – corporations in Canada and the USA -- then adopted was to encourage key personnel to own shares in their own company. The thinking being that if an employee is also a shareholder then they have an incentive to work harder to make the company a success – and thereby share in the company’s profits -- and in addition they would not be so easily enticed away by competitors in the field.

To entice key employee’s to purchase their shares corporations adopted – one or both – of the following contract plans. One plan known as:- The Employee Share Purchase Plan, (ESPP) offered key employees the privilege of contracting to buy company shares – at a small premium nominally 15% below the average closing price of the shares over the previous few days. This average closing price was known as the Fair Market Value, (FMV).

An alternative scheme offered employees to purchase “Call Options” at a small premium below the FMV. The problem with Call options being that they expire on – or about – the third Friday of their Option Month. An option that has an expiry month over a year in the future is known as a “leap”. The scheme of selling employees shares options became known as ESO plans.

Several methods of payment were often allowed – from payroll deduction – to cash or check.
The plans placed a limit on the number of shares an employee might purchase at any given offer time and the offer was frequently repeated such that employees could purchase, second and even a third or more times. Over a period of years even a low paid employee might acquire tens of thousands of shares.

Shares purchased on an ESPP plan were not issued or delivered at the time of purchase. Delivery was scheduled for up to a year after the purchase date and because of this delay purchases and deliveries frequently overlapped.

The employee had no control over the shares purchased until they were actually delivered.
There was little, or no, information given the employee as to whether or not they should, or must, sell their shares at the time they received them. A serious oversight that later became a major factor in the problem that developed.

For reasons not apparent to the layman the legislation applicable to shares acquired via an ESPP or an ESO plan were not classed as an investment in the traditional sense of the word.

These shares are classed as a “Taxable Gift” from the employer to the employee – and as such the premium discount at the time the shares are purchased – and any positive difference between the
Shares adjusted cost base and the FMV calculated on the shares -- at time of delivery to the employee -- are reported – at the year’s inclusion rate -- by the employer to Revenue Canada as the employees:- “Earned Income”.

Although this tax scheme resulted in the participating employee’s being taxed -- at an inflated rate of income – if they could sell their shares for anything close to the calculated FMV – there was no serious hardship imposed on the taxpayer.

After all -- a taxpayer who can sell their shares -- at a handsome profit – can absorb the few extra dollars tax produced by being taxed on an artificially inflated income. If the taxpayer liquidated a large number of shares at a significant gain then they paid both a Capital Gains Tax and a taxable benefit tax on the same shares.

The tech-market crash of July 2000 revealed the trap hidden in the defective taxable benefit legislation. We now had thousands of Canadian taxpayers levied horrendous taxes on shares that were delivered – and the taxable FMV calculated – at the peak of the tech-market boom.

Ordinary employees, with real incomes below $ 60,000 per year -- were being levied taxes on theoretical “Earned Incomes” running into the hundreds of thousands of dollars. In many cases the tax alone exceeded the person’s income by 500% or more.

Instead of applying plain ordinary common sense – and correcting the defective legislation -- the government of the day compounded the felony by merely offering the victimized taxpayers up to a $100,000 per year share purchase tax deferment. Even this token relief had some flaws in it.

For example the taxpayer had to apply for the deferment every year from then on.
Secondly the deferment would expire promptly if:-

(1) The taxed shares were sold, traded or exchanged.
(2) The corporation went out of business or was taken over, sold etc.
(3) The taxpayer moved out of Canada.
(4) The taxpayer died.

Finding the authorities were immune to appeals for fair treatment the victims did everything in their power to pay the devil his due.

They mortgaged their homes. They cashed in their RRSP’s. They borrowed money from the bank if they could. Many couldn’t borrow any money because there employment was terminated during the corporate downsizing that took place following the market crash.

Well how about that for something to give you a stress heart attack, and/or keep you awake nights, and/or give you a mental breakdown.

The victims gave up their futile appeals and made whatever changes in their life plan that was necessary to carry on.

When the federal election of 2006 arrived the Conservative Party campaigned on the promise of fair taxation. They must have known about this taxable benefit fiasco but perhaps did not know the full extent of the problem.

After pushing through a Tax Remission Order for a few SDL Optics/JDSU victims in the British Columbia -- Saanich-Gulf Islands riding of Conservative Member of Parliament Gary Lunn -- and making a few speeches about providing Fair and Equal Taxation for All Canadians – the Conservatives fell silent on the issue.

True there was the implementation of a Taxpayers Bill of Rights – but no one with a mandate to enforce it.

True there was the appointment of a Taxpayers Ombudsman – limited to recommending the Tax Collectors treat all taxpayers civilly.

These were mere token moves that did absolutely nothing to relieve those victimized by those outrageous taxes – and deferred taxes that they can’t possibly pay.

After all the fanfare about fair taxation for all Canadians – why has no one taken up the issue in government. They all know it is an unreasonable situation and demands correction.

It seems no one knows just how many victims there are.
If they do know they are not telling anyone.

It seems no one knows how much money is involved.
If they do know they are not telling anyone.

It seems our opposition party’s are equally ignorant of the facts or at least too timid to criticize the government for inaction on this issue. Surprising silence from those that were ready to face the Taliban not so long ago.

This issue is not now – or ever -- going to go away.

Those victimized are not all top level corporate executives – with millions of dollars stashed away.
The far greater majority are ordinary people financially ruined by this insidious tax.

If the Conservative government was blind-sided by the financial magnitude of this fiasco – then like the victims themselves – they have a real lemon of a situation to deal with.

Victims had only two options – if they could beg, borrow and/or sell their assets -- for enough money to pay the unjustified tax – that was their lemonade.

If they fell short of being able to pay all the tax – perhaps they could apply the T1212 option and live the rest of their lives under a hanging threat of pre-mature expiry of their deferment – and that was their lemonade.

The government also has two choices. They can keep silent and lose what credibility they had while they renege on all the fine promises they made, i.e. to provide all Canadians with Fair and Equal treatment under the law.

And hope to be re-elected to power.

Or they can put some substance to the promises they made – change the taxable benefit legislation – compensate those previously and presently victimized – and have a real platform of performance upon which to campaign for re-election with a majority government.

Then all Canadians will share in the governments:- REAL LEMONADE.

See you at the next federal election voting polls O’Grady. (Ref. prior posting:- O’Grady sez.)

Victor Drummond ©