WHAT DO YOU BELIEVE...

WHAT DO YOU BELIEVE?

There are still a few adult people who believe the world is flat.
And there are a lot of mature Canadians who believe the Honourable James M. Flaherty,Canada’s Minister of Finance,when he reiterates the taxing of Honest, Hard-Working Canadians,out of their lifetime savings, and/or homes, based upon fictitious income -- is “fair”.

Following is a summary of the real facts inherent in the taxing of “phantom income”
By Victor Drummond ©
November 2009

Our Honourable James M. Flaherty, Canada’s Minister of Finance, has declared on several occasions that Canada’s on-going policy of taxing phantom income is “fair” because:

(1) “The legislation has been on the Law-books for a long time which makes it a good law.” and
(2) “Taxpayers who hold their ESPP/ESO acquired equities past the date of exercise are treated the same as all other Canadian stock market investor/speculators.”

So let us examine those arguments:

(1) How many laws do you suppose -- that have been on the Canadian Law-Books a lot longer that our defective “taxable benefit” legislation -- that are now considered bad laws?

Laws pertaining to “Capital Punishment” are now in question – original laws have been amended.
Laws pertaining to “Abortion on demand” are now in question -- (as above)
Laws pertaining to “Same Sex Relationships” are now in question – (as above)
Laws pertaining to “Young Offenders” are now in question – with many already amended.
And these examples barely scratch the surface.

So if there is any relevance between the length of time a law has been on Canadian Law books it is: “The longer a law has been in use the more likely it is to be outdated and in need of updating.”

Argument (1) is “BUSTED”

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(2) At what point -- in the tax process -- does the tax treatment of taxpayers who hold their ESPP/ESO acquired equities, past the date of exercise, become the same as the tax treatment of all other Canadian investor/speculators?

We will begin by listing the tax treatment of: “All other Canadian investor/speculators.”

Honest, hard-working citizens of civilized democracies such as Canada and: The United States of America: are able to buy and sell equities on a variety of established stock, commodity, and financial exchanges.

Using common shares and shares options contracts -- to make my point(s) – the following facts and comments apply.

Anyone who can meet the age and financial requirements of a stock broker may open an account that allows them to buy, sell, and/or short-sell the above named equities.

Buy/sell, and/or short-sell, orders can be placed with your broker in person, or by phone, or via, an on-line computer.

Once an investor has established a broker account and has equities, and/or cash, deposited in their account they may then be extended the option of trading additional equities on “margin”.

Margin buying/selling of equities carries additional risks along with the advantage of providing leverage to increase potential gain.

Fact (a) No matter how many shares you buy, from your broker, or what price you pay for those shares there is no “income tax” implication so long as you do not sell, trade or liquidate any of your holdings or collect interest or dividends from them.

Purchased equities remain in your account -- which is also known as your “portfolio”-- tax free indefinitely.

Regardless of whether the value of your portfolio increases, or decreases, or stays the same – as long as you are merely holding equities in it -- there are no tax implications.

Fact (b) It makes absolutely no difference if you happen to be an employee of the broker you are buying and selling these equities through -- so long as the equities are not shares in your employers organization offered to you via an Employee Shares Purchase Plan, (ESPP) or an Incentive Shares Options (ISO/ESO) agreement.

Fact (c) It makes absolutely no difference if your broker-employer sold you the equities you purchased at the market high, or the market low, for the day. Any difference between the actual cost to you and the deemed Fair Market Value (FMV) of those same shares does not generate any tax implications. The price you pay for your equity buy(s) only relate to your Adjusted Cost Base (ACB) of each specific purchased equity.

Fact (d)At tax time, each year, your broker will provide the Canada Revenue Agency (CRA) a summary of your equity trades during the previous year -- complete with the type/class of each equity traded, the trade volume, the price received/paid per equity unit -- the gross value of the trade and any commission or foreign exchange paid/received.

Fact (e)When you prepare your “Income” Tax Return you report the details of all CLOSING equity trades on the S3 --S3-Supplement form of your Income Tax Return.

A CLOSING trade is the combination of the buy and sell transactions involving the same equity.

Equity’s that expire or consolidate/split shares, and/or change their name are tracked in order to accurately report the ACB and final loss/gain on the closing trade.

On your S3 – S3 Supplement you identify the type/class of equity, i.e. Common or Preferred Shares, or Put or Call Option, the volume of the equities traded, the ACB, the gross value of the trade – other costs or expenses and finally the years net Loss or Gain.

Fact (f)If you have a loss to report – then you may apply this loss against any Capital gain on which you paid tax -- at the Capital Gains inclusion rate -- in the last three years. Or you may carry the loss forward indefinitely -- to be applied against any future capital gain.

Conversely if you have a net gain to report, and no offsetting Loss, then this gain is added to your “income” – at the current Capital Gains Inclusion rate – and you pay tax on this profit.

Fact (g)Only closing trades are reported on the S3 -- S3-Supplemnt Tax form and all other equities still held by you, the investor/speculator, remain in your portfolio indefinitely with zero tax implications as per Fact (a).

There is no issue with the “income tax” regulations as stated in the foregoing investment tax policy facts (a to g). Where no monetary gain has been received -- no tax is levied.

Up to this point Canadians have a “fair” and “equitable” income tax system and tax policy.

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The CRA has a different rationale they apply to tax “fictional earned income”, i.e. when you buy equities from your employer via an ESPP and/or an ESO/ISO.

Then the CRA levies a tax on any "theoretical" gain you might have realized -- at the moment your ESPP/ESO purchased equities are delivered to your account -- even though these equities are still in your portfolio -- and no closing trade has yet taken place. You have not yet realized one red cent of actual income.

Is this change of tax policy justified?
Has it been, or can it ever be, applied fairly and equitably?

Here are the facts – and you be the judge.

Fact (h) Equities offered employees per an ESPP and/or an ESO are “purchased” by the employee with their own after tax dollars.
No gift or award has been bestowed on the employee by the employer.

Fact (i)Equities offered by an employer, per an ESPP/ESO agreement, may be offered at a discount below the deemed FMV of those shares as traded on a conventional stock
exchange.

Where the buyer acquires ESPP/ESO equities at a discount (typically 15%)the CRA deems this 15% difference may become a component of a taxable benefit.
(Fact (c) is applicable to “All other Canadian investor/speculators” -- but not to the holders of ESPP/ESO equities.)

Fact (j)There is normally a significant delay between the time an employee agrees to purchase shares under an ESPP/ESO agreement and the beginning of the delivery date(s)(exercise dates). This time delay may range from months to years during which time the buyer (employee) has no control over the equities being purchased.

By comparison equities purchased by way of a conventional broker are delivered immediately and the buyer has full control over these equities until they are liquidated.

Fact (k)Although you have not received so much as one red cent, in hard cash, you are taxed on any theoretical gain your ESPP/ESO purchased shares might have produced had you sold them at the moment you received them from your employer.
i.e. The “exercise” date. (This treatment is unique to ESPP/ESO taxpayers.)

When a theoretical profit is possible, at the moment of “exercise”, it is “deemed” by the CRA to be a “taxable benefit”. Even though no tangible money has actually changed hands. (This treatment is unique to ESPP/ESO taxpayers.)

Note:(1)During the stock market boom years – 1985 to 2000 – this tax policy caused no problem for you as your ESPP/ESO equities went up in value almost daily. Victims of taxes levied on “deemed” earned income could easily duplicate the dollar value that fictitious income by selling sufficient shares to pay the tax.

When the stock market boom went bust in mid year 2000 victims of taxes levied on phantom income could no longer actually realize the deemed “earned income” as the value of the shares held had fallen below the level of the taxes levied on them.

Note (2)During those same boom years the government of Canada encouraged Canadian Hi-Tech Corporations to offer their key employees Incentive Shares/Options purchase plans as a means of increasing employee loyalty. and productivity and as a method to reduce the level of technical people being enticed to switch employers and leave Canada. i.e. Fighting the so-called “Brain Drain”.

Government and Corporate ESPP/ESO brochures during those years encouraged employees to participate in these incentive plans as investors in Canada’s future.

There was no mention that these “investments” could be classed as a taxable benefit that could end up leaving you -- the employee -- financially devastated.

Fact (l)Although the ESPP/ESO acquired equities, (with a theoretical gain), are “deemed” to be a “taxable benefit” at the moment they are exercised. they somehow morph into Capital equities if these same items are later sold at a loss.
(This treatment is unique to ESPP/ESO taxpayers.)

Now regarding James M. Flaherty’s argument (2) “Taxpayers who hold their ESPP/ESO acquired equities past the date of exercise are treated the same as all other Canadian stock market investor/speculators.”

The point at which this argument becomes true is after the ESPP/ESO tax victims have been processed per Facts (h through l). At that point they have already been financially exploited.

Therefore argument (2) is also BUSTED. Taxing anyone on money that never existed is NOT FAIR OR JUSTIFIABLE Mr. Flaherty – and you know it.

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The U.S.A. congress also knows that taxing phantom income is unfair and that is why the amended their comparable “Alternative Minimum Tax” (AMT) legislation to put and end to this tax policy.
Ref. www.reformamt.org

Over 400 Canadians who have signed the CFET petition do not believe taxing phantom income is “Fair” Ref. www.cfet.ca (petition).

Our Right Honourable Stephen Harper, Prime Minister of Canada, doesn’t believe taxing Canadians on phantom income is “fair” or he would never have approved the Gary Lunn Tax Remission Order (TRO) revoking this tax and related penalties for a paltry 37 victims in Saanich – Gulf Islands British Columbia.

Her Excellency, The Right Honourable Micheal Jean, Governor General for Canada doesn’t believe the taxing of Canadians on phantom income is “fair” as evidenced by her signing the Gary Lunn TRO and saying: “ I do so in the best interest of All Canadians”.

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Fact (m)The recourse open to you, as a victim of this taxable benefit tax trap, consist of the following:

(1) You can apply to your local Canada Revenue Office – Chief of Appeals Officer for a reassessment of your “Income Taxes”. These direct appeals are typically denied.

According to a report by the Federal Auditor General, in 2008, the prospect of you receiving a favourable decision using this approach depends as much, or more, upon the location where you submit your appeal as it does upon the merits of your case.

(2) You can hire a lawyer and appeal to the “Tax Court of Canada” (TCC) to have your case decided by a judge’s decision.

The greater majority of phantom income tax victims who have tried this avenue have ended up having their appeal denied – on the grounds that no laws have been broken -- and those victims who tried this avenue have usually found they have only sent good money after bad.

(3) You may apply to have your taxes reduced, or revoked, on the basis of being in financial distress and you are eligible to be treated as a “hardship case”.

Do you believe allowing financial hardship situations to be a factor in the reduction, or cancellation, of “Income taxes” is fair to all Canadians?

Or does this avenue of tax remission merely reward the spendthrift and penalize the thrifty?

Fact (n)Both the Right Honourable Paul Martin, former Prime Minister of Canada, and the Right Honourable Stephen Harper, Canada’s current Prime Minister made public commitments to correct the phantom tax problem. Paul Martin is reported in the Victoria Times Colonist Newspaper as saying: “We’ll fix it” when asked what he intended to do about the taxing of Canadians on money never seen?

Then following the Gary Lunn “Tax Remission Order” (TRO) Stephen Harper is quoted as saying: “We’ll get it resolved - it will take a change of code.” when asked if the same tax relief would be provided to all Canadians caught in the same tax trap.

As of November 2009 the problem has not been “fixed” or “resolved” and the “code” remains unchanged.

Did either Prime Minister ever say they failed to take the promised corrective action because they believe the taxing of phantom income to be “fair”?

The answer is “No.”
Why? Because they know it is unfair and unjust.

The foregoing bogus arguments put forward by our government authorities are deliberately slanted to deceive the average Canadian into believing something they do not believe themselves. i.e. “that the Canadian policy of taxing honest, hard-working Canadians on “income” money that never existed – is “fair” and justified.”

I do not believe it is “fair” and neither should you.

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The means to make the taxation of ESPP/ESO/ISO acquired equities truly “fair” and “justified” is very simple and straightforward.

Simply remove ESPP/ESO/ISO acquired equities from the “taxable benefit” classification and place them in the “Capital Equity” classification where they rightfully belong.

Compensate those victims who have already paid, or deferred, taxes on phantom income as the U.S.A. government is doing.

Then all Canadian investor/speculators will really be provided the same tax treatment making Minister Flaherty’s argument No. (2) TRUE and Canada’s “income” tax legislation “fair” at last.

See you at the voting polls in the next federal election O’Grady.

Victor Drummond ©