
Canada Tech Startups Winners as Morneau Backs Off Options Plan - daegloe
http://www.bloomberg.com/news/articles/2016-03-22/canada-tech-startups-winners-as-morneau-backs-off-options-plan
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cperciva
To provide some background for non-Canadians: Rather than having entirely
separate rates, capital gains in Canada are taxed as "half income" based on
the normal tax brackets. So if you earn $X of regular salary and I earn no
salary but make a capital gain of $2X (or if I earn $X/2 salary and make a
capital gain of $X) then we pay the same amount of income tax.

If you buy a stock option, it ends up resulting in a capital gain or loss;
either you dispose of the option and directly produce a capital gain or loss,
or you exercise the option and it counts towards the book value of the shares
you acquire, resulting in a capital gain/loss later.

The tax treatment of _incentive_ stock options is weird, because they don't
consider you to "own" the options in question. So instead of getting a capital
gain as the stock option gained value, you're considered to be paid the
ultimate value of the stock option as "earned" income. People realized this
was dumb, so a rule was put in place to "fix" this: Incentive stock options
would be 50% tax-exempt, bringing them down to the capital gains tax rate.

The issue at hand here was whether that "fix" should be removed, limited, or
left intact. Right now inventive stock options receive the same net tax
treatment (via a different route) as purchased stock options; the proposal was
to tax employees at a higher rate than investors.

If this proposal had passed, it wouldn't have yielded any significant increase
in tax revenues, since there was a simple workaround: Rather than granting
stock options to employees, pay them a small bonus and then have them buy the
stock options from you. The lawyers would have made plenty of money drawing up
the paperwork, but nobody else would have benefited.

[I am neither a tax lawyer nor an accountant. This is not legal or tax
advice.]

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3pt14159
I benefit from Canada's favourable option plan, but it is still bullshit.
These tax loopholes are how a VP of Marketing at an obviously going-to-be-
successful company like Shopify makes $1m / year while only paying half the
top marginal tax rate.

Even more if they are clever. I'm not sure if they've closed the loophole but
you used to be able to max out their TFSA by exercising their options,
claiming the share certificates, then putting them into their brokerage
account before the Series A is closed. It only costs $500 / year at RBC to do
this you / your family just can't ever own 10% of the stock in question and it
is completely legal. Then when your $40k of shares grows to $4m after the IPO
you have a perpetual tax free investment account.

But these tricks are nothing new. Businesses have all the flexibility in the
tax code. The only year I was in the 1% in terms of income I paid an effective
tax rate of 12%, and this wasn't because I qualified for the capital gains
exemption tax when my business was acquired (the business wasn't was too
young, your business needs to be at least 2 years old to qualify).

Investment income should be taxed the same as normal income with one caveat:
losses should decrease normal income and should be _after_ inflation. Right
now the biggest pushback I hear (that I think is legitimate) to raising the
capital gains / dividends rate is about inflation; which makes sense for 4%
blue chip bonds, but falls apart on 40% yoy options that are more like
deferred income plans than they are investment schemes.

Edit: Downvote me all you want. People disagree with things that challenge
situations that are good for them.

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cperciva
You can't put shares into your TFSA if you don't operate at arm's length from
the company. And if you're operating at arm's length from a company yet are
able to predict which shares are going to increase in value, you should be
running a VC fund.

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3pt14159
You at the very least can once you're leaving the company, which were the
circumstances of someone I know who has done this. Even if you are right (I
can't quickly find a good definition for "Arms length" as it relates to non-C
level employees) it doesn't materially change my point that people in our
position pay substantially less tax than people in the medical or legal
profession.

Whether it's bulk asset sales and dividends, or Hong Kong holding companies
and tax treaties, or capital gains exemption to "retain top talent" if
Canadians actually knew how it worked 90% of the time they would never stand
for it.

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cperciva
_You at the very least can once you 're leaving the company, which were the
circumstances of someone I know who has done this._

Sure. But then you have to put in the shares (or options) at their _fare
market value_ , which is going to be pretty high if there's an IPO on the
horizon.

~~~
3pt14159
Fair point. Although I still feel the way we value startups (at the last
funding event) warps decision making greatly. The person I knew did this with
a company about 6 months before they raised their next round. So the company
was valued at around $15m for 2.5 years, person invests, then BAM company
valued at $45m on year 3 6 months later. And I think if you're in a company
that is really going to make it you know. Especially if you've been in
startups for a while.

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cperciva
_the way we value startups (at the last funding event)_

That may be how you value startups, but I guarantee you that if the CRA looks
closely it's not how _they_ would value the shares on the eve of a deal which
values the shares much higher.

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3pt14159
My experience is that short of being 60 days before a deal the CRA generally
accepts the previous funding round as the valuation. I agree that the actual
eve of the deal wouldn't fly though.

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scosman
While nerve racking, this ended up being quite civil. A party proposed a tax
plan, the community gave great feedback, and they revised. Thanks to Tobi,
OMERS and everyone who spoke up.

~~~
kspaans
But they were only going to raise them for options worth more than $100k
right? Other than people "winning the lottery", and C-level staff, how many
startup employees would be affected by this? My understanding is that comp
packages above $100k are much rarer in Canada than in the US?

~~~
cperciva
_Other than people "winning the lottery", and C-level staff, how many startup
employees would be affected by this?_

I'm guessing not many, but that's not really the point. The possibility of
"winning the lottery" is very important for startup recruiting.

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kspaans
Right, and I can see your point above about the change being pointless because
it's so easy to work around ISOs!

