Principal Issues: What are the withholding obligations on certain transactions relating to distributions of shares?
Position: Withholding is required subject to any CRA administrative provisions that may be applicable.
Reasons: Responses were prepared by Trust Accounts.
CLHIA Roundtable 2009
Question 2: Employer Withholding
Question
What are the employer's withholding obligations in circumstances where:
a) shares are distributed out of an employee benefit plan trust in satisfaction of an employee's benefits; and
b) in the exercise of an employee stock option, shares acquired under the option are first sold and the proceeds are then distributed to the employees?
CRA Response
a) As noted in paragraph 48 of IT-502 Employee Benefit Plans and Employee Trusts, when payments are made out of or under an employee benefit plan, a requirement to withhold tax will arise on the earlier of the date the payment is made to the recipients or the date on which the recipient receives an unrestricted right to receive the payment. Accordingly, a trustee of a trust governed by an employee benefit plan will be required to withhold tax on the fair market value of the shares at the time they are issued to, or constructively received by an employee and report the benefit on a T4. In a situation where an employee is not being paid any cash remuneration, CRA will administratively waive the withholding on the benefit. This administrative position only applies to Canadian residents and withholding must be made for non-residents regardless of whether or not there is any cash remuneration to be paid to the employee.
b) In situations involving the exercise of an employee stock option an employee may elect (or the terms of the option may require) the use of a broker to sell the security short. The broker must then remit all or a portion of the net cash proceeds to the employer to pay for the shares being exercised. The balance is then paid by the employer to the employee. These types of transactions are often referred to as a same-day sale or cashless exercise.
Where the employer is aware of the same-day sale or cashless exercise, the employer is required to withhold tax and Canada Pension Plan contributions on the benefit. No administrative position can be applied under these circumstances which would reduce or eliminate the requirement to withhold deductions on the benefit. The only administrative position that can be applied is if the employee is entitled to claim the security options deduction the employer can reduce the benefit subject to tax by taking into account this deduction which reduces the benefit subject to tax by 50%.
It should be noted that the benefit in a cashless exercise will be based on the fair market value of the security at the time the treasury share is transferred to the employee or the employee's broker.