An NDP pledge to raise $500-million in new revenue by changing the tax treatment for employee stock options would increase income tax costs for top executives by about 10 per cent a year, but might not have the anticipated benefit if companies shift compensation design in response.
A new analysis of stock-option tax treatment for CEOs at Canada's 120 largest corporations – who receive the largest employee stock option grants in Canada – shows they would pay about 10 per cent more income tax on average if an NDP government changed the stock-option tax treatment, according to Toronto compensation consulting firm Gallagher McDowall Associates.
Gallagher McDowall principal consultant Bernie Martenson said stock-option grants have been falling sharply in Canada in recent years as companies increasingly favour other compensation tools, especially grants of share units.
The shift means the NDP's anticipated $500-million a year in annual savings over the next four years – which the party said would be used to reduce child poverty – could be less than estimated if stock-option grants continue to decline in popularity.
"It's a little more sizzle than substance in terms of its reality," Ms. Martenson said. "It absolutely will have an impact, but not as big as it would have been 10 years ago."
In 2014 alone, grants of stock options to CEOs of Canada's 100 largest companies fell an average of 40 per cent, while share-unit grants became the preferred alternative, climbing 37 per cent, according to an analysis released earlier this year by Global Governance Advisors.
CEOs of Canada's largest companies in the S&P/TSX 60 index paid about $3.44-million in personal income tax on average compensation of $7.64-million in 2014, which included stock-options grants with an estimated value of $1.73-million last year, the Gallagher McDowall analysis shows. Their tax bill would have risen by 9 per cent to $3.75-million, or $310,000 more, under the NDP's proposal.
At the next 60 largest companies in Canada, ranking from 61st to 120th in market value, CEOs paid an estimated average of $1.62-million in tax last year, which would have climbed by 13 per cent to $1.83-million under the option tax change.
Under current rules, employees who earn gains on their stock options pay income tax on 50 per cent of the profit in the year when they are exercised, which mirrors the tax treatment for capital gains on profits earned by investors who sell shares.
The NDP is proposing to tax stock-option gains on the full amount of the profit, rather than the 50-per-cent capital-gains rate, calling the current tax treatment a loophole that needs to be closed.
Ms. Martenson said such a change would accelerate the current trend away from options by making them even less attractive.
She said some employees already find options less appealing because they have a higher risk of expiring worthless, whereas shares typically retain at least some of their value even if the price falls. Ms. Martenson said employees essentially trade off the risk for better tax treatment, but that benefit disappears if the loophole is closed.
As well, companies currently get no writeoff of the expense when they grant their employees stock options, while they do get writeoffs for granting shares and share units. The lack of a tax writeoff for options has served as a sort of quid pro quo to offset the favourable treatment for recipients on their personal income tax bills, Ms. Martenson said.
Without the employee benefit, companies would also have more incentive to switch to compensation that is tax deductible, she said.
NDP candidate Andrew Thomson, who is a former Saskatchewan finance minister now running in the Toronto riding of Eglinton-Lawrence, said the most recent available data shows the tax treatment for stock options costs the government $750-million annually. He said the $500-million estimated savings from the tax change is based on the assumption some companies will reduce their use of options in response, calling it a "very prudent and realistic" estimate.
He added the party would move to close other loopholes "as people try to exploit them."
Ms. Martenson said many people believe wealthy CEOs pay little tax and deserve to lose more loopholes, but the reality is that they pay millions of dollars in tax every year.
An employee earning the average industrial wage of $48,636 last year paid $7,918 in income tax (assuming no other deductions, such as RRSP contributions), which is a 17-per-cent tax rate, the Gallagher McDowall analysis shows. Top 60 CEOs, by comparison, paid an estimated 45 per cent of their income in tax for an average of $3.44-million each.
That means they earned $157 for every $1 an average worker got, but paid $435 in tax for every dollar of tax paid by an average worker, the analysis says.
The tax analysis assumes all the CEOs pay tax at the Ontario rate, even if some are based in other locations with different systems. It also assumes grants of restricted share units and stock options were worth their estimated grant date value, and were exercised and taxed last year, whereas they would typically be exercised in a future year and taxed at that date.