Rewarding executives is taxing
Designing the optimal compensation package for the newly hired executive is no easy task. A recent tax case illustrates this.
Robert Van De Velde was a senior executive with Allstream Inc. In 2003 and 2004, as part of Allstream's Management Incentive Plan to retain its senior executives, Mr. Van De Velde received Restricted Stock or Share Units (RSUs). These are a grant of company stock to an employee, but the stock is not given to the employee outright until the completion of a vesting period. The vesting period is generally time-based (for example, three years after the grant date) or performance-based (the company achieving certain financial targets).
Most RSU plans also have a "change of control" clause, which specifies that if the company is acquired, the RSUs immediately vest regardless of whether the original conditions were met. That's exactly what happened in May, 2004, when Allstream was acquired by Manitoba Telecom Services Inc. The new entity was called MTS Allstream.
The question before the tax court was how the benefit associated with the immediate vesting of the RSUs should be valued and taxed. Mr. Van De Velde argued the benefit should be based on the price of the shares when the RSUs were granted. The price on April 17, 2003, when the bulk of his RSUs were granted, was $36.30.
The Canada Revenue Agency argued that the takeover price of $69.90 of May 25, 2004, was to be used to value the taxable employment benefit since that's when the RSUs vested.
The judge concluded that while Mr. Van De Velde did indeed receive a benefit at the time the RSUs were granted, the benefit could not be quantified until the RSUs vested. As a result, the judge found the benefit should be valued at the $69.90 price, which coincided with the vesting date of May 25, 2004, "as this was when he acquired legal ownership of the RSUs."
Thus, Mr. Van De Velde's taxable benefit was found to be equal to the number of RSUs vested, multiplied by the takeover price of $69.90.
Note that this tax treatment differs from employee stock options in that generally only 50% of the difference between the fair market value of the shares upon exercise and the exercise price is taxable as employment income. With RSUs, 100% of the benefit is deemed to be employment income.