How to calculate capital gains tax for an employee share purchase plan

Q: I have a large Employee Share Purchase Plan that I have participated in for a number of years. In this plan, for every share I buy (not discounted) my employer gives me a matching share. I pay tax on the shares the company purchases for me. My U.S. accountant (I have U.S. tax obligations) says that I can include this tax component when calculating the adjusted cost base for my employer purchased shares. However, my Canadian accountant is saying no. Since I paid tax on the employer shares, I would think this should be included in my cost to acquire the shares? – Kelly A: Employee share purchase plans (ESPPs) are indeed common, Kelly, and cross-border issues tend to make them more complex. There are two potential cross-border issues that Canadian taxpayers may need to deal with: 1) buying U.S. shares; and 2) dealing with U.S. tax obligations if you’re a U.S. citizen. I will assume that your plan is a non-registered ESPP, so not a registered plan like a Registered Retirement Savings Plan (RRSP), since you’re asking about capital gains tax For Canadian tax purposes, when you’re buying shares in an ESPP, you need to calculate the adjusted cost base (ACB) for all the shares you have purchased over the years. Your capital gain to be taxed is based on your sale price less your adjusted cost base for the shares sold. Ask a Planner: Leave your question for Jason Heath » To use an example, if you’ve purchased 10 shares for $10 ($100) and 10 shares for $20 ($200), you own 20 shares with an ACB of $300. If you sell half – 10 shares – you still own 10 shares with an ACB of $150. If you buy 10 more shares for $30 ($300), you own 20 shares with an ACB of $450. If you sell all 20 shares for $500, you have a $50 capital gain to report on your tax return. Clear as mud? To use another example, if you’ve purchased 10 shares for $10 ($100) and 10 shares for $20 ($200), and your employer matches your purchases 100%, you own 40 shares with an ACB of $600. The 20 shares your employer matched (purchased) on your behalf is as if they gave you the money first and you then used the money to buy the shares yourself. That’s why an ESPP or similar non-registered plan has a taxable benefit component to it that is added as income to your T4 slip, and you pay tax on the employer’s matching contributions. The basic idea is that your cost base for capital gains tax purposes is based on the cumulative shares you’ve purchased historically. If the shares are denominated in U.S. dollars, and trade on a U.S. stock exchange, it’s a bit more complicated. You need to figure out the purchase price in Canadian dollars based on the exchange rate at the time of each purchase. This can be incredibly difficult if you’ve been buying shares for several years with each biweekly pay cheque and reinforces the benefit of updating your cost base at least annually in this case. Canadian taxpayers often make the mistake of thinking that they can just use the exchange rate at the time they sell the shares. It’s the exchange rate at the time of purchase – or times of purchases – that matters for calculating your cost for Canadian tax purposes. The exchange rate at sale will apply to your sale price only. If your adjusted cost base exceeds $100,000 Canadian, Kelly, you may even need to file form T1135 Foreign Income Verification Statement. This may require you to report to the Canada Revenue Agency (CRA) the maximum cost and year-end cost OR the maximum market value and year-end value of the shares, depending on whether they are held in an account in the U.S. or in Canada. All this tax complexity can be enough to convince people not to participate in an ESPP! But the company matching contributions are like free money, so it’s hard to pass up. Your U.S. accountant may be getting confused with the way an ESPP frequently works in the U.S., where stock purchases are often allowed for employees at a price that is lower than the current market price, generally by up to a 15 per cent discount. In this case, no tax is payable at the time of acquisition of the shares on a U.S. tax return. The taxable event occurs when the shares are sold, and the discount to fair market value is taxed as ordinary income, with the capital gain based on the difference between the fair market value at the time of acquisition and the sale price. Or, it’s possible your U.S. accountant isn’t confused, but just explained this to you in a way that has you confused, Kelly. Either way, the tax you paid to acquire the shares does not impact your cost base for calculating the capital gain on your shares. The tax paid is in respect of the money you received from your employer to effectively buy more shares (the employer matching contribution), which is like salary or a bonus. Only the purchase price of the shares is relevant for capital gains tax purposes. As a U.S. citizen, you will have annual U.S. tax filing obligations, since U.S. citizens must file a tax return every year regardless of where in the world they live. There may be nuances like whether the capital gain is taxed as a short-term or long-term capital gain, depending upon how long you have owned the shares. If the shares are denominated in Canadian dollars, you will have the same foreign exchange issues to worry about, since your U.S. tax return is, of course, filed in U.S. dollars. U.S. and Canadian taxation may differ in some cases, and that’s an important consideration in your case, Kelly. It can be beneficial to work with an accountant who can do both your Canadian and U.S. tax returns, or at least with accountants who can coordinate their tax advice. And since taxes can be confusing, there’s no harm in asking your accountants for clarification if you didn’t understand the first time. Ask a Planner: Leave your question for Jason Heath » Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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Raj says:

February 18, 2021 at 11:43 am

Jason,
This is valuable knowledge at this point of time for my situation. I had several espp shares of my company, some sold in US brokerage when I was US resident. Now I’m Canadian resident and transferred those stocks to Canadian brokerage.
So I’ll have to calculate ACB for all historical stock sold and purchased irrespective of my residency status ?
In USA stocks have longterm and short term holding tax benefit. So I get Canada does not provide any preferential tax treatment for long term stocks (i.e 2 years+)?

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1. MoneySense Editors says:
  
  March 11, 2021 at 12:05 pm
  
  Thanks for the question. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
  
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Pamela Bates says:

June 10, 2021 at 6:28 pm

My husband received free shares over 3 years from his employer. He is paying income tax on the shares the company purchased. Why?

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1. Courtney Reilly-Larke says:
  
  July 29, 2021 at 11:11 am
  
  Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with a qualified advisor.
  
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Robert Private says:

August 31, 2021 at 11:12 am

The amount of the taxable benefit included on the Canadian T4 should be the amount that is included in the ACB of the employer match shares. The employer gave you shares worth $xxx, which you didn’t pay for, and as the author says, this is income as the employer has effectively given you $xxx of cash income and you’ve and you’ve used that cash to acquire the shares. (employer gives you $10,000 cash as income (no tax deducted, but added to your T4 as a taxable benefit) you purchase shares for $10,000. Your ACB is $10,000, and you are taxed on $10,000 of income as a taxable benefit on your T4 – the tax paid on the $10,000 taxable benefit doesn’t increase your ACB from a Canadian tax perspective. Your ACB should be equal to the taxable benefit that the tax was calculated on. Pamela – this should answer your question as well. Your husband received shares valued at $xx, that value is taxable, the same as it would be if he was given cash of $xx.

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