British Columbia

Thousands of Canadians taxed on 'phantom income'

Thousands of Canadian workers who purchased stock options from their employers before the market downturn are expected to pay millions of dollars in taxes on income they haven't received because the shares have lost their value.

Employees who lost on stock options face bankruptcy over huge tax bills

Shannon McLeod had to pay a $100,000 tax bill on 'phantom income' from worthless stock options. ((CBC) )

Thousands of Canadian workers who purchased stock options from their employers before the market downturn are expected to pay millions of dollars in taxes on income they haven't received because the shares have lost their value.

"I had to take out over a hundred thousand dollars in loans, plus interest, in order to pay off taxes," said marketing manager Shannon McLeod, a tech-industry worker in Vancouver who faced the same situation several years ago.

"I was a good little Canadian taxpayer and I paid it off, but it had a huge effect on me."

The income tax is applied to stock options, a benefit many Canadian employees are given as part of their remuneration. Employees at various levels of companies in high tech, mining, banking and other industries are allowed to buy stock in their firm at a significantly reduced price.

"Companies give out stock options to their employees thinking it is a huge benefit, and it's actually a huge liability," McLeod said.

Because of a little-known loophole in Canada's tax law, people are expected to pay income tax on the market value of the stocks when they are issued — not on their lesser value if they are later sold at a lower price. Those affected call it a tax on "phantom income."

Tax experts estimate many Canadians have been hit since the latest stock market downturn. The national group Canadians for Fair and Equitable Taxation says it's hearing about dozens of new cases from people who have just received their assessments for the 2008 tax year.

Taxpayers going bankrupt, losing homes

"I have colleagues at many different companies I've worked at since that have actually lost their homes," McLeod said. "They've gone bankrupt. It's a huge catastrophe — and it's something that the government can easily fix."

Tax lawyer William Cooper thinks Ottawa should allow people to claim their losses against the 'income.' ((CBC))

For example, if an employee bought $100,000 worth of stock for the employee price tag of $25,000 early in 2008, they would be taxed on $75,000 worth of "income" for that year. If the employee held on to their stock, as many do, they would still have to pay tax on the $75,000 — even if the stock's value drops to mere pennies. Employees can defer remitting the tax until they sell the stock or the company is sold, but the tax bill doesn't change.

Thousands of tech-industry employees like McLeod have been hit since 2000.

McLeod bought 10,000 shares in Burnaby, B.C.-based digital-imaging company Creo — with money borrowed against the stock — for $17 each. At the time, the stock was trading at $53. She was assessed income tax on $360,000 — the difference between what she paid and the market value of the shares at that time. She was 27 years old and earning a modest salary of less than six figures.

"On the advice of my financial planner and my accountant, I held on to the shares. And then the market crashed," she said

Ottawa taxed McLeod $100,000 on the stock options, even though by the time the tax was assessed, the shares were worth less than she bought them for. Creo stock didn't recover and McLeod said she didn't make a penny. The company was eventually sold, and McLeod had to use a line of credit to pay the $100,000 bill.

"If I had again gone into the stock option plan with the company I am with now, right before the 2008 crash, I would again be in the exact same situation," McLeod said.

Thousands more potentially hit by downturn

"People just don't want to talk about it, and they certainly don't want to say I owe the government a quarter of a million dollars and I can't pay it," Vancouver tax lawyer William Cooper said.

"Right now there are probably thousands of people under water. And how many know about this tax before they get the bill? Not a lot. I would say very few."

Finance Minister Jim Flaherty indicated Ottawa has no plan to help affected taxpayers.

"The tax laws apply to all of us equally," Flaherty said. "There are some remedies that are available through hardship cases, but the reality is that those stock option situations are not uncommon and apply to a large number of Canadians. So, I can't and I won't hold out any hope of any tax exemptions in respect to that."

When Flaherty mentioned "hardship" cases, he was likely referring to JDS Uniphase employees from Victoria. After lobbying by their MP, Gary Lunn, 35 employees with the optical-equipment company were granted exemptions from paying the tax last year.

Nortel employees are another example, but they haven't received any exemptions. Many are still holding on to stock they bought at the employee rate years ago, when the market value was over $100 per share.

Federal Finance Minister Jim Flaherty says no exemptions will be granted. ((CBC) )

If Nortel's bankruptcy proceedings force the shares to be sold, their huge tax bills on those shares — worth approximately 25 cents each now — will come due. Former Nortel executive Ragui Kamel, an Ontario resident, said he has already paid $300,000 in taxes on stock he sold and could be hit with another bill soon.

"If Nortel collapses, through no action or desire of my own, I will be deemed to have sold the [remaining] shares I still hold in Nortel. That will trigger a tax of over $500,000 — wiping out the bulk of my savings in 30 years of work," Kamel said.

Former Nortel employee contemplates suicide

Another former Nortel manager from Toronto, who was let go in 1999, said he will get hit with a $204,000 tax bill on stock he still owns, which is worth $250.00 now. The man, who didn't want his name used, is 69 years old and said he has seriously contemplated suicide to avoid being forced to sell his house.

"I've been living a nightmare, not sleeping at nights. It's affecting my marriage," he said.

Tax lawyer Cooper said that, in his experience with tax policy makers in Ottawa, the effects of unfair rules are often not taken into consideration.

"Sometimes I think they are just in this bubble. All the technicians are saying, 'Well, this is how the rules work and this is how they are supposed to work and it all fits within the scheme of the Income Tax Act, so what is the problem?' "

"I think that the country needs to pull together and talk to their MPs and voice their opinion and let the government know that this isn't acceptable," McLeod said.

The United States had a similar tax policy until 2008, when the law was changed to essentially fix the problem for American employees who lost money through stock options.

"The fact that we are the only G7 country to do this still is kind of embarrassing. It's pretty archaic," McLeod added.