NO CHANGE TO STOCK OPTION TAX REGULATIONS IN CANADA

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1 EXECUTIVE BRIEFING CANADA Your executive compensation resource March, 2016 Issue 2 NO CHANGE TO STOCK OPTION TAX REGULATIONS IN CANADA FEDERAL BUDGET MARCH 22, 2016 No change. Despite pledging to change The Liberal government proposed the stock option tax regulations during to limit the amount that could the election campaign, the new federal be claimed by an individual government did not include any such through stock option deductions changes in its first federal budget by increasing taxes on employee released on March 22, stock option benefits in excess of From the Liberal Fiscal Plan and Costing released in 2015, the Liberal campaign platform stated: A starting point would be to set a cap on how much can be claimed through the stock option deduction. $100,000 annually. Under the initial proposal, taxes on stock option gains above $100,000 could, theoretically, increase up to the point where they are taxed at the same rate as regular income. As a result of the withdrawal, employees who exercise stock deduction of as much as 50 percent of the benefit, without any cap. % % 50% options can continue to claim a 75% Highlights Withdrawal of proposed tax changes Other incentive vehicles Better compensation mix

2 SHOULD COMPANIES CONSIDER OTHER INCENTIVE VEHICLES IN ADDITION TO STOCK OPTIONS? Yes. Tax should not impact the pay mix in terms of doing what is right for the organization. Regardless of the proposed stock option tax changes, Compensation Committees and companies should always review the mix of pay. This includes In theory, a company can achieve due to their leveraged nature, a balanced incentive program by long time horizon, and singular aligning executive compensation focus on share price. Even if stock with the specific risk and time options may become taxed at horizon through calibration of the a higher rate going forward, mix of incentive vehicles. Among under certain circumstances S&P/TSX60 companies, about they can still provide large 75% have a combination of stock payouts relative to Restricted options and other share based Share Units (RSUs) and program for their NEOs. How Performance Share Units (PSUs) companies evaluate their use of if share price increases stock options will depend on their significantly. individual circumstances: Companies in the start-up Companies that are concerned with share dilution and do different incentive vehicles and phase will likely continue to use not consider stock options as the role of performance within stock options. They are useful a key part of their compensation that mix. At various executive for fostering an entrepreneurial program may consider levels, the pay mix should suit environment and attracting changing their program and the organization s business talent with the potential of reducing or eliminating the objectives and circumstances. large payouts aligned with use of options. Incentive plans can be broadly classified into short term incentive (STI), medium term incentive (MTI), and long term incentive (LTI) with each of them rapid company growth. These companies are typically under financial constraints that make stock plans attractive. Some companies consider stock In Canada, almost all MTI programs are designed with a 3-year performance period under the Salary Deferral Arrangement (SDA) rules and we suspect the federal focusing on a particular time options to be a key part of their government s original proposal horizon (i.e., 1 year or less for compensation program, and will would likely have encouraged STI, 1-3 years for MTI and up likely continue to rely on them an earlier exercise of options. to 10 years for stock options). Tax changes to stock options 2

3 IS THERE A BETTER COMPENSATION PLAN MIX FOR INCENTIVIZING LONG TERM RESULTS? It depends. The alignment of business strategy with compensation philosophy should be the starting point. A better mix depends on individual company circumstances. Due to their cash flow position, stock options would still remain the main compensation tool among start-ups, as mentioned previously. For other more mature companies, Compensation Committees and management need to critically evaluate the objectives of the incentive compensation program, striking a balance between performance, risk alignment and retention needs. A more fundamental question that Compensation Committees and management need to ask themselves is, how long is long term? In addition to the mix of incentive vehicles, Compensation Committees also need to consider related governance policies to arrive at a better solution for risk management; for example, should there be more post-vest or post-exercise holding requirements and/or clawbacks? For companies considering reducing the proportion of stock options used or eliminating them entirely, PSUs may be a viable option. PSUs are a popular replacement for stock options as their payout value can be leveraged on specific performance metrics (e.g. Relative Total Shareholder Return), which can still drive management s focus on intended performance appropriately. As well, PSUs with a mix of metrics (e.g. relative vs. absolute; market based vs. internal) can drive balanced performance! Authors: Christopher A. Chen christopher.chen@haygroup.com T Kennedy Lee kennedy.lee@haygroup.com T Tax changes to stock options 3

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