The article “How To Calculate Capital Gains Tax For An Employee Share Purchase Plan” was originally published on MoneySense on January 29, 2019.
Kelly is confused about how to calculate the capital gains tax on her company savings plan shares.
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?
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.
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?
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.
As you mentioned, Kelly, the matching contributions from your employer are taxable each year on your Canadian tax return and get added to your income on your T4 slip. It’s basically as if your employer gave you a bonus and you invested it directly into company shares. Unfortunately, the tax you paid does not get added to your acquisition cost on the shares. Only the actual cost of the shares is considered when calculating your adjusted cost base and capital gain.
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.
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.