Canada Tech Startups Winners as Morneau Backs Off Options Plan

If you buy a stock option, it ends up resulting in a capital gain or loss; either you dispose of the option and directly produce a capital gain or loss, or you exercise the option and it counts towards the book value of the shares you acquire, resulting in a capital gain/loss later.

The tax treatment of incentive stock options is weird, because they don't consider you to "own" the options in question. So instead of getting a capital gain as the stock option gained value, you're considered to be paid the ultimate value of the stock option as "earned" income. People realized this was dumb, so a rule was put in place to "fix" this: Incentive stock options would be 50% tax-exempt, bringing them down to the capital gains tax rate.

The issue at hand here was whether that "fix" should be removed, limited, or left intact. Right now inventive stock options receive the same net tax treatment (via a different route) as purchased stock options; the proposal was to tax employees at a higher rate than investors.

If this proposal had passed, it wouldn't have yielded any significant increase in tax revenues, since there was a simple workaround: Rather than granting stock options to employees, pay them a small bonus and then have them buy the stock options from you. The lawyers would have made plenty of money drawing up the paperwork, but nobody else would have benefited.

[I am neither a tax lawyer nor an accountant. This is not legal or tax advice.]

Even more if they are clever. I'm not sure if they've closed the loophole but you used to be able to max out their TFSA by exercising their options, claiming the share certificates, then putting them into their brokerage account before the Series A is closed. It only costs $500 / year at RBC to do this you / your family just can't ever own 10% of the stock in question and it is completely legal. Then when your $40k of shares grows to $4m after the IPO you have a perpetual tax free investment account.

But these tricks are nothing new. Businesses have all the flexibility in the tax code. The only year I was in the 1% in terms of income I paid an effective tax rate of 12%, and this wasn't because I qualified for the capital gains exemption tax when my business was acquired (the business wasn't was too young, your business needs to be at least 2 years old to qualify).

Investment income should be taxed the same as normal income with one caveat: losses should decrease normal income and should be _after_ inflation. Right now the biggest pushback I hear (that I think is legitimate) to raising the capital gains / dividends rate is about inflation; which makes sense for 4% blue chip bonds, but falls apart on 40% yoy options that are more like deferred income plans than they are investment schemes.

Edit: Downvote me all you want. People disagree with things that challenge situations that are good for them.