I received this detailed analysis by email, from “LionSteak”. It explains (with the help of, er, what’s the word… oh, yeah, expertise!) why I believe supporting Joe Wood is the right thing for the Tories to do.

“The definition of income is the issue here. And I don’t know where you shop, but in my grocery store, the register doesn’t have slots for 10’s, 20’s and stock certificates. Because my supermarket won’t accept stocks as payment for a loaf of bread. Therein lies the difference between the way the world defines income, and the way the ESPP tax laws do.

The fact that the government is taxing unrealized investment gains as ordinary income should be alarming to every Canadian who assumes erroneously that no matter how bad taxes are, they can’t possibly demand more money than a person has actually made. Let’s consider the salient issues:

ESPP’s Are A U.S. Employment Benefit With A Canadian Tax Code

Canada adopted a U.S. employment benefit without properly vetting the tax codes relating to it. Since JDSU had offices in both the U.S. and Canada, employees of the same salary were enrolled in the same program within the same company, but the ones on the Canadian side of the border faced a tax liability in the hundreds of thousands of dollars the moment the shares were distributed (a date they had no control over), while the ones on the U.S. side of the border faced no significant tax liability until they realized the value of their shares. Because ESPP’s are designed to allow employees the opportunity to participate in the long-term growth of their companies, the U.S. tax laws encourage a two-year holding period in order to receive the most favorable tax treatment. Like most ordinary investors, the U.S. employee can hold his or her shares indefinitely, and only sell them at the point they determined to be most appropriate to their financial circumstances. Naturally, the U.S. employee would have to record a capital gain or loss when they sell, however the amount of taxes owing would be directly proportionate to the amount they actually gained or lost. What a concept.

ESPP’s Are Not Stock Options

Many people are confusing the ESPP benefit with stock options. They are not the same thing, nor are they being taxed the same way. In the case of stock options, a person actively “exercises” his vested options on a date of their choosing. But ESPP participants purchased their shares on the date of enrollment in the program, generally their date of hire. The shares were set aside for these employees, paid for over time through regular payroll deductions, and distributed over time on a schedule governed by the company. The shares were never available on the open market, and represent no actual income to the employee until they’re sold.

No one is arguing that ESPP’s are a taxable benefit. I’m sure ESPP participants would be delighted to pay taxes on any actual income received from their shares. But if no shares were sold, no income was received. Period. Do we want to give the CCRA the authority to start taxing everyone on the value of their stock portfolios, regardless of whether or not they choose to sell at a particular time? This is precisely why the law as it relates to ESPP’s is fundamentally flawed.

The Political Fight

John McCallum, Minister of National Revenue, asserts that all taxpayers must be treated the same. Apparently, Mr. McCallum fails to understand that no ordinary taxpayer would ever face a tax liability that represents not only the loss of a principal investment, but 85 times that amount due to an ill-considered tax legislation they refuse to sufficiently address.

Additionally, his use of the word “fair” is nothing short of unconscionable. It’s NOT “fair” to tax unrealized investment gains as ordinary income. It’s NOT “fair” to force people into bankruptcy due to unpaid taxes on income that was never received. It’s NOT “fair” to impose a lifetime of debt upon people who have never had so much as an unpaid parking ticket based on “income” that never “came in.” It IS fair for ESPP’s to be treated as a taxable benefit. But the method of taxation must be directly proportionate to what was actually gained or lost. Only that would be fair and consistent with the treatment of other taxpayers.

Someone also used an analogy that ESPP participants received stock through “borrowed money” and have therefore gotten what was coming to them. Hmmm. I wonder what those regular payroll deductions were all about then! It seems they were accidentally borrowing their own money.

This is not a time for political posturing. This is a time for all good men and women to stand up for what’s right.

The “Market Risk”

There are those who opine, “Well, I lost money in the market too. At this point, my stocks are barely worth the paper they’re printed on. If I’m not getting any tax breaks, why should they?”

I’ll tell you why. Because they’re not fighting to be compensated for their stock market losses. They’re fighting tax assessments that equate to more money than they would probably have if they liquidated all assets because stock market gains they never received we recorded on their T4’s as ordinary income.

Yes, countless individuals have been adversely affected by the market downturn over the past several years. To hold stock that is now essentially without value, but was once worth hundreds of thousands of dollars is a crushing blow that many investors are facing. But to be also facing a tax liability as if the near-peak value of those shares was recorded as ordinary income on their earnings statements is a situation unique to ESPP participants.

Since they could have sold and chose not to, they accepted a “market risk” and must pay? It’s an argument that simply defies all logic and reason. JDSU employees are not only loosing their principal investment, they’re loosing their entire financial
solvency because they’re being taxed as if they received the near peak value of unsold shares as income.

Blame The Company Or The Accountants

Who would have thought enrollment in a “company benefit” on a person’s date-of-hire could have imbedded within its poorly vetted tax code the possibility of total financial ruin? Should JDSU have properly informed employees of that risk? Yes, assuming they were fully aware of the ramifications. But the core issue is that the law is grossly flawed. The fact that the company and/or Accountants did not properly inform employees is another example of the extent to which these people have been victimized. However, it’s not relevant to the core issue, which is that legislation exists regarding a “company benefit” that treats unsold stocks as ordinary income. The government is NOT entitled to collect taxes on income that never even existed in the economy.

Relief Is Long Overdue

These people have been fighting this issue for over four years, and I strongly applaud their courage. For them, relief is long overdue. For those who paid? They shouldn’t have. They should have joined the fight, because not doing so makes them complicit in this gross miscarriage of fairness and I truly believe it’s too late for them. But relief is long overdue for those people who have put their lives on hold to “fight the big fight” in the name of all “ordinary” people who care about preserving the right to protect themselves against big government and big corporations screwing them over. If the government doesn’t want to change the tax laws as they relate to ESPP’s because it would open a Pandora’s box of similar laims, then give these people the relief they so richly deserve and discontinue ESPP’s altogether from this point forward.”

Q.E.D.