MORNEAU MAY DROP TAX HIKE ON OPTIONS,

Part of tax-the-wealthy election platform

Finance Minister Bill Morneau is expected to drop, or at least postpone, his party’s plans for increasing taxes on employee stock option benefits — a move that would prompt a huge sigh of relief in the high- tech community. Industry sources say the more Morneau and his staff examined the issue, the more they became convinced it required further study.

“They hadn’t realized the unintended consequences,” said one industry official recently briefed by Morneau’s staff. Among the potential issues: government tax savings would likely be less than advertised, perhaps considerably so. And the Liberals may also have underestimated the potential benefits of the current tax regime.

On the face of it, the Liberal promise to allow employees to claim a tax deduction on just the first $100,000 worth of stock option benefits fit in well with the party’s tax-the-rich philosophy.

The current rules permit taxpayers to deduct about 50 per cent of their net gains from the exercise and sale of stock options. These can be considerable.

Last year, for instance, employees at Ottawa- based Shopify Inc. — an electronic commerce company — exercised nearly 4.7 million options to buy shares.

Employees paid 34 U. S. cents on average for each share, which were sold at prices ranging from US$17 to US$42.

Shopify founder and CEO Tobias Lutke has maintained that his ability to offer stock options to new employees was key to attracting top talent and creating a worldbeating technology platform.

Raising serious amounts of capital is one of the biggest difficulties faced by Canadian high-tech entrepreneurs, who usually face much better financed rivals, especially in the U.S. This is why substituting portions of annual salaries with stock options helps the Canadians so much in the early years. Hard-working employees are motivated by the hope that their options one day will be worth something. Success stories such as Shopify give shape to that hope.

During the election campaign, the Liberals appeared to focus on a relatively tiny group of very well off Canadians. The party platform noted that some 8,000 Canadians ( out of roughly 27 million taxpayers) deducted an average of $ 400,000 from their incomes in 2014 through stock options.

The Finance Department calculated that this elite cadre accounted for the lion’s share of the $750 million annual cost of the stock option deductions.

The Liberals apparently reckoned that by permitting deductions for stock option gains short of $100,000, they would allow tech startups to continue attracting talent — while at the same time recouping considerable sums in extra taxes from the plus $100,000 club members.

But reforming the stock option rules proved extremely complex. For starters, tech firms that award options are not permitted at the same time to deduct the associated costs on the corporate ledger — this, according to a note published by KPMG, a chartered accountant consultancy.

However, tax rules do allow cash compensation to be deducted from income. The less attractive stock options become, the more likely it would be for companies to pay workers in cash. Depending on how deductions associated with the latter work out, the Liberals might not save anything at all.

Tech executives also pointed out to Morneau’s officials that the Liberal party platform did not appear to include the considerable potential benefits of the current tax regime. Again taking the example of Shopify — the exercise of stock options has recently injected tens of millions of dollars into the economy, much of it in the Ottawa area.

This unexpected gift could lay the base for a fresh round of startups — and, ultimately, thousands more taxpayers.