Canada startup employee equity taxes for stock taken in lieu of a salary?

Question

I am an early employee at a startup, and I took a large equity stake in-lieu of salary.

I expect that Canada Revenue Agency taxes this as income when the shares are sold. So in the year the company is sold for a $Bn ;-) I will owe 40% income tax on the value of these shares when they were granted and capital gains on the profit — less a whole bunch of startup-friendly capital gains exemptions.

My concern is what if the company doesn't make it but is still sold? Imagine if instead of bankruptcy it is sold for $1, e.g. for the value of the IP minus debts.

When the shares vested, they were nominally worth $1M (at the rate we were then raising money) — would I still have a tax bill on this value i.e. $400K — but no actual money?

Canada Revenue Agency's phone help line seems only to deal with filing actual returns, not 'what if' questions.

I know the answer is always ask a lawyer / accountant / ninja, but I wondered if anyone had any suggestions where to look for answers?

Answer 1

I'm not a tax expert but my understanding is:

1. The current value of the shares is considered to be income on the day you receive them and will be taxed as income.
2. The difference between that value and the price you sell them for is considered capital gains, and you will pay tax on the day you sell them. I believe there may be ways to pay that tax early (and thus spread it between years).
3. If you sell them for less than their market value when you received them, then that is considered to be a capital loss. You won't pay additional tax, but you also don't get back any tax you paid in 1 above. If you have other capital gains you can offset that loss against them, but not against income.

So yes, you still owe the $400K tax and you don't get anything back. I actually had this happen to me on a much smaller scale, with a grant of shares that then went down.

However you absolutely should get a professional tax accountant involved. Don't assume there isn't a way round this. There wasn't one I knew, and the few hundred dollars I lost wasn't worth getting an accountant involved, but for $400K it's definitely worth asking.