The Price of Not Reporting Stock Options

“A taxpayer is required to include the proper amount in income even if no slip has been issued..”

A recent tax court case is a warning to taxpayers who assume that, if their employer does not issue a slip, the related income need not be reported. Forty-six Pfizer Canada employees exercised stock options from 1993 to 1997. Twenty-three of them did not report the benefits related to the exercise of their stock options in their tax returns. The stock options that were exercised were options to acquire shares of Pfizer U.S.A., not Pfizer Canada. For reasons of confidentiality, U.S.-based employees of Pfizer dealt with the stock options. However, Canadian-based employees processed the T4 (employment income) slips. Consequently, no T4 slips were issued in respect of the stock option benefits even though they were taxable in Canada.

The CRA discovered that the 23 individuals did not report their stock option benefits when their employer, Pfizer Canada, was audited.

The CRA attempted to open the individuals’ statute-barred years, pursuant to subsection 152(4) of the Income Tax Act, and also applied gross negligence penalties under subsection 163(2).

The taxpayers argued that because no stock option benefit was included on the T4, they believed that they did not have to include any amounts in income. They also claimed that section 7, which deals with stock option benefits, was a complicated provision and it would be unfair to penalize them for gross negligence because they did not understand the technicalities of that section. The taxpayers also argued that they did not intentionally omit the unreported income.

Unfortunately, the Court was provided with written evidence that all of the employees were told to consult a tax advisor to determine the implications of the stock option exercise and sale. The Court was not impressed with the other arguments and allowed the CRA to open the statute-barred years and to apply penalties under subsection 163(2).

The lesson to be learned is that each taxpayer is responsible for correctly reporting his/her income. Relying on the employer corporation to calculate their income does not absolve an individual from reporting income correctly. Moreover, taxpayers at a certain level of sophistication are expected to consult tax professionals. Not doing so can result in the application of penalties, as was the case here.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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Cadesky Tax