Just when you may have thought cross-border taxation was getting simpler, the Canada Revenue Agency (CRA) recently put forward Technical Interpretation (CRA Views 2019-0832211I7) to provide further guidance on the concept of sourcing a cross-border employee’s compensation when in receipt of Restricted Stock Unit (RSU) benefits. What the CRA has brought forward is a new methodology of sourcing and is referred to as the “Hybrid Methodology.” They have stated this methodology will be their approach as of the 2021 tax year.
RSUs for domestic and cross-border employees
An RSU is one of the many stock-based and equity participation plans provided to employees. In the case of an RSU, an employee is granted “phantom” units that track the value of the employer’s treasury shares which vest at a set date in the future or are based on some pre-determined criteria. The vesting can be time-based and/or performance-based. An RSU has little or no value until the vesting (restrictions) conditions have been achieved. At the time the RSUs vest, the employee is typically provided with shares and a portion of those shares are withheld to cover the resulting payroll tax. The balance of the shares remaining can be sold or held by the employee.
The above explanation provides an overview for a domestic employee, but what about additional complexity for a cross-border employee?
From a Canadian tax perspective, an additional complexity results when your employee may have been granted RSUs prior to their arrival in Canada or the RSUs vested once the employee was no longer a Canadian tax resident. In these scenarios, there is a need to consider how much RSU income is taxable in Canada. This concept is referred to as “sourcing.” Sourcing is the determination of the amount of a benefit attributable to each of the taxing jurisdictions at the time the RSU was exercised.
The CRA has held different positions over the years but since 2012, the CRA has remained consistent by following the modeling outlined in the Organization for Economic Co-operation and Development (OECD) commentary. Under the OECD commentary, RSU (and other similar benefits) are presumed not to be based on past services of the employee unless there are specific factors which indicate otherwise.
With the above concept, the sourcing of the RSU benefit implies the benefit may be reasonably allocated between each of the various countries based on the number of days between the grant date and the vest date.
CRA guidance for sourcing RSU income
Based on Technical Interpretation (CRA Views 2019-0832211I7), the CRA is looking to change their position on sourcing such that a portion of the taxable benefit related to RSU should be allocated to “past services.”
The CRA guidance has introduced a Hybrid Methodology that should be used for sourcing RSU income for cases related to employment exercised both inside and outside Canada as follows1:
- Separate the in the money (ITM) portion of RSU benefits at the date of grant and the portion of RSU benefits relating to the increase in fair market value (FMV) of the underlying shares from the date of grant to the date of vesting. The ITM portion is typically equal to the FMV of the underlying shares at the date of grant.
- The ITM portion at the date of grant generally pertains to past services and is sourced to the jurisdiction in which the employment services were rendered in the year in which the RSUs were granted (if there are multiple jurisdictions, in proportion to the employment period exercised in each jurisdiction in that year).
- The FMV Portion generally pertains to services rendered during the vesting period and is sourced in proportion to the employment exercised in each jurisdiction between the date of grant and the date of vesting.
The CRA believes it is “important and necessary” to determine where the employment giving rise to the RSU benefits was exercised, and that Canada may give up its rights to taxation under domestic law (under an applicable income tax treaty) if it is determined the benefit does not relate to Canadian employment or that certain thresholds are met. The CRA also makes it clear that the sourcing under the Hybrid Methodology is not impacted by the individual’s Canadian tax residency during the vesting period, but by the jurisdictions where the employee’s duties were performed. However, the taxpayer’s residency position will have a significant impact on how the RSU benefits are ultimately taxed.
When sourcing cross-border RSUs where Canada is involved, it is important to remember that the sourcing is a question of fact where not only the employee’s award agreement should be reviewed but also the entire RSU plan documents. Because the Hybrid Methodology may not align with the sourcing approach used by other taxing jurisdictions, there may be a potential for double taxation and a mismatch of foreign tax credits for your mobile employees connected to Canada. As you can see, this can be a very complicated area. Schedule a call with our team so we can help you further clarify how the CRA's new position on RSUs may impact your employees and mobility program.
1Technical Interpretation CRA Views 2019-0832211I7