In today's business world, skilled labour is becoming scarce and it is common for an employee to change jobs several times over the course of his career. As a result, it can be difficult for business owners to build a team that is committed to the business for the long term and to retain potential successors within the business. The agri-food industry is no exception to this reality.
In this context, the implementation of an incentive plan for key employees of a business is a cornerstone in retaining these highly skilled employees. Indeed, such a plan may help in achieving following objectives:
- retain specific employees;
- promote the recruitment of skilled workers in a competitive environment;
- increase the employees’ sense of belonging to the business in order to achieve a common objective; and
- align the employee’s financial interests with the business’ performance.
To that end, there are many incentive plans available to business owners. This article briefly examines the characteristics of frequently used incentive plans[1], which plans are divided in two main categories:
- Bonus-type incentive plans, and
- Quasi-equity or equity incentive plans
Each incentive plan has its pros and cons, depending on the objectives pursued by the business owner. One important aspect to consider in the implementation of an incentive plan is the tax impact this plan will have on both the corporation and the employees covered by the plan. In fact, an incentive plan favourable tax-wise for the employees may constitute an additional incentive for the retention of such employees. We have thus outlined, for each plan summarized below, the tax benefits (or negative impact) of such plan for the employee and the corporation.
Bonus-type Incentive Plans
A bonus-type incentive plan (for example, a bonus payable annually based on certain individual or common objectives to be met or a phantom stock plan[2]) does not involve any change in the shareholding of the corporation and does not grant the employees any additional rights with respect to the corporation.
On the tax side, the employee will be taxed on this bonus as employment income, i.e. at a marginal tax rate of 53.31% (2019), and the corporation will be able to deduct the bonus from its income. However, the use of a bonus-type plan where the payment of the bonus (and the resulting tax) is deferred at a later date (for example, if we wish to allow the employee to receive the bonus only once he needs it financially or if for retention purposes, the bonus is payable following the achievement of some goals over a period of time) has its limits. In such a case, the taxation of such a bonus earned cannot be deferred for a period longer than 3 years. However, if specific conditions are met, this time limit will not apply to a phantom stock plan.
Quasi-equity or Equity Incentive Plans
A quasi-equity incentive plan (for example, a stock option plan) or an equity incentive plan (for example, a restricted stock plan) is a solution halfway between a bonus and a direct and unconditional holding of equity by employees in the corporation.
Stock Option Plan
The grant of stock options in favour of an employee allows him to have shares of the corporation issued in his favour at a preset price and at a predetermined time. The employee may exercise these options at a price equal to the fair market value of the underlying shares at the time the option is granted or at a discount. The option may be exercisable only upon the occurrence of a liquidity event (for example, the sale of the corporation's shares or assets) or upon the achievement of certain specific quantitative objectives (for example, the passing of a period of time or the corporation reaching a specific profit amount). This plan does not involve any change in the shareholding of the corporation and does not grant the employees any additional rights with respect to the corporation at the time of the grant of the options in their favour.
On the tax side, the grant of options has no tax impact for the employee or the corporation. The exercise of the option by the employee will trigger a taxable benefit for him equal to the difference between the exercise price paid by the employee and the fair market value of the shares at the time of the option is exercised but the inclusion of such benefit in his revenue will be deferred until the employee sells the shares. This benefit will be taxable for the employee as employment income, i.e. at a marginal tax rate of 53.31% (2019). However, if certain conditions are met, the employee will be able to benefit from a deduction which could lower the taxation of the taxable benefit to the same level as the taxation of a capital gain (i.e. 26.65%)[3]. In certain specific circumstances, the employer will be able to deduct the cost of such a plan from its income but in this event, the employee will not have access to his own deduction. Indeed, the employer will have to renounce to its own deduction in order to allow the employee to benefit from his.
Following the exercise of an option by an employee, the increase in value of the shares thus held by the employee between the exercise of his option and the sale of such shares will be taxable to the employee as a capital gain, i.e. at an effective marginal tax rate of 26.65% (2019).
Restricted Stock Plan
In the case of a restricted stock plan, the corporation’s shares are issued to the employee upon implementation of the incentive plan but are subject to restrictions on the increase in value of the shares, voting rights and dividend rights. As in the case of options, the restrictions may be lifted upon the achievement of certain specific quantitative objectives (for example, the passing of a period of time or the realisation by the corporation of a certain level of profit). The employee may acquire these shares at their fair market value or at a discount. It is also possible for the employee to pay for these shares by renouncing to portion of his salary. This plan involves a change in the shareholding of the corporation since the shares of the corporation are issued to the employee from the outset. Employees will therefore have the right, for example, to review the corporation’s financial statements but in this context, it will also be possible for the corporation to tighten the non-competition and non‑solicitation obligations of such employee shareholders.
On the tax side, the issuance of the shares in favour of the employee has no tax impact for the employee, the taxation (if any) being deferred to the time of the sale of the shares by the employee. If the shares were issued to the employee for a price equal to their fair market value, the increase in value of the shares between the time of issuance of the shares and the time of their sale will be taxable to the employee as a capital gain, i.e. at an effective marginal tax rate of 26.65% (2019). However, if the shares were issued to the employee at a discount, the difference between the fair market value of the shares at the time of their issuance and the discounted value actually paid by the employee will be taxable to the employee as employment income, i.e. at a marginal tax rate of 53.31% (2019) while the increase in value of the shares will be taxable to the employee as a capital gain. As in the case of options, the employee will be able to benefit from a deduction which can lower the taxation of this taxable benefit to the same level as the capital gain (i.e. 26.65%) if certain conditions are met.
Finally, in the context of a stock option plan and of a restrictive stock plan, it is advisable to have an agreement signed between the corporation and the employee to govern, among other things, the share holding (once the shares are issued) as well as the rules relating to the transfer of the shares.
The incentive plans presented above are examples frequently used by Quebec businesses, but there are a multitude of them that can be adjusted according to the specific needs and objectives of an agribusiness.
The BCF team can advise you on the best strategy to adopt to retain your key employees and plan your succession.
[1] In the context of a Canadian-controlled private corporation.
[2] A phantom stock plan is a plan that allows an employee to receive a bonus based on the variation in value of the corporation's shares, although he is not a shareholder.
[3] It should be noted that in the March 19, 2019 federal budget, the Minister of Finance announced that amendments would be made to the taxation of stock plans to limit the deduction that can be claimed by an employee benefitting from such a plan. The details of these amendments are expected before summer 2019.
