Year-end best practices: Cross-border compensation for dual taxpayers

Jennifer Lennon (00:05): So you've been told that one of your retiring board members is a U.S. taxpayer, as well as a Canadian taxpayer, and holds DSUs, so what do you need to do to ensure that the director's retirement doesn't trigger any unintended tax consequences? I'm Jennifer Lennon, and I'm joined today by my partner, Ellie Kang from New York to discuss some tips to ensure your directed compensation programs work for dual taxpayers.

So Ellie, what do companies need to keep in mind when they have directors who are both U.S. as well as Canadian taxpayers?

Ellie Kang (00:37): Companies need to remember that while DSUs are a very common form of director compensation in Canada, and they're also used in the U.S. to compensate directors, the tax rules for DSUs are different. This could pose complexity for directors who are both U.S. and Canadian taxpayers. For example, under Canadian rules, directors have the flexibility to elect to redeem their DSUs until the end of the calendar year after the year in which they retire.

But this flexibility is not workable for U.S. taxpayers, generally for U.S. taxpayers. DSUs must be redeemed within 90 days after they retire, or on a fixed payment date or fixed payment schedule. Also, for U.S. taxpayers, retirement must qualify as a separation from service within the meaning of the applicable U.S. tax rules, and a separation from service does not always align with similar payment triggers for Canadian tax purposes.

So, Jen, can you explain what the relevant payment trigger is in Canada?

Jennifer Lennon (01:42): Absolutely. So for Canadian tax purposes, DSUs are generally structured to pay out once a director ceases to hold all positions with the company and its affiliates. Now, in many cases where a director is stepping down from the board, they'll have a good payment trigger for both Canadian and U.S. rules. But there are some situations for companies need to be careful.

For instance, transitioning from a director to a consultant or other advisory role can lead to a situation where DSUs must be paid out under the tax rules of one jurisdiction, but cannot be paid out under the tax rules of the other. Now, a well drafted DSU plan should contemplate these circumstances to ensure the company doesn't have any foot faults.

Often, a DSU plan will provide that there's a forfeiture of DSUs to the extent you don't have a good payment trigger on both sides of the border. So, generally speaking, if you do have a director who's subject to both U.S. and Canadian taxes, you generally want them to have a clean break from the company when they step down from the board.

So Ellie, what are some of the other issues you've seen with director DSU plans?

Ellie Kang (02:50): If properly structured, U.S. taxpayers should not incur income taxes on the DSUs until they are redeemed. This tax deferral feature is similar to how DSUs are taxed in Canada. One difference is that for U.S. taxpayers, Social Security and Medicare taxes are owed on the DSUs when they are vested. This means that for DSUs that are awarded in lieu of the director's cash retainer fees, these taxes would become due for the current year of the awards notwithstanding that the DSUs are not going to be redeemed until the directors retire.

Jennifer Lennon (03:27): So, as you can see, the tax rules relating to DSUs for dual taxpayers are quite complicated, and you want to get it right. In our experience, identifying who among the directors are dual taxpayers and ensuring that the DSU plan is well drafted to contemplate these circumstances are key to avoiding any unintended tax consequences, both in Canada as well as the U.S.

Ellie Kang (03:50): To learn more about positioning your director compensation programs for the 2025 tax season, please do not hesitate to reach out to us.