The comparison suggests that the personal tax regime may have been one of the factors which impacted the desire to receive backdated options in lieu of other forms of compensation in Canada but not so in the United States. Prior to 2003, the long-term capital gains rate was generally 20%. The practice of backdating executive stock options has received significant attention in the U. financial and legal literature, and has recently begun to be discussed in the Canadian legal literature. Backdating, in its most basic form, is the use of hindsight to selectively pick a local low point in a stock’s trading price and issue executive stock options stipulating the selected date as the grant date when, in fact, the options are granted at a later date. In 2003, the rate was reduced to 5% for individuals in the lowest two income brackets and 15% for all others. (ii) Interest.—For purposes of clause (i), the interest determined under this clause for any taxable year is the amount of interest at the underpayment rate plus 1 percentage point on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is not subject to a substantial risk of forfeiture. Neither § 409A nor the final regulations issued to date under the statute specify the amount included in income (and the basis for the additional tax). The first example assumes that the individual exercises the options and sells the resulting shares on the same date, which is a common occurrence. The sale price of the shares on the date of exercise is .77. However, the proposed regulations indicate that the amount to be included is the intrinsic value of the option on the last day of the employee’s taxation year in which the option vests and any subsequent year in which a vested option remains unexercised, and, in the year of exercise, the actual value on the exercise date. The income inclusion and penalty tax apply regardless of when (or if) the options are ultimately exercised. In effect, § 409A provides for income inclusion (and a corresponding penalty tax) in each year following the year in which an option vests, and until and including the year of exercise, depending on the value of the underlying shares on December 31 (or the date that the options are exercised in) of the subsequent year. Based on the above discussion, the most preferential compensation regime from an executive’s tax perspective in either Canada or the United States is one in which the options are granted not-in-the-money (or for our purposes, backdated to appear as such). To demonstrate the tax consequences of backdated options in each country, consider the following example. Table 1 summarizes the tax consequences of this example in Canada and the United States.  The AMT is a tax designed to ensure that no taxpayer—whether individual or corporate—may disproportionally benefit from certain tax preferences.
In particular, the relevant personal income tax rules in the two countries are compared and contrasted to demonstrate the role these rules may play in determining the demand for backdated options in the two countries. As will be shown, this is potentially an important component in the decision of executives to accept backdated stock options and may provide an additional incentive for executives to demand them in Canada.
This paper contrasts the post-tax returns of backdated at-the-money options to currently-dated in-the-money options (with the same strike price as the backdated options) and demonstrates that a Canadian executive can earn a significantly larger after-tax return from backdated options compared to a US executive.
We tie this to the favorable Canadian tax treatment of executive options relative to their treatment in the United States.
Because the backdated options’ strike price is lower than the market price on the actual grant date, the recipient has received something of greater monetary value (even if the options have not yet vested) than a correctly dated at-the-money option. Companies could reward executives with cash compensation or additional properly dated and priced incentive awards, including options, rather than engage in dubious backdating practices. It is clear that there must be reasons other than greed that have led so many to backdate executive options. Academics, regulators, and practitioners alike have tried to gain a better understanding of these incentives and the roles they have played in the backdating scandal; however, there is as of yet no consensus regarding the causes of backdating. This is problematic because policy, legislative, or regulatory changes are unlikely to be effective if the root causes are unknown. In 2008, the long-term capital gain rate for individuals in the lowest two tax brackets (currently 5% and 15%) was further reduced to zero.
Untangling the causes of backdating will remain elusive unless each factor is considered in detail using evidence from different regimes. III 2009) (allowing carry forward for a credit for the prior year’s minimum tax liability that resulted from certain timing differences). D (illustrating in Example 4 the effect of AMT); see generally Francine J. 337 (2002) (providing a detailed discussion of the AMT and its application to ISOs). These reduced rates are currently effective until the end of 2012. 111-312, 124 Stat 3296 (extending reduced rates from the end of 2010 until the end of 2012).