Strategies for Executive Compensation: Design and Tax Issues for a ...

Strategies for 

Executive Compensation: 

Design and Tax Issues for 

a Turbulent Environment 

Tuesday, April 10, 2012 

MONTRÉAL OTTAWA TORONTO CALGARY VANCOUVER NEW YORK CHICAGO LONDON BAHRAIN AL-KHOBAR* BEIJING SHANGHAI* blakes.com 

*Associated Office 

Blake,Cassels & Graydon LLP

SEMINAR INDEX 

TAB 

STRATEGIES FOR EXECUTIVE COMPENSATION: 

DESIGN AND TAX ISSUES FOR A TURBULENT ENVIRONMENT 

TUESDAY, APRIL 10, 2012 

1. WELCOME LETTER 

2. AGENDA 

3. INCENTIVE AND STOCK COMPENSATION ARRANGEMENTS FOR 

PRIVATE EQUITY TRANSACTIONS 

ELIZABETH BOYD AND JEREMY FORGIE 

4. INCENTIVE COMPENSATION ISSUES IN CORPORATE TRANSACTIONS 

DAVID CRAWFORD AND BILL SUTHERLAND 

5. LONG TERM INCENTIVE PLAN CLAWBACKS: DESIGN, TAX AND OTHER 

LEGAL ISSUES 

KATHRYN BUSH 

6. UPDATE ON CANADA REVENUE AGENCY POSITIONS ON LONG TERM 

INCENTIVE PLAN CONVERSIONS AND CROSS BORDER CASH BASED 

INCENTIVE PLANS 

ELIZABETH BOYD 

7. TOWER WATSON PROFILES 

DAVID CRAWFORD 

BILL SUTHERLAND

April 10, 2012 

Strategies for Executive Compensation: Design and Tax Issues for a Turbulent 

Environment 

As hosts, we welcome you to today's session. 

This morning you will be hearing Speakers from the Blakes Pensions, Benefits and Executive 

Compensation Group and the Towers Watson Executive Compensation Group review and 

consider various issues relating to the design and taxation of executive compensation 

arrangements, with a particular focus on private equity and mergers and acquisition 

transactions. 

We are particularly pleased to be joined for this morning’s session by David Crawford and 

Bill Sutherland of Towers Watson. 

Each of the presentations, as well as additional related materials, is available electronically by 

visiting http:///www.blakes.com/StrategiesforCompensation. 

Profiles of the Blakes presenters and other lawyers in the Blakes Pensions, Benefits and 

Executive Compensation Group are available on our website at www.blakes.com. For your 

convenience profiles for David Crawford and Bill Sutherland are included in our booklet. 

This morning’s presenters will be available during breakfast and at the end of the session to 

meet with you. 

Thank you for taking the time to join us this morning. Enjoy the seminar.

SEMINAR AGENDA 

7:30 - 8:00 A.M. BREAKFAST 

INTRODUCTION 

8:05 - 8:40 A.M. INCENTIVE AND STOCK COMPENSATION ARRANGEMENTS 

FOR PRIVATE EQUITY TRANSACTIONS 

ELIZABETH BOYD AND JEREMY FORGIE 

8:40 - 9:15 A.M. INCENTIVE COMPENSATION ISSUES IN CORPORATE 

TRANSACTIONS 

DAVID CRAWFORD AND BILL SUTHERLAND 

9:15 - 9:35 A.M. LONG TERM INCENTIVE PLAN CLAWBACKS: DESIGN, TAX 

AND OTHER LEGAL ISSUES 

KATHRYN BUSH 

9:35 - 9:50 A.M. UPDATE ON CANADA REVENUE AGENCY POSITIONS ON 

LONG TERM INCENTIVE PLAN CONVERSIONS AND CROSS 

BORDER CASH BASED INCENTIVE PLANS 

ELIZABETH BOYD 

9:50 - 10:00 A.M. Q & A AND CLOSING REMARKS

Incentive And Stock 

Compensation Arrangements For 

Private Equity Transactions 

Presented by: 

Elizabeth Boyd 

Jeremy Forgie 

April 10, 2012 

Overview of Presentation 

• Types of Private Equity Transactions 

• Corporate Governance Considerations 

• Participation of Target/Portfolio Company 

Management 

• Exit Strategies and Investment Horizons 

• Key Design Considerations and Commonly 

Used Incentive Arrangements 

2 

Overview of Presentation (cont’d) 

• Stock Options – Rules for Canadian-Controlled 

Private Corporations and Ordinary Stock Option 

Rules 

• Share purchase loans 

• Cash Based Long Term Incentive Plans and the 

SDA Rules 

• Non-Portfolio Company Incentives 

• Focus on employee-level tax issues – corporate 

tax considerations may also affect compensation 

design 

3 

1

Types of Private Equity 

Transactions 

• The structure of the transaction and 

objectives of the principal investors will 

have a significant impact on design of 

incentive compensation arrangements – 

resulting in differences from public 

company equity and incentive 

compensation arrangements 

4 


Transactions (cont’d) 

• Most common are leveraged buyouts of 

target (or portfolio company), often with 

the participation of management 

• Transaction may be structured as a takeover 

bid, court-approved plan of 

arrangement, amalgamation or sometimes 

as an asset sale 

5 



• In some cases, a private equity fund or 

firm will take a minority equity position in 

the portfolio company or invest in debt of 

the company with the possibility of taking a 

longer-term equity stake 

Sources: Getting the Deal Through: Private Equity 2011, David I. 

Walker, Executive Pay Lessons from Private Equity, Boston Law 

Review May 2011 (survey of 144 U.S. portfolio companies) and 

September 2011 Blakes Study Recent Developments in Canadian 

Private Equity and Private Equity: 2012 Trends 

6 

2



• After initial investment by private equity 

fund or firm in portfolio company, there will 

often be “follow-on” investment that is 

intended to raise further capital to facilitate 

additional growth of the portfolio 

company’s business 

7 



• The private equity fund will also often 

recapitalize the business of the portfolio 

company by re-leveraging and taking out 

invested funds - those funds can then be 

distributed to investors in the private equity fund, 

deployed by the fund to make new investments 

or even redirected to other portfolio companies 

in which the private equity fund invests 

8 

Corporate Governance 

Considerations 

• Private equity fund or manager will often 

prefer to be the majority shareholder so 

that it retains ultimate decision-making 

power over the portfolio company 

9 

3

Corporate Governance 

Considerations (cont’d) 

• Where there are minority shareholders 

(including management and other institutional 

investors) following the transaction, the 

shareholders’ agreement will typically dictate the 

manner in which the target company is 

governed, including any negotiated veto rights 

for minority shareholders and special liquidity 

events for shareholders including management 

10 

Participation of Target/Portfolio 

Company Management 

• A private equity fund will often regard 

management of the portfolio company as 

being critical; for example, where the 

portfolio company is in an industry that is 

not familiar to the private equity fund or 

where the portfolio company’s existing 

management team was a significant factor 

in the attractiveness of the investment 

11 


Company Management (cont’d) 

• From the perspective of the private equity 

fund and other investors, the objective will 

often be to emphasize retention and 

improvement in the portfolio company’s 

business and downplay compensation tied 

to the closing of the transaction 

12 

4



• Often there will be employment contracts 

with key management and target financial 

performance hurdles that may be 

incorporated into equity and other 

incentive compensation arrangements 

13 



• Bearing in mind (particularly in a take-over bid) 

disclosure requirements relating to proposed 

management incentive compensation 

arrangements, it is quite common for there to be 

negotiation between members of key 

management and the private equity fund of 

different (and, in some cases, enhanced) salary, 

bonus and incentive compensation 

arrangements compared to what existed when 

the company was still a public company 

14 

Exit Strategies and 

Investment Horizons 

• Due to the additional debt that is incurred 

by the portfolio company, leveraged 

buyouts can present greater potential risk 

to equity investors 

15 

5


Investment Horizons (cont’d) 

• The private equity firm or fund will usually 

develop a strategy that is intended to 

result in adding value to the portfolio 

company’s business with the objective of 

realizing on its investment in the portfolio 

company as soon as is practical 

16 



• The mechanism for realization (i.e., the 

exit strategy) may be a private sale or 

initial public offering together with 

subsequent secondary offerings 

17 



• The time horizon for a liquidity event or 

exit can vary significantly – for example, 

the private equity fund may have a longterm 

investment strategy with the objective 

of recouping its investment along with a 

return 

18 

6



• On the other hand, there could be other 

factors which make a faster exit attractive 

including opportunistic events such as a 

particular buyer (or type of buyer) 

becoming interested in the portfolio 

company due to a variety of different 

factors including tax, regulatory or 

competition law considerations 

19 



• Portfolio company shareholder agreements 

often contain provisions dealing with anticipated 

liquidity events such as merger, sale to another 

corporation or initial public offering and, where 

there is an initial public offering, ensuring that 

shareholders, including management, have 

freely trading shares in the event of an IPO 

20 

Key Design Considerations and Commonly Used 

Incentive Compensation Arrangements 

• Plan governance – compared to public 

companies (board reacting to 

management proposals), in many cases, 

compensation decisions such as approval 

of management contracts, equity grants 

and other incentive compensation plans 

require only approval of principal investors 

21 

7


Incentive Compensation Arrangements (cont’d) 

• Performance objectives – because of significant 

leveraging, promoting cash flow and debt 

service are often important objectives which 

impact on plan design – incentive compensation 

plans may be designed, for example, to reward 

management’s contribution to control of 

discretionary costs, improving productivity, 

strategic repositioning and growth of the 

business that exceeds the rate of return 

assumed by the principal investors 

22 



• Importance of equity-based incentives – 

studies noted above suggest that for 

portfolio companies: 

– equity-based incentives for key management 

often represent 65% to 70% of total 

compensation opportunity 

23 



– providing a piece of the total appreciation in value of 

the portfolio company is a main driver as opposed to 

competitive equity grants 

– relatively large up-front equity grants for key 

management – most often in the form of stock 

options, a portion of which may be subject to timebased 

vesting and a portion subject to performancebased 

vesting, including measures such as EBITDA 

and internal rate of return (IRR) 

24 

8



– expectation that key management (e.g., CEO) 

will make a significant personal equity 

investment in the portfolio company at the 

outset and investment in the company 

following the liquidity event 

25 



• Equity grants will often be reserved for key 

management and principal investors may 

be reluctant to authorize increase in 

available option or equity pool – provision 

in original pool for additional grants to 

employees promoted into key 

management roles and new hires 

26 



• Equity grants may not be available for 

management beneath the top “key 

management” tier, in which case, cash-based 

long-term incentive plans can be important, 

including appreciation rights, cash-settled 

restricted share units (RSUs), cash-settled 

performance share units (PSUs) and sometimes 

even cash-settled deferred share units (DSUs) 

which incorporate vesting provisions 

27 

9



• Private equity fund often wants to limit ability of 

portfolio company executives to liquidate their 

equity holdings prior to an IPO or other defined 

liquidity event. Sometimes, there will be an 

exception for shares already acquired by the 

executive as opposed to outstanding stock 

options or in some cases for certain narrowly 

defined events (e.g., death or disability). 

28 

Stock Options – Rules for Canadian-Controlled 

Private Corporations and Ordinary Stock 

Option Rules 

• Employee stock options and other equity 

awards granted by a Canadian-controlled 

corporation (CCPC) have preferential 

Canadian income tax treatment: 

- taxable employment benefit arises when shares 

are disposed of (subsection 7(1.1) of Income Tax 

Act (Canada) (ITA)) – the exercise of the stock 

option or the issuance of shares under a stock 

bonus or share-settled restricted share unit is not a 

taxable event 

29 



Option Rules (cont’d) 

– the employee may claim a 50% deduction 

(paragraph 110(1)(d.1)) against the taxable 

employment benefit (e.g., in-the-money 

amount when the option was exercised or in 

the case of a stock bonus, the fair market 

value of the share at the time it was issued) 

provided: 

30 

10




• the employee does not dispose of the share (other 

than because of death) or exchange the share 

within 2 years of the date the employee acquired 

the share 

• the employee has not claimed the regular stock 

option deduction under paragraph 110(1)(d) 

• Alternatively, employee may be able to claim the 

50% deduction under paragraph 110(1)(d) that 

is also available for “ordinary” non-CCPC 

options 

31 




• Unlike with publicly traded companies subject to 

stock exchange rules, there is no requirement 

that private company options be issued at fair 

market value provided that when shares are 

issued they are “fully paid” in cash, past services 

or a combination 

• “Fully paid” requirement can be an issue with 

stock bonuses or immediately exercisable 

discounted options for new employees or 

employees of a new entity 

32 




• For some CCPCs, employee may be able to 

claim capital gains exemption for “qualified small 

business corporation shares” (sections 110.6(1) 

and 110.6(2.1)) although this is subject to 

various restrictions where the taxpayer has 

cumulative net investment losses (CNIL) and 

allowable investment business losses (ABIL) 

and claiming the deduction may trigger 

alternative minimum tax (AMT) 

33 

11




• The determination of whether the portfolio 

company is a CCPC is not always 

straightforward 

• A CCPC is a Canadian corporation (generally a 

corporation resident in Canada constituted 

under the laws of Canada or a province) that is 

not controlled by a publicly listed corporation or 

by one or more non-residents 

34 




• In determining CCPC status “control” in the 

ordinary sense is not required – where the 

shares of a corporation are widely held by nonresidents 

and/or publicly listed corporations such 

that none of those shareholders controls the 

corporation, the corporation will not be a CCPC 

if it would be controlled by one person if that 

person owned all of the shares held by such 

non-residents and publicly listed corporations 

35 




• By “ordinary stock options,” we refer to an agreement by 

a particular corporation that is not a CCPC (or mutual 

fund trust) to sell or issue its shares (or trust units) to an 

employee or an employee of a corporation (or mutual 

fund trust) with which the particular company does not 

deal at arm’s length 

• General stock option tax treatment: (i) no tax on grant; 

(ii) tax on benefit arising on exercise; (iii) benefit equals 

excess of fair market value of shares acquired under the 

option over the exercise price (i.e., the in-the-money 

amount) 

36 

12




• Employee can claim a 50% deduction under 

paragraph 110(1)(d) against the taxable benefit arising 

on the exercise of the options if the following conditions 

are met: 

– the exercise price is at least equal to the fair market value of the 

shares at the time the options were granted 

– the employee deals at arm’s length with the corporation granting 

the option and the employee’s employer (if different from the 

grantor of the option) 

– the shares are “prescribed shares” under Regulation 6204 

37 




– paragraph 110(1)(d) deduction can apply to ordinary options or 

to CCPC options where deduction under paragraph 110(1)(d.1) 

does not apply 

– threshold question – is there an agreement to sell or issue 

shares of the employer or a corporation with which the employer 

does not deal at arm’s length 

– query whether there is such an agreement where option 

provides that it can only be exercised on a liquidity event and will 

be automatically cashed out 

– fair market value exercise price can also be a challenge to 

establish in a private company context – “fair market value” is not 

a defined term under the ITA and CRA generally does not 

provide rulings on valuation issues 

38 




• Arm’s-length requirement – generally, 

employees, including senior management, 

are considered at arm’s length from their 

employer but where management is part 

of control group, arm’s-length requirement 

for paragraph 110(1)(d) deduction would 

not be met 

39 

13




• Prescribed shares under Regulation 6204 

– where dividends or liquidation entitlements are limited 

to a maximum or fixed at a minimum, shares will not 

be prescribed shares 

– where shares can be reacquired by issuer or person 

with whom the issuer does not deal at arm’s length, 

this may preclude shares being prescribed shares 

– conversion rights can also be problematic 

40 




– some exceptions to repurchase restrictions if price 

does not exceed fair market value and/or to provide a 

market or protect employee from loss 

– relevant dividend, liquidity and repurchase provisions 

can be in share terms or under an agreement in 

respect of a share or its issue, which could include 

shareholders agreement, credit agreement, etc. 

– prescribed share test is at time shares are issued (or 

would have been issued in the case of a cash-out) 

41 




– paragraph 110(1)(d) deduction will not be available on 

an option cash-out unless company that granted 

option files election under subsection 110(1.1) to 

forego any deduction of cash-out amount 

• subsection 110(1.1) election is made on employee’s T4 

for the year in which the option is cashed out 

• where options cashed out on exit event, purchaser will 

control company at time T4s are prepared 

• commitment from purchaser to cause election to be 

made can be included in purchase agreement but 

employees may not be parties 

42 

14

Share Purchase Loans 

• Management investment can be facilitated 

through a share purchase loan, as loans 

generally not included in income unless forgiven 

• Where employee is a shareholder, need to 

consider shareholder loan tax rules, in particular, 

subsections 15(2) and 15(2.4), as well as 

section 80.4 which provides for a taxable benefit 

where employee receives a low interest or 

interest-free loan as a consequence of his/her 

office or employment 

43 

Share Purchase Loans (cont’d) 

• Under s. 5(2), the amount of a loan 

received by a shareholder of a corporation 

from the corporation, a related corporation 

or a partnership of which the corporation 

or related corporation is a member, is 

included in the shareholder’s income for 

the year in which the loan was received, 

subject to certain exceptions: 

44 


• S.15(2.4) provides that s.15(2) will not apply where the 

loan is provided to an individual who is both an 

employee and a shareholder of the lending corporation 

or of a related corporation to enable the individual to 

acquire newly issued shares of the lending corporation 

or a related corporation where: 

– it is reasonable to conclude that the loan was provided because 

of the individual’s employment and not because he/she is a 

shareholder 

– at the time the loan is made, bona fide arrangements were made 

for repayment within a reasonable time 

45 

15


• Requirement for bona fide arrangements for repayment 

within a reasonable time does not require all of the loan 

terms be “commercial”, e.g., would not preclude an 

interest-free loan and may not require specific 

contractual repayment terms, but does require that 

arrangements for repayment exist when the loan is 

granted and the loan be repayable within a “reasonable 

time” 

• Requirement for repayment on termination of 

employment, sale of shares or other event, the timing of 

which is uncertain, is unlikely to constitute bona fide 

arrangement for repayment within a reasonable time 

46 


• Interest-free loans and loans at an interest rate 

below the “prescribed rate” for employee loans 

will result in a taxable benefit under s. 80.4 

• Essentially, benefit equals difference between 

the prescribed rate and amount of interest 

actually paid by the employee for the year and 

not later than 30 days after year-end 

47 


• S. 80.4 applies to loans provided because of or 

as consequence of an individual’s previous, 

current or intended office or employment 

• Taxable benefit under s. 80.4 is deemed under 

section 80.5 to be interest for purposes of 

paragraph 20(1)(c), which may allow employee 

to deduct interest benefit (provided shares can 

be said to have been acquired to earn income) 

48 

16

Cash-Based Long-Term Incentive 

Plans and the SDA Rules 

• Where real equity reserved for key 

executives, other employees typically 

receive cash-based long-term incentives, 

including: 

– restricted share units 

– performance share units 

– unitized awards not based on shares values 

– appreciation rights 

49 


Plans and the SDA Rules (cont’d) 

• Salary deferral arrangement (SDA) rules 

will be relevant 

• Components of SDA definition 

– right to receive an amount after the year 

– in respect of an amount on account of salary 

or wages for services in the year or a 

preceding year 

50 



• Components of SDA definition (cont’d) 

– must be reasonable to consider that one of 

the main purposes is to postpone tax 

– includes a right subject to conditions unless 

there is a substantial risk one such condition 

will not be satisfied 

51 

17



• There is virtually no jurisprudence relating to the 

SDA rules 

• Deferred compensation plans generally 

designed to minimize CRA assessing risk 

• Commentary to date suggests the following 

about CRA’s position with respect to the SDA 

rules 

– time-based vesting is not sufficient to create a 

substantial risk of forfeiture 

52 



• Share unit plans that pay out by the end of the 

third year following the year in which the 

relevant services are rendered should fall within 

the paragraph (k) exception to the SDA definition 

applicable to bonuses and similar payments 

• Share appreciation rights should not result in an 

SDA provided payments occur promptly 

following vesting 

53 



• Where awards subject to genuine, 

reasonably stringent performance 

conditions, there may be a substantial risk 

that one of the conditions will not be 

satisfied such that no SDA arises 

• In private equity context, may want to tie 

settlement/vesting to liquidity event to 

retain employees and limit cash drain 

54 

18



• Where incentive is based on appreciation rights 

model, some concern that CRA may challenge if 

share value is based on a formula that reflects 

financial measures (e.g., EBITDA, sales etc.) but 

not necessarily a commercial fair market value 

or where appreciation not based on share 

values at all but on increases in a notional unit, 

although favourable rulings have been granted 

in the past 

55 

Non-Portfolio Company Incentives 

• Private equity incentives sometimes provided at 

“holdco” level 

• Common where “holdco” is U.S. LLC to provide 

employees with “profits interests” in LLC 

• LLC not specifically recognized under ITA but 

CRA position to date seems to be that LLCs will 

generally be treated as corporations, while in 

U.S. they are considered to be a flow-through 

entity akin to a partnership 

56 

Non-Portfolio Company 

Incentives (cont’d) 

• Profits interests share in increases in the 

value of the LLC only after the agreed 

upon value is allocated to other LLC units 

• Profits interest should be a security under 

Canadian securities laws so in principle 

should result in same tax treatment as 

acquisition by employee of any other 

security as a result of employment 

57 

19



• If LLC is a corporation for Canadian tax 

purposes, profits interest may be a share 

for purposes of section 7 of ITA 

• Regardless of whether section 7 applies, if 

profits interest granted to employee, it 

appears that fair market value at grant 

would be taxable benefit of employment 

58 



• Profits interests generally have no intrinsic 

value at grant since if LLC liquidated at 

that time holders of profits interest would 

receive nothing 

• In U.S., current tax rules allow profits 

interests to be granted at zero value (i.e., 

no income inclusion on grant) and any 

increase to be taxed as a capital gain 

59 



• Would expect profits interests to have 

some positive fair market value for ITA 

purposes, but can be difficult to establish 

• Appears to be no published CRA 

commentary on taxation of profits interests 

granted to employees as a form of 

incentive compensation 

60 

20



• Where “holdco” or “opco” is actually a partnership for ITA 

purposes, this may affect available forms of incentive 

compensation 

• In particular, partnerships cannot grant options on 

partnership units under section 7, although CRA’s 

published statements indicate that employees may still 

benefit from section 7 where options granted by partners 

that are corporations 

• Not clear how CRA’s position applies with multi-tiered 

partnerships or structures involving trusts; sometimes 

see separate management holdco established which 

grants options subject to section 7 

61 

21

Incentive Compensation Issues in Corporate Transactions 

David Crawford 

Bill Sutherland 

April 10, 2012 

© 2012 Towers Watson. All rights reserved. 

Introduction 

• A thorough assessment of incentive compensation programs is often 

overlooked during corporate transactions 

• At times, a thorough assessment does not get completed until well after the 

transaction has been completed 

• Our discussion today will aim to highlight some of the issues that can 

materialize for organizations that put themselves in play and for organizations 

looking to make an acquisition 

towerswatson.com 2 

1

Acquirer (Buyer) Priorities in a Corporate Transaction 

Specific focus related to incentive compensation includes: 

Identifying and quantifying key issues that could impact the value of the 

transaction or the profitability going forward 

Identifying key issues that could impact business sustainability 

Identifying and quantifying any potential reputational risks 

Retaining key resources required to ensure success 

Limiting distractions 


Acquirer (Buyer) Perspective 

• A full review of the compensation programs needs to be completed concurrent with all 

other assessments during the due diligence phase, 

• The goal is to identify key issues that could impact the value of the transaction or the 

profitability going forward. 

Personal terms/contracts 

Formal plan documentation review 

Quantify the Potential financial 

impacts 

Who has contracts 

What are the separation liabilities that will be triggered 

as per change of control agreements, or as a result of 

future departure scenarios 

Are all long-term incentive awards immediately 

accelerated as a result of the transaction 

Does the plan include roll-over provisions 

What have the historical incentive payments/awards 

been 

What is the value of all outstanding equity holdings 

What are the financial obligations owed - in aggregate 

and for key executives 


2

Transaction Scenarios 

Acquisition 

A purchases B 

Sale/Divestiture 

A sells part of its 

business to B 

Merger 

A and B combine 

Joint Venture 

A and B create C 

IPO 

Go Private 

 

 

 

 

 

 

 

 

 

 

 

Acquired company’s incentive compensation plan tends to disappear 

May include a standstill agreement that leaves plans unchanged for a 

period of time 

Acquired business tends to see its incentive plans disappear or, at the very 

least, significantly modified to align with the new culture 

Incentive plans can take on a ‘yours, mine, or ours’ mindset 

Provides an opportunity to take the ‘best-of’ 

Can lead to dramatically different reward cultures and pay philosophies 

Highly focused/customized incentive plans created – opportunity to 

experiment 

Bigger executive role 

Anticipate pay disclosure and governance scrutiny 

New ownership 

Equity focused on deal price 


Company In-Play or Reviewing Strategic Alternatives 

Implication for management: May have Winners and/or Losers 

Bigger Job, Same Job, Smaller Job, No Job 

Security / 

Protection 

 

 

Understanding termination benefits can foster significant retention for ‘atrisk’ 

positions. 

Formalize/clarify understanding of severance protection. 

Program 

Treatment 

 

 

Providing clarity around the equity treatment could provide a strong 

incentive to retain key talent – particularly if potential value is meaningful. 

Important to also ensure responsible treatment to allow for retention 

beyond transaction. 

Additional 

Retention 

Incentives 

 

 

May require the creation of retention programs to ensure that critical talent 

is retained and key executives are acting in the best interests of the 

desired transaction efforts. 

Need to ensure that any amounts are responsible in the context of the 

entire pay package. 


3

Program Treatment – Equity Compensation (LTI) 

Consider the following principles: 

A technical change-of-control (COC) should not result in automatic vesting. 

— If there is an ongoing share price and/or company performance can still be 

reasonably measured, there is no need to automatically vest or wind down the 

plans 

Participants should not be penalized 

— If the plans cannot, from a practical point of view, continue (e.g., no share price 

available or acquiring company does not want the equity continuing), full value 

should ultimately be settled. 

— A participant whose employment is terminated as part of the COC should receive 

the full benefit of the LTIP awards (i.e., fully vested) 


Stock Option in Transaction 

 

3 types of treatment for stock options on a change-in-control: 

1. Accelerate vesting and settle on transaction price; 

2. Accelerate vesting and exchange options for those of the acquiring company 

(maintaining the option holders economic value); or 

3. Maintain vesting and exchange options for that of the acquiring company 

(maintaining the option holders economic value). 

 

 

 

The 3 rd treatment is preferable with acceleration only if: 

The participant is actually or constructively terminated, or 

It is not practical to exchange the options (e.g., no publicly-traded share is available). 


4

Stock Option Rollover – Maintaining Economic Value 

Assumptions 

Pre-Transaction Price [P1] $50.00 

Post-Transaction Price $20.00 

Exchange Ratio [P1 / P2] 2.5000 

OPTIONS 

Pre 

Exchange 

Exchange 

Adjustment 

After 

Exchange 

Exercise Price $30.000 / 2.5 $12.000 

Options 10,000 x 2.5 25,000 

Exercise Cost $300,000 $300,000 

Underlying Market Value $500,000 $500,000 

In-the-Money $200,000 $200,000 

Combined Exercise Price Adjustment x 0.4 

Combined Number of Shares Adjustment x 2.5 


No Reason to Accelerate RSU/PSU Payment (Vesting) 

Share Price 

NewCo RSUs 

RSU Grant 

Transaction 

RSU $ Value 

No Share Price 

$ Payment Withheld 

Grant Year 3 


5

Dollar Amount Converted to RSUs/DSUs 

Company in black-out, or 

Company anticipating IPO 

Grant Year 3 

Remain Cash 

Settle 

$ Denominated 

Retention 

Convert to RSUs 

Settle 

Convert to DSUs 

Continue 


Key Points 

Ensure a complete review of all contracts and plan terms 

Understand the financial obligations triggered as a result of the transaction 

Understand specific program treatment 

Immediate vesting is not always a requirement 

Pay particular attention to retaining key talent 


6

Long Term Incentive Plan 

Clawbacks: Design, Tax and 

Other Legal Issues 

Presented by: 

Kathryn Bush 

April 10, 2012 

Introduction 

• Since 2008, substantial growth of the use 

of clawbacks in Canada 

• Blakes Bulletin: “Clawbacks Coming to 

Canada” dealing with securities and 

corporate law aspects 

• Current public examples 

• Design issues 

• Canadian tax issues 

2 

U.S. Statutory Clawbacks 

• Sarbanes-Oxley Act of 2002 (SOX) 

– negative revision of financial results 

– executive misconduct 

– material non-compliance in the financial 

results 

– any incentive payments and entire payment 

– 1-year period 

– CEO and CFO 

– enforced by SEC 

3 

1

U.S. Statutory Clawbacks (cont’d) 

• Dodd-Frank Wall Street Reform & 

Consumer Protection Act (DFW) 

– applies in wider circumstances and to more 

employees than SOX 

– any material non-compliance that results in a 

financial restatement 

– all current and former executives 

4 

U.S. Statutory Clawbacks (cont’d) 

– 3-year look back 

– absolute liability 

– excessive portion of the award 

– enforced by the Issuer 

5 

Financial Stability Board Principles 

• FSB co-ordinating national financial 

authorities 

• Bank of Canada, OSFI and federal 

Ministry of Finance are FSB members 

• Principles for Sound Compensation 

Practices - Implementation Standards 

6 

2

Financial Stability Board 

Principles (cont’d) 

• OSFI best practices for Canadian financial 

institutions 

• Canadian issuers which are subject to 

SEC listing requirements 

7 

Contractual Clawbacks 

in Canada and the U.S. 

• Executive misconduct or bad behaviour 

• Joining a competitor 

• Movement to absolute liability 

8 

Type and Relative Prevalence of 

Clawbacks in the U.S. and Canada 

• 450 public companies surveyed by Hay 

Group 

– > 50% use clawbacks 

– 82% of Fortune 100 companies use 

clawbacks 

– clawbacks used in 

• annual incentives 

• stock options 

• RSUS 

9 

3

Type and Relative Prevalence of 

Clawbacks in the U.S. and Canada 

(cont’d) 

– less frequent in Canada except top-tier banks 

and insurance companies are almost 100% 

now 

– typical 2 or 3-year look back 

10 

Three Major Categories of 

Clawbacks 

• Bad faith (including breach of noncompete) 

• Fraud, negligence or intentional 

misconduct resulting in a financial result 

revision 

• Any restatement of financial results 

(growing in prevalence) 

11 

Three Major Categories of 

Clawbacks (cont’d) 

Paper includes 9 examples of U.S. and 

Canadian clawback provisions in 2011 

proxies 

12 

4

Canadian Taxation 

• Clawback in current year poses no 

difficulty 

• Clawback in later year creates problems 

due to section 8 of Income Tax Act 

(Canada) 

13 

Potential Tax Relief for 

Later Year Clawbacks 

• Filing an Amended Tax Return 

– Armstrong - CRA discretion 

14 


Later Year Clawbacks (cont’d) 

• Mistake 

– “If the parties base their contract on a fundamental 

error about the assumptions supporting their 

agreement, and neither party agrees to bear the risk 

of the assumption turning out be false, the contract 

can be held void on the basis of the doctrine of 

common-law mistake.” 

– procedural and jurisdictional hurdles - Fradette 

15 

5



• Remission 

– “The Governor in Council may, on the 

recommendation of the appropriate Minister, remit 

any tax or penalty, including any interest paid or 

payable thereon, where the Governor in Council 

considers that the collection of the tax or the 

enforcement of the penalty is unreasonable or unjust 

or that it is otherwise in the public interest to remit the 

tax or penalty” 

– no public record of such a remission order having 

ever been granted in the case of a clawback 

16 



• Unjust enrichment 

– enrichment without juristic reason 

17 



• Rectification 

– “In order for a party to succeed on a plea of 

rectification, he must satisfy the Court that the parties, 

all of them, were in complete agreement as to the 

terms of their contract but wrote them down 

incorrectly. It is not a question of the Court being 

asked to speculate about the parties’ intention, but 

rather to make an inquiry to determine whether the 

written agreement properly records the intention of 

the parties as clearly revealed in their prior 

agreement.” 

18 

6

Design Alternatives to Avoid Adverse 

Canadian Tax Consequences 

• 3-year bonus 

– exclusion from the Definition of Salary Deferral 

Arrangement 

– a plan or arrangement under which a taxpayer has a 

right to receive a bonus or similar payment in respect 

of services rendered by the taxpayer in a taxation 

year to be paid within 3 years following the end of the 

year, … 

– downside 

• delayed receipt by executive 

• 3-year limit 

19 



(cont’d) 

• Employee loan 

– taxable benefit with respect to interest may 

result 

– downside 

• cumbersome 

• must be repaid if clawback operative 

20 



(cont’d) 

• Use of a trust 

– s. 7 income inclusion by s. 8(12) deduction if 

clawback occurs 

– downside 

• immediate tax without cash unless a loan is also 

used 

• trust needs to be established 

• securities compliance 

21 

7

Conclusion 

• Clawbacks in Canada seem to be growing 

in prevalence and scope 

• Canadian tax result likely to be harsh 

unless there is planning at the time of the 

relevant award 

22 

8

Long Term Incentive Plan Clawbacks: 

Design, Tax and Other Legal Issues 

Kathryn Bush 

Partner 

416.863.2633 

kathryn.bush@blakes.com 

Blake, Cassels & Graydon LLP 

Barristers, Solicitors 

199 Bay Street 

Suite 4000, Commerce Court West 

Toronto, ON Canada 

M5L 1A9 

www.blakes.com

Long Term Incentive Plan Clawbacks: Design, Tax and 

Other Legal Issues 

Kathryn Bush, Blake, Cassels & Graydon LLP 

1. INTRODUCTION 

In recent years, particularly since the global financial crisis, the use of clawback 

provisions in executive compensation plans has become more widespread in Canada. 

Basically, clawbacks are arrangements under which an employee’s compensation that 

has previously been awarded is forfeited or ‘clawed back’. Canadian public companies 

listed in the United States are subject to statutory clawbacks for certain employees. As 

well, certain Canadian financial institutions regulated by the Office of the Superintendent 

of Financial Institutions (“OSFI”) have adopted clawbacks as an OSFI-recommended 

best practice. Other Canadian public companies are not required to adopt clawbacks, 

but may choose to do so by agreement with affected employees. The increasing use of 

these provisions in Canadian employment contracts raises a series of interesting and 

potentially difficult issues that should be kept in mind when designing executive 

incentive plans. A potentially problematic example is the income tax consequences of 

compensation clawbacks in the context of the Canadian income tax laws. As will be 

discussed, the potentially harsh tax treatment of the clawed back amounts in Canada is 

an added layer of complexity that should be taken into account, particularly when using 

existing U.S. policies as a source for drafting Canadian clawback provisions. 

As explained in the Blakes Bulletin “Clawbacks Coming to Canada”, clawback 

provisions can take a variety of forms and be triggered by different types of events. 1 

They may apply to vested and unvested awards, affecting different forms of 

compensation from annual bonuses to long term incentive awards of equity and non- 

The author acknowledges the assistance in the preparation of this paper of Atbin Dezfuli, Articling 

Student.

- 2 - 

equity compensation. Triggers range from fraudulent misconduct to bad faith behaviour 

and even the mere occurrence of a negative restatement of financial results. 

2. U.S. STATUTORY CLAWBACKS 

Specific types of clawbacks are statutorily mandated under the U.S. Sarbanes-Oxley 

Act of 2002 (“SOX”), and Dodd-Frank Wall Street Reform and Consumer Protection Act 

(“DFW”). These measures are relevant for Canadian corporations which are foreign 

private issuers under U.S. securities laws. These provisions are also of more general 

interest since the concepts introduced and developed in the U.S. statutory clawbacks 

are widely adopted by both US and Canadian issuers in drafting their contractual 

clawback policies. 

The clawback provisions in SOX adopted the basic notion, incorporated in most current 

clawback policies, that executive bonuses based on materially inaccurate financial 

results that are subsequently subject to a negative revision should be forfeited. The 

forfeiture, or clawback, is conditioned on a finding of executive misconduct that has 

resulted in the material non-compliance in the financial results. These provisions apply 

to any incentive payments, covering both cash and equity awards, in the one-year 

period following the issue of the financial results that later had to be restated. The 

clawback is mandatory for U.S. public companies but only applies to the CEO and the 

CFO. However, the misconduct required to trigger the provision is not required to be 

that of the CEO or the CFO. 2 

The DFW introduced ‘bigger and better’ clawbacks that apply in a wider set of 

circumstances to a wider base of employees. Under these provisions, any material 

non-compliance with reporting requirements that necessitates a restatement of financial 

results triggers a clawback mechanism that applies to incentive awards received by all 

current or former executives. There is a three year look-back period, which means that 

incentive awards handed out during the three years preceding the date of restatement 

1 J. Tuzyk, Blakes Bulletin on Securities “Clawbacks Coming to Canada”, November 2011, available at 

http://www.blakes.com/english/view_bulletin.aspID=5026

- 3 - 

are subject to recoupment. It is significant to note the absolute-liability nature of these 

provisions in that there is no misconduct requirement for the DFW clawbacks to be 

triggered. 

DFW measures apply in addition to the already in place SOX provisions discussed 

above, yet they are in one aspect narrower: DFW clawbacks only apply to the excessive 

portion of the award that was received by the executive based on inaccurate financial 

results, whereas, under the SOX, the entire payment may be subject to forfeiture. This 

is probably an appropriate policy choice in light of the no-fault nature of DFW 

clawbacks. Also unlike SOX, which tasks the SEC with enforcing the clawbacks by 

litigation, the DFW provisions are required to be enforced by the issuer, who should 

disclose its policies for doing so as part of its securities reporting requirements. 3 

3. FINANCIAL STABILITY BOARD (“FSB”) PRINCIPLES AND CANADIAN 

ADVISORY POLICIES 

The FSB is an international organization co-ordinating national financial authorities of 

countries such as the U.S., and Canada. Bank of Canada, OSFI and the Federal 

Ministry of Finance are members of FSB, which has issued FSB Principles for Sound 

Compensation Practices – Implementation Standards. The Principles espouse the 

basic notion that executive incentives based on inaccurate financial results that are 

subsequently subject to downward revision should trigger some form of recoupment or 

clawback mechanism. Further, unvested portions of deferred compensation should also 

be clawed back based on the actual performance of the business in the year of vesting. 

There are no regulatory or statutorily mandated clawbacks in Canada. However, 

Canadian issuers which are subject to SEC listing requirements are subject to clawback 

provisions, and clawbacks following the general guidelines of FSB Principles are 

recommended by OSFI as a best practice to the Canadian financial institutions that it 

2 Ibid 

3 Ibid

- 4 - 

regulates. As the OSFI-regulated entities are not subject to a specific legislative 

provision in this regard, there is no prescribed form of clawback as in the U.S. 4 

4. CONTRACTUAL CLAWBACKS IN CANADA AND THE U.S. 

The Canadian clawback is therefore primarily a contractual measure. In drafting 

contractual provisions, Canadian companies have tended to follow the U.S. precedent, 

which has a longer and more established history of using such provisions. The 

historical use of U.S. contractual clawbacks has been directed at executive misconduct 

or bad behaviour, a common example being situations where employees left to join 

competitors. 

Following the example of U.S. lawmakers, however, clawback provisions are 

increasingly being used to address a much more far reaching set of issues, going 

beyond ‘bad behaviour’ to include absolute liability-type situations where a negative 

restatement leads to disgorgement regardless of executive fault. This signals a new 

understanding of clawbacks as a risk-management mechanism and more generally a 

“corporate governance tool to deter management from taking actions that could 

potentially harm the company’s financial position”. 5 

5. TYPES AND RELATIVE PREVALENCE OF CLAWBACKS IN U.S. AND 

CANADA 

According to the HayGroup report, a survey conducted over 450 US public companies 

with revenues over $4 billion showed (i) more than half of them adopting some form of 

clawback; (ii) this figure is at 82% for Fortune 100 companies; (iii) clawbacks are 

applied to annual incentives as well as unexercised stock options and restricted 

stock/share units (RS/RSU), (iv) clawbacks are a much less frequent sight in Canada 

overall, apart from top tier banks and insurance companies which have been almost 

unanimous in adopting some form of recoupment policy since 2009, and (v) as in the 

4 supra note 1 

5 HayGroup, Executive Briefing—Canada, Issue 1, March 2011

- 5 - 

U.S., a wide range of incentives are subject to disgorgement in Canada, with a typical 

look-back period of two to three years. 6 

Clawback provisions have been commonly categorized into the following three major 

categories: 

(1) the first category covers “bad faith” conduct which includes the breach of 

non-compete policies, and more generally conduct that is not in good faith 

and goes against the best interests of the company. 

(2) The second major category covers fraud, negligence or intentional 

misconduct, where the employee has unearned income as a result of 

fraudulent or negligent conduct leading to financial results that need to be 

revised at a later point. 

(3) The third major categories are clawbacks that are triggered directly by a 

restatement of financial results, with no need for the company to show a 

causal link between the negative revision and employee misconduct. 

Companies may adopt a combination or all of these measures in their clawback 

policies, and the following examples will demonstrate that companies may adopt 

language that is not clearly caught by these categories. Overall, it seems however, that 

the inclusion of strict restatement clawbacks is increasingly common, particularly in 

Canadian entities that adopt such provisions. 

6 Ibid

- 6 - 

6. EXAMPLES OF U.S. AND CANADIAN CLAWBACK PROVISIONS IN 

2011 PROXIES 

(a) 

(i) 

U.S. Public Issuers Clawbacks; DEF 14A forms available on EDGAR 

General Motors Company 

GMC’s initial clawback policy was adopted in response to TARP measures and covered 

fraud, negligence and intentional misconduct. More recently, the board has 

expanded the recoupment policy to cover material inaccuracy in financial statements, 

applying to any SEO and the next top 20 earners of the company. The policy however 

adds a knowledge condition for recoupment which separates it from the absolute-liability 

type provisions: 

“Recoupment Policy on Incentive Compensation 

On September 8, 2009, our Board reaffirmed and expanded our policy regarding the 

recoupment of incentive compensation paid to executive officers in situations involving 

financial restatement due to employee fraud, negligence, or intentional misconduct and 

posted it on our website, www.gm.com/investors, consistent with the requirements for 

TARP recipients. Our recoupment policy now provides that if our Board or an 

appropriate committee thereof has determined that any bonus, retention award, or 

incentive compensation has been paid to any SEO or any of the next 20 most highly 

compensated employees of the Company based on materially inaccurate misstatement 

of earnings, revenues, gains, or other criteria, the Board or Compensation Committee 

shall take, in its discretion, such action as it deems necessary to recover the 

compensation paid, remedy the misconduct, and prevent its recurrence. For this 

purpose, a financial statement or performance metric shall be treated as 

materially inaccurate with respect to any employee who knowingly engaged in 

providing inaccurate information or knowingly failed to timely correct information 

relating to those financial statements or performance metrics. We will continue to

- 7 - 

review our policy to assure that it is consistent with evolving best practices and SEC 

and NYSE requirements.” 7 

(ii) 

CISCO Systems, Inc. 

Clawbacks in CISCO are limited to the cash incentives for restatement triggered 

provisions, going back to July, 2007. The proxy however also mentions possible 

forfeiture of equity awards for detrimental activities and termination for misconduct: 

“Since March 2008, Cisco has maintained a recoupment policy for cash incentive 

awards paid to executive officers under Cisco’s annual cash incentive plan, the EIP. In 

the event of a restatement of incorrect financial results, this policy would enable the 

Compensation Committee, if it determined appropriate and subject to applicable laws, to 

seek reimbursement of the incremental portion of EIP awards paid to executive officers 

in excess of the awards that would have been paid based on the restated financial 

results. This policy also was applied to the discretionary cash incentive awards paid to 

executive officers for fiscal 2009. Cisco’s variable cash incentive and long-term, equitybased 

incentive award plans also generally provide for forfeiture if a named executive 

officer participates in activities detrimental to Cisco or is terminated for misconduct.” 8 

“Cisco has adopted a senior executive compensation recoupment policy. This policy is: 

In the event of a restatement of incorrect financial results, the Compensation and 

Management Development Committee (the “Compensation Committee”) will review all 

cash incentive awards under the Executive Incentive Plan (“bonuses”) that were paid to 

executive officers (within the meaning of Rule 3b-7 of the Securities Exchange Act of 

1934, as amended) for performance periods beginning after July 28, 2007 which occur 

during the restatement period. If any such bonus would have been lower had the 

level of achievement of applicable financial performance goals been calculated 

based on such restated financial results, the Compensation Committee will, if it 

determines appropriate in its sole discretion, to the extent permitted by governing 

7 DEF 14A filed 2011-04-21

- 8 - 

law, require the reimbursement of the incremental portion of the bonus in excess 

of the bonus that would have been paid based on the restated financial results.” 9 

(iii) 

Dell Inc. 

Dell’s clawback is a straightforward restatement-based policy that applies to all awards 

made in the restatement period: 

“Recoupment Policy for Performance-Based Compensation 

If Dell restates its reported financial results, the Board will review the bonus and other 

awards made to the executive officers based on financial results during the period 

subject to the restatement, and, to the extent practicable under applicable law, Dell will 

seek to recover or cancel any such awards which were awarded as a result of 

achieving performance targets that would not have been met under the restated 

financial results.” 10 

(iv) 

Exxon Mobil Corporation 

Exxon’s recoupment policy is a straightforward restatement-triggered clawback that 

applies only to cash awards. The look-back period and the employees to whom the 

clawback would be applied are not made clear in the proxy: 

“The annual bonus and retirement benefits also align the interests of senior executives 

with the priority of long-term, sustainable growth in shareholder value. Specifically, 50 

percent of the annual bonus payout is delayed based on earnings performance, as 

described in the CD&A, and the entire annual bonus is subject to recoupment. In 

addition, pension values are highly dependent on executives remaining with the 

Company for a career and performing at the highest levels. 

(...) 

8 DEF 14A filed 2011-10-18 

9 available at http://investor.cisco.com/contacts.cfm 

10 DEF 14A filed 2011-05-26

- 9 - 

Cash and Earnings Bonus Unit payments are subject to recoupment in the event 

of material negative restatement of the Corporation’s reported financial or 

operating results. Even though a restatement is unlikely given ExxonMobil’s high 

ethical standards and strict compliance with accounting and other regulations applicable 

to public companies, a recoupment policy was approved by the Board of Directors to 

reinforce the well-understood philosophy that incentive awards are at risk of forfeiture 

and that how we achieve results is as important as the actual results.” 11 

(v) 

Qwest Communications International Inc 

Qwest’s restatement clawback, adopted in 2005, applies to performance based awards 

made in the restatement period to executives: 

“Our Board has adopted a policy whereby, in the event of a substantial restatement of 

previously issued financial statements, our Board will review all performance-based 

compensation awarded to executives that is attributable to performance during the time 

periods restated. Our Board will determine whether the restated results would have 

resulted in the same performance-based compensation for the executives. If not, the 

Board will consider: 

Whether the restatement was the result of executive misconduct; 

the amount of additional executive compensation paid as a result of the previously 

issued financial statements; 

our best interests in the circumstances; and 

any other legal or other facts or circumstances our Board deems appropriate for 

consideration in the exercise of its fiduciary obligations to us and our shareholders. 

If our Board then deems that an executive was improperly compensated as the 

result of the restatement and that it is in our best interests to recover the 

11 DEF 14A filed 2011-04-13

- 10 - 

performance-based compensation paid to that executive, our Board will pursue 

all reasonable legal remedies to recover that performance-based compensation. 

We have not been required to take any action under this policy since its adoption in 

January 2005.” 12 

(b) 

(i) 

Canada; Proxies available on SEDAR 

Brookfield Asset Management Inc. 

Members of Brookfield’s management committee are subject to clawbacks upon the 

occurrence of ‘certain events’. A material restatement leads to clawbacks for only the 

CEO and CFO. Other members of the management committee are subject to 

clawbacks for materially detrimental conduct after leaving the company, including 

breach of confidentiality agreements and defamation. The look-back period is two 

years: 

“Reimbursement of Incentive and Equity-Based Compensation Specified executives, 

including all members of the Management Committee, are required to pay to the 

Corporation an amount equal to some or all of any Bonus or other incentive-based or 

equity-based compensation and the profits realized from the sale of securities of the 

Corporation upon the occurrence of certain events. The amount, if any, will be 

determined by the Compensation Committee which will recommend appropriate action 

to the Board and will take appropriate steps to ensure that such amount is recovered. In 

the case of a significant restatement of financial results, the Chief Executive 

Officer and the Chief Financial Officer may be required to make such a payment. 

In order to protect the Corporation’s reputation and competitive ability, members 

of the Management Committee may be required to make such a payment if they 

engage in conduct that is materially detrimental to the Corporation after the 

cessation of their employment with the Corporation. Detrimental conduct includes 

participating in transactions involving the Corporation and its clients which were 

12 DEF 14A filed 10-03-17

- 11 - 

underway or contemplated at the time of termination, solicitation of clients or 

employees, disclosing confidential information or making inappropriate or defamatory 

comments about the Corporation or its clients. The policy relates to any amounts or 

benefits received within two years prior to the event giving rise to the claim and includes 

both monetary payments and shares received from exercise of options or redemption of 

RSUs and DSUs.” 13 

(ii) 

Nexen Inc. 

A material restatement of financial results may lead to clawback but only “as required by 

law”, and not as a contractual measure. Nexen identifies barriers in Canada for formally 

enacting US-type clawbacks, including employment, taxation, and enforcement issues. 

“Reimbursement 

If, as a result of wilful misconduct, Nexen’s performance results were restated in 

a way that would have resulted in lower incentive awards, the CEO and CFO 

would reimburse Nexen proportionately as required by law. While Nexen is aligned 

and committed to the US model for clawbacks, we are monitoring the development of 

proposed US requirements and are consulting with industry leaders and shareholder 

advisory groups to better understand the development of clawback policy models in 

Canada. Identified barriers to implementation include employment law, enforcement 

and tax issues. Nexen is working on a more formal solution that effectively addresses 

alignment of shareholder and executive interests by ensuring that compensation is not 

increased as a result of wilful misconduct.” 14 

(iii) 

Royal Bank of Canada 

RBC uses explicit risk-control language that goes beyond financial results to cover 

inappropriate or extreme risk-taking behaviour. The policy is applied to a wide range of 

13 Proxy filed March 28, 2011 

14 Proxy filed March 25, 2011

- 12 - 

executives, and includes a financial restatement trigger as well as a broader misconduct 

trigger covering any failure to follow internal policies and procedures: 

“Addresses situations in which individuals might profit from business activities 

that are conducted inappropriately or outside of approved risk limits and 

tolerances, or from financial results, financial reporting or financial statements 

that are erroneous or misstated. 

Applicability 

The CEO, members of the Group Executive, all executives of RBC and Capital Markets 

employees who participate in the RBC Capital Markets Compensation Program. Under 

the policy, the financial restatement trigger applies to the CEO and the CAO and CFO, 

and all other members of the Group Executive. 

Key features 

• Allows RBC to recoup incentive awards that have been paid or vested and 

cancel unvested mid and long-term incentive awards in the event of 

misconduct, including failure to follow internal policies and procedures. 

• A financial restatement trigger permits RBC to recoup incentive awards that have 

been paid or vested and to cancel unvested mid and long-term incentive awards 

in excess of the amount that would have been received under the restated 

financial statements, subject to the board’s discretion. 

• Additionally, performance-based incentive programs at RBC include provisions 

that would revoke certain awards to the CEO, members of the Group Executive, 

and other participants if their employment is terminated for cause. In the event of 

termination for cause and consistent with the law of the jurisdictions in which we

- 13 - 

operate, the terminated participant would forfeit all previously awarded unvested 

mid and long-term incentive awards.” 15 

(iv) 

Sun Life Financial Inc. 

The clawback here applies to all employees, disgorging incentive payments made under 

inaccurate financial results with a two year look-back. Interestingly, the policy, adopted 

in 2010, includes instances of omission such as any failure to report or take action to 

stop misconduct of another employee that an employee knew, or ought to have known, 

about: 

“New clawback provision for all employees 

The board adopted a new clawback provision that allows it to recoup incentive 

compensation if an incidence of misconduct led to an overpayment of incentive 

compensation. This new provision is consistent with emerging competitive practice 

and regulatory principles. 

Clawbacks 

Our CEO and CFO are required by law to reimburse their incentive compensation if 

there is an incidence of misconduct and we need to restate our financial statements. In 

2010 the board approved a new clawback policy, allowing it to demand that former or 

current employees pay back any or all of the incentive the compensation they received 

or realized in the previous 24 months if: employee was involved in misconduct (such as 

fraud, dishonesty, negligence or non-compliance with legal requirements or Sun Life 

Financial’s policies, any other act or omission that would justify termination of 

employment for cause, and any failure to report or take action to stop misconduct of 

another employee that an employee knew, or ought to have known, about), and the 

15 Proxy filed February 6, 2012

- 14 - 

misconduct directly or indirectly resulted in the employee receiving or realizing a higher 

amount of incentive or deferred compensation.” 16 

CANADIAN TAXATION 

From the Canadian tax perspective, a clawback occurring in the same taxation year as 

the receipt of the compensation should pose no difficulty. The employer and employee 

can adjust the compensation and the related source deductions, prior to making the 

required tax filings in respect of the year. The difficulty arises when the clawback 

occurs in a subsequent year. 

Limitations of Section 8 of the Income Tax Act 

The difficulty stems from subsection 8(2) of the Income Tax Act, (Canada) (the “Act”) 

which reads as follows: 

Except as permitted by this section, no deductions shall be 

made in computing a taxpayer’s income for a taxation year 

from an office or employment. 

The balance of section 8 of the Act provides for a number of express deductions in 

computing income from employment, including deductions for: 

• the reimbursement of amounts included in income for periods during 

which no services were rendered (8(1) (n)). 

• amounts previously included in income but forfeited under a salary 

deferral arrangement; (8(1) (o)) and 

• expenses incurred by employees engaged in the selling of property or 

negotiating of contracts, which deduction may provide relief in respect of a 

clawback in limited circumstances. (8(1) (f)). (See CRA Document 2004- 

0103391E5, where a commission salesperson was unable to make full 

16 Proxy filed March 29, 2011

- 15 - 

use of the provision where amounts had to be repaid to his former 

employer.) 

None of the deductions set out in section 8 expressly covers the scenario where a 

reimbursement or forfeiture of a bonus is required. 

Accordingly, relief would have to be sought elsewhere. 

Filing an Amended Tax Return 

The taxpayer subject to a clawback could simply file an amended return for the year in 

which the bonus was received. However, there is no general, statutory right to file an 

amended return as established in Armstrong v. The Queen, 2006 DTC 6310 (FCA). 

While the Act contains specific provisions that permit or mandate the filing of an 

amended return in specific circumstances, (See, for example, paragraph 164(6) (e), 

regarding the carry back of losses to a deceased’s terminal year.) No provision 

expressly permits an employee to do so in the case of a clawback. 

Accordingly, relief would depend on the discretion of the Canada Revenue Agency 

(“CRA”) to assess on the basis of the amended return. 

The Law of Mistake 

A taxpayer may argue that the prior income inclusion ought to be reversed on the basis 

of a mistake of fact which rendered the agreement to pay the bonus void. A clawback 

would not seem to meet the Canadian definition of a mistake: 

“If the parties base their contract on a fundamental error about the assumptions 

supporting their agreement, and neither party agrees to bear the risk of the assumption 

turning out be false, the contact can be held void on the basis of the doctrine of 

common-law mistake.” 17 

17 Bell v. Lever Bros. Ltd., [1932] A.C. 161, [1931] All E.R. Rep. 1 (H.L.).

- 16 - 

Even if the clawback could meet the test of a mistake under Canadian law, which 

seems very unlikely, the taxpayer would have to navigate the procedural and 

jurisdictional hurdles. 

In Fradette v. The Queen, [20] the taxpayer mistakenly received approximately $26,000 

from a provincial pension commission over a period of years, which was included in the 

taxpayer’s income and subject to provincial and federal income tax. When the payer 

discovered the error years later, it required the taxpayer to repay the sums paid in error, 

which the taxpayer did. 

While Revenue Quebec agreed to reimburse the taxpayer for the provincial tax paid on 

the repaid amount, the CRA did not so agree, and issued a nil assessment for the year 

of the final repayment. The taxpayer’s appeal to the Court was met with the Crown’s 

motion to dismiss on the basis that no appeal lies from a nil assessment. The Crown’s 

motion was successful. However, Mr. Justice Tardif made the following comments: 

This is a very special case which causes one to have great 

sympathy for the appellant, who must bear unaided the 

consequences of a mistake in which he had no part. 

Unfortunately, I have no jurisdiction to correct this injustice 

except that I would like to think that Parliament had such a 

situation in mind when it adopted the [Financial 

Administration Act]. 

Remission 

Remission orders are extraordinary measures that provide for complete or partial relief 

from taxes, interest or penalties. Remission orders are granted by the Governor 

General in Council, under the authority of subsection 23(2) of the Financial 

Administration Act: 

The Governor in Council may, on the recommendation of the 

appropriate Minister, remit any tax or penalty, including any

- 17 - 

interest paid or payable thereon, where the Governor in 

Council considers that the collection of the tax or the 

enforcement of the penalty is unreasonable or unjust or that 

it is otherwise in the public interest to remit the tax or 

penalty. 

A remission order must be sponsored internally by the CRA and the procedure is timeconsuming. 

The CRA will generally require evidence of extreme hardship or incorrect 

action or advice from the CRA that led to additional tax. There is no public record of a 

remission order ever been provided in the case of a clawback. 

Unjust Enrichment 

Unjust enrichment is another remedy that might be considered. This equitable remedy 

requires an enrichment of one party, a corresponding deprivation of another, and the 

absence of any juristic reason for the enrichment. The remedy has been raised by 

taxpayers in a number of cases, with mixed results. 

One difficulty in raising the remedy is that it will often conflict with the legislation on 

which the particular assessment is based. In the British Columbia Ferry Corp. v. 

M.N.R., [2000] FCJ 227 F.C.T.D. in which the plaintiff sought a determination of whether 

it had overpaid taxes on fuel oil, the Court concluded that the Excise Tax Act constituted 

a complete code and excluded any equitable remedy that might otherwise have been 

available. 

Another difficulty with the remedy in the case of a clawback is that there may arguably 

be a juristic reason for the enrichment and deprivation, namely the operation of the Act 

as it applies to the receipt of employment income in a particular taxation year.

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Rectification 

Rectification is another equitable remedy that has been used by taxpayers in a number 

of tax cases. In H.F. Clarke Ltd. v. Thermidaire Corp. Ltd., [1937] 2 OR 57, at 64-65 

(C.A.) the doctrine of rectification was described as follows: 

In order for a party to succeed on a plea of rectification, he 

must satisfy the Court that the parties, all of them, were in 

complete agreement as to the terms of their contract but 

wrote them down incorrectly. It is not a question of the Court 

being asked to speculate about the parties’ intention, but 

rather to make an inquiry to determine whether the written 

agreement properly records the intention of the parties as 

clearly revealed in their prior agreement. 

As rectification requires an error in the recording of an agreement, it would appear this 

would be of little use in the case of a clawback. 

DESIGN 

Based on the above, there does not appear to be a clear and certain way in which the 

negative tax impact of a clawback may be reversed. The following are some methods 

by which a clawback could be structured to take advantage of existing tax rules. 

(a) 

Three-Year Bonus 

An exception to the salary deferral arrangement definition in paragraph 248(1)(k) 

permits a bonus for services rendered in a year to be deferred for three years: 

“salary deferral arrangement”, in respect of a taxpayer, 

means a plan or arrangement, whether funded or not, under 

which any person has a right in a taxation year to receive an 

amount after the year where it is reasonable to consider that 

one of the main purposes for the creation or existence of the

- 19 - 

right is to postpone tax payable under this Act by the 

taxpayer in respect of an amount that is, or is on account or 

in lieu of, salary or wages of the taxpayer for services 

rendered by the taxpayer in the year or a preceding taxation 

year (including such a right that is subject to one or more 

conditions unless there is a substantial risk that any one of 

those conditions will not be satisfied), but does not include ... 

a plan or arrangement under which a taxpayer has a right to 

receive a bonus or similar payment in respect of services 

rendered by the taxpayer in a taxation year to be paid within 

3 years following the end of the year, ... 

The deferred bonus may be subject to conditions during the deferral period, which could 

include the absence of a financial restatement or wrongdoing. If such a condition 

materialized, the bonus would not be paid and there would never have been an income 

inclusion to reverse. Of course, the downside is that the employee does not have 

access to the bonus amount during the deferral period. Further, under this approach, 

the clawback period would have to be restricted to three years and the particular three 

years drafted carefully. Nevertheless, this is likely the easiest way to implement a taxneutral 

clawback under the current state of the law. 

(b) 

Employee Loan 

The employer and the employee could agree to arrange a loan, equal to the amount of 

the bonus, for a term equal to the duration of the desired clawback regime. During the 

term of the loan, the loan amount would not be included in the employee’s income, the 

loan would be included in income if and when forgiven rather than repaid although a 

taxable benefit in respect of interest may result. (See Subsection 80.4(1) and 

subsection 6(9) of the Act.) This may not be a concern in the era of low interest rates 

and could be dealt with by grossing-up cash compensation. At the end of the term, the 

bonus is paid to the employee, which is used to repay the loan. If the bonus does not

- 20 - 

become payable due to a clawback, the employee would repay the loan. While 

imperfect and slightly cumbersome, this method would avoid having to unwind an 

income inclusion in a prior year. 

Care will need to be taken to structure the loan such that it is clearly a loan and not, for 

example, a taxable advance, or in the case of an employee who holds shares, a 

shareholder benefit. 

(c) 

Use of a Trust 

The bonus could be structured using a trust to hold employer stock during the clawback 

period. Upon issuance of the stock to the trust, the employee would have an income 

inclusion (see Subsection 7(2) and paragraph 7(1)(a) of the Act). (It is assumed the 

deferral provided for in subsection 7(1.1) for shares of a Canadian-controlled private 

corporation would not be relevant in the context of clawbacks.) At the end of the 

clawback period, if the stock is released from the trust, the employee would not have an 

additional income inclusion and would be able to liquidate the stock. If the clawback 

was engaged prior to the release of the stock to the employee, and the arrangement 

provided for the stock to be returned to the issuing employer, the employee would be 

entitled to a deduction in computing income equal to the amount of the income inclusion 

in the prior year under Subsection 8(12) of the Act. Subsection 8(12) of the Act 

provides a deduction for an employee who forfeits rights to a share in certain 

circumstances. The deduction is available if the employee is deemed to have disposed 

of the share held by a trust pursuant to subsection 7(2) of the Act. The trust must have 

disposed of the share to the corporation that issued the share as a result of the 

employee failing to meet the conditions necessary for title to the share to vest in the 

employee. Furthermore, the corporation must acquire the share from the trust or 

redeem or cancel it for an amount no greater than the price paid to acquire the share 

from the corporation. 

If the foregoing conditions are satisfied, the employee may, in the year of forfeiture, 

deduct the excess of the amount of the benefit deemed to have been received by the

- 21 - 

taxpayer under subsection 7(1) in respect of the share over the amount, if any, 

deducted under paragraph 110(1)(d) or (d.1) of the Act in respect of that benefit. Where 

a deduction is available under subsection 8(12), that subsection deems any gain or loss 

from the disposition of the share to be nil and provides that section 84 does not apply to 

deem a dividend to have been received in respect of the disposition. 

Clearly, this approach is not elegant. The employee would have additional taxable 

income in the year the bonus is awarded but would not have additional cash with which 

to pay the tax unless a loan as described above was employed. Securities law 

compliance issues would also have to be considered. However, this approach provides 

a clear way of achieving the deduction for clawed-back compensation. 

7. CONCLUSION 

Some may hope for a specific amendment to the Act of dealing with the clawback issue 

although there may be very limited sympathy, and therefore political will, for such an 

amendment. Accordingly, structuring a clawback utilizing one of the three methods 

above may be the most prudent if there is a desire to ensure that the clawback is tax 

neutral. 

22214407.1

Update on Canada Revenue 

Agency Positions on Long Term 

Incentive Plan Conversions and 

Cross Border Cash Based 

Incentive Plans 

Presented by: 

Elizabeth Boyd 

April 10, 2012 

1


Bill is a Senior Consultant in the Executive Compensation practice of Towers 

Watson, located in our Toronto office. 

Prior to joining Towers Watson, Bill held a number of senior level human 

resources and compensation positions over a 12 year period at a leading 

Canadian financial institution, most recently in the role of Vice President, Human 

Resources, Wealth Management. During this time, Bill was involved in 

numerous practical experiences with respect to employee, executive, and Board 

of Director compensation analysis and design. 

Bill has worked closely with senior executives in supporting a number of 

strategically important initiatives such as: 

• Preparation of public disclosure documents (e.g., proxy circular) 

• Assessing compensation implications during mergers and acquisitions 

• Leading the design of a Total Rewards strategy 

Bill is a former president of the WorldatWork GTA Rewards Association, and 

holds a Bachelor of Science degree from the University of North Carolina, 

Greensboro. 

Contact: 


Towers Watson 

175 Bloor Street East 

South Tower, Suite 1701 

Toronto, ON M4W 3T6 

PH: 416 960-7481 

Email: bill.sutherland@towerswatson.com


David Crawford is a Senior Consultant in the executive compensation practice of 

Towers Watson. He has consulted on executive compensation issues for twenty 

years. A significant portion of his time is spent working with clients in the areas 

of stock and incentive based compensation, as well as executive and director 

pay related governance. 

David’s work crosses a number of industries including financial services, media, 

manufacturing, energy, and cyclical businesses. He acts as lead consultant for a 

number of large Canadian companies, as well as supports clients of other 

Canadian consultants on technical, financial and corporate transactional issues 

relating to executive compensation. 

David has written several articles and papers in these areas. He recently coauthored 

publications on executive pay and director pay as part of a “20 

Questions Directors Should Ask” series, produced by the Risk Management and 

Governance Board of the Canadian Institute of Chartered Accountants. David 

received an MBA from The University of Toronto and is also Chartered Financial 

Analyst (CFA). 

Contact: 


Towers Watson 

175 Bloor Street East 

South Tower, Suite 1701 

Toronto, ON M4W 3T6 

PH: 416 960-7145 

Email: david.crawford@towerswatson.com

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