Bridging the border

Compensation challenges for Canadian companies can arise from various scenarios. The first such challenge is the acquisition of a U.S. company. Canadian employers that acquire a U.S.-based company confront challenges in part due to differing legal or tax regimes and in part due to seemingly different cultural expectations around compensation. Employers quickly discover that the American employment relationship can be somewhat armslength and adversarial between the company and the employee.

In contrast, Canadian employees can view their employer as more paternal. “U.S. employees know more about their rights and are strong negotiators,” offers Jean-Francois Albert, vice-president of human resources of Montreal-based MEGA Brands, which acquired two U.S.-based companies in 2005 and 2006. “The acquisitions have put us in a position that we need to find advisors for the U.S. market who understand the business realities there, for example, advisors who understand differences between various U.S. locations and the way employees expect to be paid,” adds Albert.

Differences between U.S. and Canadian compensation practices require intense focus during the due diligence phase of an acquisition to be sure that compensation costs are not overlooked. For example, it could be an expensive mistake not to factor into the acquisition price the costs of U.S. golden parachute taxes that could be triggered by a change in control of the U.S. company, but would not be reflected in ordinary operating expenses.

Under U.S. rules(Section 280G of the Internal Revenue Code), excess parachute payments, such as severance pay and vesting of incentives, that are paid to certain senior executives upon a change in control are subject to an extra 20% excise tax. In addition, some U.S. companies have promised to cover those taxes for the employee, an extremely expensive promise that is not deductible to the employer. Such taxes do not exist in Canada and might be misunderstood by a Canadian employer.

EXPAT SUCCESS

Multinational companies want to avoid the premature return of expatriates due to failed assignments and the poor retention of returned expatriates due to failed repatriation. To reduce these costs, multinational corporations are striving to improve their capability to manage their expatriates before, during and after international assignments.

Two key success factors are managing expectations up-front, before the employee’s assignment, and establishing consistent policies that provide expatriate support throughout. “Before they move, our international transferees meet with move managers and financial advisors who know our compensation programs, at our expense, so even if they will have an adverse tax event, such as the possibility to lose residency status in their home country if they sell their home, they understand the implication of that.” says Gary Dobbie, senior vice-president of compensation, benefits and employee relations at the Royal Bank of Canada in Toronto. “They come to appreciate that [the international assignment is] a personal decision. And they understand what they will gain from the assignment, personally and professionally.”

Expatriates who are not well-informed about the financial implications of accepting a foreign assignment may tend to be more resentful of their employer when they later learn that the assignment resulted in slightly adverse tax effects or internal inequities with pay rates back home. Proper support throughout the assignment, such as financial assistance for outside tax advice, is essential. “The faster they can become acclimatised and the family can get settled, the better for business, the more productive they can be in their new office,” says RBC’s Dobbie. RBC has found success by offering personal services, including advice about local schools and financial assistance for tax preparation, for example.

“When I moved to Canada, the relocation company that RBC provided helped me sell my house in the U.S., coordinated the move, and liaised with the lawyers to coordinate visa and work permit issues, it really took a lot of pressure off me to know knowledgeable experts were helping each step of the way,” says Alison Cosadinos, senior manager of U.S. pensions and benefits for RBC who was formerly a U.S. resident.

CROSS-BORDER COMP

After the acquisition, or after an employee transfer, it is tempting to try to roll-out a single compensation platform in both countries. But such uniformity is nearly impossible. A prime example of where Canadian employers should take a closer look is share-based compensation. Stock plans are popular compensation tools in both the U.S. and Canada.

But American employees tend to have a stronger focus on the incentive portion of their total compensation. Employer stock options are often offered deeper into a U.S. organization, rather than remaining reserved for executives. “Our employee stock purchase plan was rolled out to U.S. employees,” said MEGA Brands’ Albert, “We had better participation than we expected from the newly-acquired company, and a higher rate of participation in the U.S. than from our Canadian employees.” Albert attributes this experience in part to a high-level of stock market savviness among U.S.-based employees.

TAX BREAKS

It is critical for Canadian employers to understand that U.S. citizens they hire to work in Canada are still subject to the U.S. tax rules. U.S. citizens and permanent residents are taxed based on their worldwide income, regardless of residency. For example, U.S. taxpayers working in Canada might participate in deferred stock plans, Canadian pension or savings arrangements sponsored by their employer that comply with Canadian tax laws.

However, unless the plans comply also with U.S. law, participation may result in a combination of additional U.S. taxes and a requirement to include in taxable income amounts not yet received from such arrangements. Canadian registered pension plans and other certain qualified savings plans, such as RRSPs, are generally exempt from income tax treatment for U.S. tax purposes through the U.S.-Canada Tax treaty; however, other deferred compensation plans such as supplemental pension plans do not receive the same treaty benefits.

In order for U.S. taxpayers to avoid such adverse tax consequences, their participation in deferred compensation plans must comply with recent U.S. tax laws governing deferred compensation, particularly Section 409A of the U.S. Internal Revenue Code, which was added under the American Jobs Creation Act of 2004. Employers should first identify which arrangements provide deferred compensation. Plans or individual arrangements that promise payment in a future calendar year, such as long term bonuses, stock plans, pensions and in some cases, even severance programs, could be “deferred compensation.” Next, employers should analyze them against the new U.S. tax rules for necessary amendments, which might include requiring key employees to wait six months to get payments after separation from employment. The deadline to amend the plans and agreements is December 31, 2007.

North American compensation practices are evolving as a result of increased employee mobility and acquisition activity by Canadian employers. The role of the human resources professionals has expanded to be an important business partner, by establishing supportive expatriate policies, identifying potential costs to acquisition that would affect the business, and coordinating legal and tax obstacles in both countries.

Sandra Cohen is a partner with Osler, Hoskin & Harcourt LLP in New York. sandra.cohen@osler.com

For a PDF version of this article, click here.