Overview

Performance Share Units (PSUs) are very similar to Restricted Share Units (RSUs). PSUs are notional units granted to an employee that mirror the market value of the employer’s common shares and do not represent actual share ownership. While employees do not receive any dividends that are paid to owners of the underlying shares, they are generally granted additional units equivalent to the value of dividends. Performance shares are different from PSUs and represent actual shares that are held within a restricted account.

At the end of a predetermined period (known as a vesting period), PSUs may be redeemable for the underlying common shares. The defining characteristic of PSUs is their focus on performance. For PSUs to be redeemed for the underlying common shares, specified performance target(s) must be achieved. A PSU award may be subject to a single or multiple performance targets, relating to either an individual or the overall company. If performance targets are not met, the PSUs will be forfeited. In some cases, PSUs may also be redeemable for a cash benefit that’s based on the fair market value (FMV) of the shares.

Taxation

The general rule is that tax is payable on employment benefits in the year they are received. A benefit of PSUs is that the employee is not taxed until the year that they vest (assuming performance targets are met). This tax deferral is dependent on an exception to the Salary Deferral Arrangement (SDA) rules.

One exception to the SDA rules is allowed when there is “substantial risk” that one or more of the conditions (performance targets) will not be met. The threshold for this exception is very high, and the risk of forfeiture must be definite and substantial. If it’s likely that the performance targets will be fully or partially met, this exception would not apply.

As a result of this high threshold, PSUs typically avoid the SDA rules by relying on the three-year bonus exception. This requires PSUs to vest (pay out) before the end of the third calendar year after the year in which services relating to the compensation were rendered. This three-year vesting period incentivizes employees over a medium time horizon.

Regardless of whether the PSUs are converted to common shares or an equivalent cash benefit is received, the benefit is fully taxable as employment income and subject to payroll withholding tax. When PSUs are converted to actual common shares, an employer may address the withholding tax by paying out a net number of shares. Another option to meet this requirement would be to withhold an additional amount from other income sources such as an employee’s salary.

Employee Considerations

The terms of Performance Share Units (PSUs) are documented in a contract and will include the specific performance target(s), minimum performance required to achieve target(s), and the performance period and vesting date.

The potential benefit from PSUs is dependent on share price, resulting in a more variable incentive than a traditional cash bonus. An increase in share price would increase the desirability of the bonus. Conversely, an employee may be less motivated to achieve a performance target if the share price decreases in value.

This article is meant to provide a general overview and is not intended to provide tax or legal advice. You should consult with professionals to ensure that your own unique circumstances have been considered and any action taken is based on the latest information available.

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