Overview

Restricted Share Units (RSUs) are a type of equity compensation that may be awarded to an employee. RSUs are notional units 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. At the end of a predetermined period (known as a vesting period) RSUs can be redeemed for common shares. RSUs may also be redeemable for a cash benefit that’s based on the fair market value (FMV) of the shares.

The benefit an employee receives from RSUs is dependent on the price of the underlying shares at the time of vesting. The inherent benefit to the employer is that this incentive aligns the goals of the employee with the goals of the company. The vesting period can help with employee retention and is another reason that RSUs are a widely used form of employee compensation. If an employee leaves the company before the end of the vesting period, the RSUs are generally forfeited back to the company.

Taxation

The general rule is that tax is payable on employment benefits in the year they are received. A benefit of RSUs is that the employee is not taxed until the year that they vest. This tax deferral relies on one of the exceptions (three-year bonus exception) to the Salary Deferral Arrangement (SDA) rules. Specifically, RSUs are structured to vest (pay out) before the end of the third calendar year after the year in which services relating to the compensation were rendered. It’s important to note it’s based on the year services were rendered, not the year the RSUs were granted, which is often the following calendar year. If the SDA rules are triggered, the employee would be taxed in the year the RSU is granted, causing increased and unforeseen tax costs.

Regardless of whether the RSUs 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 RSUs 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 benefit an employee receives from RSUs is variable and uncertain, as it depends on the performance of the underlying shares. However, even if the share price depreciates, the RSUs will still have some value when they vest. Employees that have a negative outlook on future share price and / or a lower risk tolerance would likely prefer RSUs to Employee Stock Options (ESOs).

When considering the value of RSUs, employees should consider how long they plan to stay with a company. The typical vesting period for RSUs is three years, and so employees planning to leave within this timeframe will not typically derive any benefit from the RSUs.

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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