16 December 2020
The Canadian government is finally moving forward with plans to impose an annual cap on the value of employee stock options that can qualify for preferential tax treatment.
This development has been on the radar since it was announced in the 2019 federal budget, with an anticipated start date of 1 January 2020 (see here). The introduction of the change was initially delayed while the proposals were subject to consultation and then further delayed when Covid-19 caused the Canadian government to postpone the 2020 federal budget. The government included revised proposals for the tax treatment of stock options in the Fall Economic Statement (released on 30 November), which are now due to come into force on 1 July 2021.
How does the preferential tax treatment for stock options currently work?
When an employee exercises an option granted under an employee share plan, income tax is due on the positive difference between the value of the shares on acquisition and the exercise price paid by the employee. Under the current rules, if certain conditions are met, as long as the exercise price is not less than the fair market value of the shares at the time that the options were granted, the employee can benefit from a 50% deduction on the income tax payable. The beneficial tax treatment does not apply to other types of share plan and separate rules apply in Quebec.
What is going to change?
The proposed change is to limit the scope of the benefit by introducing an annual cap on the value of options that will be eligible for the tax deduction (at the moment there is no cap). Under the proposal, an employee will only be able to claim a deduction in each calendar year for stock options valued up to CAD200,000 that become exercisable during that year. The valuation is based on the fair market value of the underlying shares at the grant date. If the annual limit is exceeded during a calendar year, the preferential tax treatment will apply to the first options granted.
Which employees are covered by the cap?
Initially, the government announced that the cap would apply to options granted to employees working for ‘large, long-established, mature firms’, the aim being to exclude small companies and start-ups, but there was no clear explanation as to how this would be defined. Under the new proposal, the cap will not apply to employee stock options granted by Canadian-controlled private corporations (CCPCs), or by non-CCPCs whose gross revenues, or whose corporate group gross revenues, are CAD500 million or less.
How does this affect the employer?
Currently, employers are not able to claim a corporate tax deduction where shares are issued following the exercise of an employee stock option. Under the proposal, employers may be able to claim a deduction for non-qualifying stock options, that is options which do not qualify for the 50% tax deduction. In addition, under the new proposals, the employer will be able to designate at grant that certain of the stock options will be treated as non-qualifying, and the non-qualifying securities will not be eligible for the preferential tax treatment but will be eligible for a corporate tax deduction. The employer must notify the employees and the Canadian tax authority within thirty days of grant if any of the stock options will be non-qualifying.
Is there any other employer reporting?
The employer will be required to report to the tax authority the issue of stock options for non-qualified securities. The report will be submitted on a prescribed form (yet to be released). Employers will also be required to track which options are qualified for the purposes of income tax withholding and for completing form T4 (the summary of the remuneration paid to an employee).
What is the timing?
The proposals are not yet in force and require approval from the Canadian parliament. Assuming the changes are approved, they will apply to options granted from 1 July 2021. The existing beneficial tax treatment will apply to all awards for options granted before 1 July 2021.
The key take away points from the new proposals are:
- The beneficial tax treatment for stock options will be capped at CAD200,000 per calendar year of vesting.
- The cap is based on the share price at time of grant.
- Employers can designate that certain options will be non-qualifying (i.e. where the employee pays the full amount of tax).
- Employers can receive a corporate tax deduction for non-qualifying options
- Employers will have additional reporting obligations.
- The rules will not apply to employees of CCPCs or companies with revenue below CAD500 million.
- The proposals are due to apply to options granted from 1 July 2021.
The availability of the 50% tax deduction has made options popular in Canada, and the new tax treatment may result in a switch to other types of incentive plans. Employees who are granted options from 1 July 2021 can however still take advantage of the beneficial tax treatment up to the CAD200,000 cap.
The extension of the starting date to 1 July 2021 allows companies additional time to review existing plans and to potentially bring forward grants, or even put in place new plans to ensure that grants are made before the cut-off date, so that employees can benefit from the current rules.
The availability of a corporate tax deduction for employers for the non-qualifying options is a positive development, although employers will need to weigh up the competing advantages of allowing employees to take advantage of the beneficial tax treatment against the ability of the employer to take a tax deduction.
We will keep you informed of the progress of this development.
If you would like to discuss this update, or anything else, please do contact us.
Sharon Thwaites and Sonia Taylor