Proposed changes to stock option rules
In 2019, the federal government announced changes to the taxation of employee stock options granted after 2019. The intention is to limit the scope of the current stock option tax regime considering the public policy rationale for preferential tax regime is to support younger and growing Canadian businesses.
Under the Canadian tax legislation, when an employee exercises a stock option, a taxable employment benefit will arise equal to the difference between the exercise price and the fair market value of the shares on the date of acquisition. If certain conditions are met, employees are entitled to a 50 percent deduction against the taxable employment benefit. If the employee exercises a stock option of a Canadian-controlled private corporation, the taxable employment benefit is deferred until the employee disposes of the shares.
Under the draft legislation, the preferential tax treatment on employee stock options issued by certain employers would be subject to an annual vesting limit of CAD 200,000 per employee, in each year in which options becomes exercisable and based on the fair market value of the underlying shares at the time the options are granted. When an employee exercised stock options that exceed the CAD 200,000 cap (“non-qualifying security”), the stock option benefit will be taxed at ordinary tax rates without the benefit of the 50 percent deduction against the taxable employment benefit.
The amounts that exceeds this limit will be eligible, if certain conditions are met, to a new employer deduction equal to the value of the taxable benefit that will be included in the employee’s taxable income for that year. In addition, employers will be able to designate options that would otherwise fall within the annual limit and hence qualify for the stock option preferential tax treatment as ineligible entitling them to the tax deduction when employees exercise the stock options.
Employers would also be subject to new reporting requirements. For example, they must file a prescribed form with their annual corporate income tax return to notify the Canada Revenue Agency any granted options that are non-qualified stocks. They must also notify the employees of any options exceeding the annual limit of CAD 200,000 or of the options that will be designated as non-qualified securities.
These new rules would not apply to stock options granted by the following employers: Canadian-controlled private corporations (CCPCs) or specified employers (start-up, emerging or scale-up companies that would meet conditions that will be prescribed by the Income Tax Regulation).
The proposed changes were supposed to become effective upon the release of the legislative proposals and applicable to stock options granted on or after 1 January 2020. However, Finance Canada announced at the end 2019, that the changes will not come into effect on 1 January 2020, as they will review the input received during consultations by businesses. There is uncertainty on the effective date of these proposals. We have to wait the 2020 federal budget.
The new rules, if and when, they are enacted will increase employers’ administrative burden, as they will have to keep track of non-qualified securities and report them to the tax authorities.
According to the proposed rules, employers may want to consider having options vest over the years to ensure the CAD 200,000 annual vesting limit will not be exceeded.
Depending on the effective date of the new rules, employers may want to consider accelerating option grants before that date.