Canada: Department of Finance Releases Draft Legislative Proposals Amending Stock Option Rules – Option Plan Amendments May Be Required Prior to 2011

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax/Pension & Employee Benefits, October 2010

On August 27, 2010, the Department of Finance released draft legislative proposals for the Income Tax Act (Canada) (the ITA). Related Explanatory Notes were made available on September 10, 2010 and additional draft legislative proposals, addressing many of the same provisions of the ITA as the August 27 proposals, were released on September 28, 2010. If enacted, many of these proposals will take effect as of 4:00 p.m., Eastern Standard Time, March 4, 2010 (the Announcement Time). For a discussion of the stock option amendments as announced earlier this year, please see our March 2010 Blakes Bulletin: Canadian Federal Budget Announces Changes to Employee Stock Option Rules.

These legislative proposals include significant tax changes with respect to employee stock options. These proposed tax changes mean that some corporations and mutual fund trusts that provide employee security options (generally referred to in this bulletin as "stock options") may need to amend existing option plans and/ or grant agreements before December 31, 2010. These tax changes were first announced in the March 4, 2010 Federal Budget (the Budget) and include:

  • the requirement, commencing in 2011, for the withholding and remittance of tax in respect of an employment benefit realized by an employee exercising a public company stock option;
  • the requirement that on a cash-out of a stock option right, the employer must elect to forego a tax deduction of the cash-out amount for the employee to be subject to capital gains equivalent tax rates in respect of the cash-out amount; and
  • the repeal of the election which allowed employees exercising public company stock options to defer including an amount in income until the shares were sold.

Grantors of stock options should review their option plans and grant agreements to determine whether amendments should be made prior to 2011 in light of the proposed changes to the ITA. If a grantor of options determines that amendments to its stock option plan or grant agreements are advisable, it should review the amending and other provisions of its plan or grant agreements, as the case may be, and the requirements of any stock exchange on which its securities are listed. Of particular concern for public companies is that, in certain circumstances, board and/or securityholder approval may be required to effect the amendments. The timeline for obtaining such required approvals should be considered in light of the changes to the ITA becoming effective as of January 1, 2011.



Under the ITA, an employee stock option is generally taxable to the optionholder at the time the option is exercised. When an employee exercises the option, there is a deemed employment benefit equal to the in-the-money value of the exercised option (essentially the difference between the exercise price paid by the employee and the fair market value of the shares at the time of exercise). Provided certain conditions are met, the employee can claim a 50% deduction against the amount of the deemed employment benefit, effectively resulting in the stock option benefit being taxed at capital gains rates.

Tax Changes

The proposed amendments include significant changes to the rules relating to the obligation of a person providing a stock option benefit to withhold and remit tax in connection with the exercise of stock options after 2010. Under the proposed changes, a person conferring a stock option benefit on an employee will be required to make withholdings from the employee's remuneration determined on the hypothetical basis that the deemed employment benefit that arises as a consequence of the exercise of the options is paid to the employee as a cash bonus. The person conferring the option benefit may be the direct employer of the option holder, but could also be a parent or affiliate of the employer. For these purposes, if the 50% stock option deduction in paragraph 110(1)(d) is available, the amount of the benefit subject to withholding may be reduced by one-half. The proposed amendments to the ITA do not address what would happen if the amount of the employee's cash remuneration available to the person conferring the stock option benefit to withhold from was not sufficient to fund the withholding obligation. Moreover, as announced in the Budget, the proposed legislation expressly provides that in granting discretionary relief from withholding under subsection 153(1.1), the Canada Revenue Agency (the CRA) will not be entitled to waive a withholding requirement in respect of a deemed benefit under subsection 7(1) solely because it is received as a non-cash benefit.

The changes to the withholding requirements will not apply to stock options granted by Canadian-controlled private corporations, nor will they apply in connection with certain charitable donations of proceeds arising from the sale of securities acquired pursuant to an option. In addition, under transitional rules contained in the draft legislation, the new withholding requirements will not apply to "grandfathered" options granted before 2011 provided the options were granted pursuant to a written agreement that (i) was entered into before the Announcement Time, and (ii) included a written condition prohibiting disposition of shares acquired through the exercise of options, for a period of time after exercise. We note that the Budget proposals referred to an agreement that "restricts" not "prohibits" disposition. In addition, under the draft legislation, the relief from withholding appears to apply only if the prohibition on disposition is contained in the option agreement itself. This would seem to mean that provisions in other documents, such as corporate share ownership policies, employment agreements, lock-up agreements with underwriters, etc., that could prohibit or restrict the sale of shares acquired under an option would not result in the application of the grandfathered tax withholding treatment.

Implications for Employers and Employees – Employers Need to Consider How Withholding will be Funded

Commencing in 2011, corporations and mutual fund trusts that provide employee stock options will not be entitled to rely on various statements made by the CRA suggesting that withholding in respect of stock options may not be required or may be reduced. The proposals offer no guidance as to how to satisfy the withholding obligation. In practice, employees receiving large stock option benefits may have to immediately dispose of shares in order to pay the tax. However, this may not be viable where the shares are not publicly traded.

Corporations and mutual fund trusts that grant options will need to review their current withholding arrangements for stock options and their stock option plans and grant agreements to determine if provision is made for funding of the withholding requirements.

Changes to stock option plans and related documents that may be advisable include provisions requiring an employee who is exercising an option to:

  • remit sufficient cash to the person conferring the option benefit to fund the withholding obligation;
  • elect to have a portion of the shares that are acquired by the employee on the exercise of the stock option deposited with a broker who is directed to sell the shares on behalf of the employee and remit sufficient proceeds to the person conferring the option benefit to fund the withholding obligation; or
  • make other acceptable arrangements to fund the withholding obligation.

Where employees will have the ability to elect to deposit shares with a broker to be sold, it may also be advisable for the stock option plan or related documents to include details regarding the process by which any shares will be sold and the obligations of the parties involved, including provisions relating to the timing and price of any sale and protections for the person conferring the option benefit and possibly the broker in the event of a delay or other complication in selling the shares.

If a grantor of employee stock options determines that amendments to its option plan or grant agreements are advisable, it should review the amending and other provisions of its plan and/or grant agreements and the requirements of any stock exchange on which its securities are listed. In certain circumstances, board and/or securityholder approval may be required to effect the amendments. The timeline for obtaining such required approvals should be considered in light of the changes to the ITA becoming effective as of January 1, 2011.

If an employee elects to sell a portion of the shares acquired on the exercise of a stock option and the employee also owns other shares, the employee should consider whether to make an election under subsection 7(1.31). Where this election is available, making the election will ensure that it is the share acquired on the exercise of the stock option that is considered to be sold (rather than another share owned by the employee) and that the adjusted cost base (ACB) of the share that is sold is not averaged with the ACB of any other shares owned by the employee, as averaging could result in a reduced ACB and an unintended capital gain from the sale of the shares.



A number of employee stock option plans provide cash-out rights (also sometimes referred to as "tandem stock appreciation rights" or "tandem SARs") whereby the employee can elect either to exercise the option in the ordinary course and receive the shares or receive a cash payment equal to the in-the-money amount of the option. The 50% deduction (capital gains rate taxation) is also generally available where the employee exercises the cash-out right provided the option itself qualifies for the 50% deduction. Historically, the CRA took the position that an employer generally could claim a deduction for the full amount of the cash payment paid to an employee upon exercise of a cash-out right even if the employee qualified for the above-noted 50% deduction, although it is understood that the availability of the employer deduction in the context of certain corporate transactions is unclear.

Tax Changes

Under the proposed amendments, the employee will be denied the 50% employee stock option deduction unless the employer elects, in prescribed form, to forego a deduction in respect of the cash-out payment. In effect, either the employee can claim the 50% deduction or the employer can claim a deduction on the cash-out payment, but not both. This measure will immediately and retroactively apply to all options exercised (or cash-out rights exercised) after the Announcement Time, regardless of the date the underlying option was granted. In order for the employee to claim the 50% deduction, the employer's election to forego a deduction must be filed with the CRA by the employer, evidence in writing of this election must be given to the employee, and this evidence must be included by the employee with his or her income tax return for the year in which he or she claims the deduction. In addition, the election must apply to all of the employee's options under a particular option agreement, although not necessarily under all option agreements with a particular employer. While the draft legislation refers to the election being in "prescribed form", to date no guidance has been provided by the Department of Finance or the CRA as to what that prescribed form will be.

Provision is made for a "designated amount", to be carved out of the amount that the employer elects to forego deducting. A designated amount will, in general, be an amount paid to a third party to hedge the employer's liability with respect to the stock option cash‑out. Specifically, it is an amount that would:

  • otherwise be deductible in computing the income of the employer in the absence of proposed subsection 110(1.1);
  • be payable to a person with whom the employer deals at arm's length, who is neither an employee of the employer (nor of a person not dealing at arm's length with the employer); and
  • be in respect of an arrangement entered into for the purpose of managing the employer's financial risk associated with a potential increase in value of the securities under the stock option agreement.

Implications for Employees and Employers

The inability of both employers and employees to take this previously enjoyed "double" deduction presents several immediate concerns.

First, employees will need to be aware that if they exercise a cash-out right, they may not qualify for the 50% deduction unless the employer elects to forego its deduction for the cash-out payment. Second, employers which provide stock options with cash-out rights will need to determine whether they are prepared to forego the deduction of the cash-out right, on some or all options, whether cash-out rights should be eliminated on some or all outstanding options and whether cashout rights should be provided with any new options. In the case of outstanding options, the employer may also wish to consider whether the cash-out right could be eliminated through an amendment or exchange of an existing option. If cash-out rights will continue to be included in a stock option plan and the employer might choose to forego a deduction of a cash-out amount to allow for preferential tax treatment to the employee, the stock option plan should be reviewed to ensure that the employer has the authority to make the required income tax elections and notifications. If there is any question on this matter, amending the stock option plan to specifically provide that the employer has the authority to make any elections permitted by the ITA would be prudent.


Background and Tax Changes

The stock option rules under the ITA were amended in 2000 to permit an employee to defer inclusion in employment income of the stock option benefit relating to publicly traded shares until the year in which the employee sells the underlying shares. Similar to U.S. incentive stock options (ISOs), there are limits on the number of options and the options must meet certain criteria in order to qualify for the deferral election. This deferral election will be repealed with the result that the election will not be available for any stock option exercised after the Announcement Time.

The proposed amendments provide some relief to individuals who took advantage of the deferral election and find themselves in the situation where the tax payable by them exceeds the value of the shares. In brief, under proposed new Part I.1 – Tax In Respect Of Stock Option Benefit Deferral – an employee will be able to elect to pay a special tax equal to the full proceeds of disposition of such shares (two-thirds of the proceeds if the taxpayer is resident in Quebec) instead of the amount that would otherwise have been payable in connection with the exercise of the options. Should the employee elect to pay this tax, he or she will lose the capital loss resulting from the disposition (i.e., the employee will not be able to offset this loss against other capital gains). The special election is intended to apply to sales of optioned shares before 2015, including sales of optioned shares in previous years where a deferral election has been made. Where an employee wants to make the election for shares sold before 2010, the employee will be required to make the election on or before their filing due-date for the 2010 tax year.

Implications for Employees and Employers

The repeal of the deferral election, combined with the new withholding requirements, will create a greater incentive on the part of many employees to dispose of shares acquired through an exercise of the option in order to pay for the tax liability that arises from the exercise of the options. This could work against the objective of employers to promote minimum or target share ownership and in practice may be difficult where the shares are not publicly traded (or only thinly traded).


The draft legislative proposals relating to stock options also clarify that the rules in subsection 7(1) apply in circumstances in which an employee disposes of rights under an agreement to sell or issue securities to the grantor of the options (or a qualifying person with whom the grantor does not deal at arm's length) and where a person with whom the employee does not deal at arm's length who has acquired the employee's rights under an option agreement disposes of those rights to a qualifying person with whom the person does not deal at arm's length.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
27 Oct 2016, Seminar, Toronto, Canada

Please join members of the Blakes Commercial Real Estate group as they discuss five key provisions of a commercial real estate purchase agreement that are often the subject of much negotiation but are sometimes misunderstood.

1 Nov 2016, Seminar, Toronto, Canada

What is the emotional culture of your organization?

Every organization and workplace has an emotional culture that can have an impact on everything from employee performance to customer or client satisfaction.

3 Nov 2016, Seminar, Toronto, Canada

Join leading lawyers from the Blakes Pensions, Benefits & Executive Compensation group as they discuss recent updates and legal developments in pension and employee benefits law as well as strategies to identify and minimize common risks.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.