Canada's 2010 Budget released March 4, 2010 makes several
significant changes to the taxation of options and stock
appreciation rights (SARs). In general, the new regime takes effect
after 4:00 p.m. (EST) on March 4, 2010.
First, the 2010 Budget eliminated the limited deferral that
allowed an optionholder to defer tax on the exercise of an option
to acquire publicly listed shares until the year in which the
shares were sold (subject to an annual limit of $100,000); so
options are now taxed at the time of exercise. The deferral for
options to acquire shares of Canadian-controlled private
corporations (CCPCs) was retained.
The 2010 Budget provides relief for employees who made the
$100,000 deferral election and experienced financial hardship
because of a decline in the value of the optioned shares: the
budget provides a new election that limits the tax liability to the
value of the optioned shares.
Second, the Canada Revenue Agency (CRA) has eliminated the
administrative policy that permitted (i) an optionholder to elect
to receive the difference between the exercise price and fair
market value of the shares (the "in the money" amount) in
cash (a SAR) and to be effectively taxed at capital gains rates;
and (ii) the employer to claim a deduction for the amount paid.
Now, optionholders will be eligible for capital gains rates taxes
only if they (i) exercise options by acquiring shares; or (ii)
exercise a SAR and the employer makes an election to forgo the
deduction for the cash payment it made. This change is not
particularly surprising, because the previous situation was
anomalous from a tax policy perspective.
Third, the 2010 Budget clarifies that employers are required to
withhold tax on the exercise of an option (other than in respect of
a CCPC). In the past, withholdings had to be made against other
cash payments and where this would significantly reduce an
employee's take home pay and create financial hardship,
employers relied on an administrative concession to reduce or
eliminate withholdings. The 2010 Budget does not address the
availability of this administrative concession. Therefore,
employers relying on "financial hardship" to reduce
withholdings should seek a formal waiver from the CRA.
Effect of the Changes on Existing Option and SAR Plans
In order to meet the CRA's previous administrative policy to
effectively get capital gains tax rates on SARs, plans were drafted
so the employee had the right to exercise the option and acquire
shares. Under the new regime, employees will now always elect to
exercise options, rather than SARs, unless the employer commits to
elect to forgo the deduction. The only exception to this may be in
unusual circumstances in which there is a requirement to hold the
option shares for a lengthy period. The effect of the tax changes
is that some of the good governance practices becoming associated
with option grants (e.g., a hold period after exercise or during
employment for the optioned shares) will likely be eliminated.
Companies that wish to encourage employees to exercise SARs
(to avoid dilution, particularly if they have a plan that allows
the shares' underlying options cancelled on the exercise of the
tandem to be added back to the reserve) should make the commitment
to forgo the deduction.
Given the lack of advantage of SARs and the potentially adverse
accounting treatment, we expect that employers will consider
whether they should retain the ability to grant SARs. Option and
SAR plans that do not provide for the employer to sell or withhold
shares on the exercise of an option, to provide for withholding
taxes, should be amended to specifically permit this.
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.
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