Last June, we provided the bulletin below outlining the Federal government's proposed changes to the tax treatment of employee stock options, and indicated the Federal government would be seeking public consultation on this proposal through September 16, 2019. The proposed changes were supposed to apply to employee stock options granted after January 1, 2020. On December 19, 2019, the Department of Finance released an update on the proposed changes and indicated the changes would not take effect on January 1 after all, and the government would take more time to review the input received on the characteristics of companies that should be considered "start-up, emerging, and scale-up companies" and exempt from the new rules. The government has not abandoned its plan to implement changes to the tax treatment of employee stock options, and will announce details on how it intends to move forward with the measure in the 2020 Federal Budget. We will follow these developments closely and provide further updates as more information becomes available.
June 25, 2019
In the 2019 Federal Budget released earlier this year, the federal government announced proposed changes to the Income Tax Act (Canada) (the “Act”) which would limit the current preferential tax treatment of employee stock options.
Under the current rules, when an employee exercises a qualifying stock option, the value of the benefit (being the difference between the exercise price of the option and the fair market value of the share at the time of exercise) is included in the employee's income, but the employee may claim an offsetting deduction equal to 50% of the benefit if certain conditions are met. The government had expressed concerns that a small percentage of very wealthy taxpayers were using stock options to significantly reduce their incomes, and indicated it would be introducing amendments to the Act to limit the deduction available to employees of “large, long-established, mature firms.”
On June 17, 2019 the government introduced draft legislation to amend the Act, and stated it would be seeking public consultation through September 16, 2019 on certain aspects of the proposed changes. The draft legislation provides for an annual limit of $200,000 on qualifying employee stock options that are eligible for the deduction, with the limit being based on the value of the underlying shares at the time the option is granted.
For example, if a taxpayer is granted 10,000 stock options by its employer which vest in a particular year, and the fair market value of the shares of the company at the time of the grant is $25 per share, only 8,000 of those options (8,000 * $25 = $200,000) will be eligible for the deduction upon exercise, and the taxable benefit received upon the exercise of the remaining 2,000 stock options will effectively be taxed at the taxpayer's full marginal rate.
These new rules will only apply to employee stock options granted after January 1, 2020 and certain employers will be exempt from the new rules. The draft legislation currently exempts stock options granted by a company that qualifies as a Canadian-controlled private company, as well as by other companies which meet certain prescribed conditions. The government has not yet released any regulations describing such prescribed conditions but has indicated that this exemption is meant to exclude “start-ups, emerging or scale-up companies” from the new rules.
When an employee exercises an option that exceeds the $200,000 annual limit, the employer will be entitled to deduct the amount of the employment benefit from its taxable income. Employers will be required to notify both the employee (at the time of grant) and the Canada Revenue Agency (at the time of filing its tax return) in writing of any options granted that will exceed the $200,000 annual limit.
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