A stock option plan provides an employee of a corporation with the right to purchase shares of the corporation at a pre-determined exercise price. To the extent the stock option is exercised and the exercise price is less than the fair market value of the share at the time of exercise, the employee realizes an employment benefit. If certain conditions are met, the employee can claim a deduction equal to 50% of the employment benefit (the "Option Deduction"), therefore, effectively taxing the employment benefit at the same tax rate as a capital gain. Presently, there is no annual maximum amount allowable to be claimed in respect of the Option Deduction.
In fulfillment of a Liberal election platform to reduce the amount of such tax reductions being claimed by high income Canadians, it is anticipated that the federal Budget, due to be tabled on March 22, 2016, will introduce an annual cap of $100,000 in respect of the Option Deduction. However, in recent comments, the Minister of Finance has indicated that any change will likely not apply to stock options granted before the effective date of the amendment, which is expected to be March 22, 2016.
Assuming the changes are made as expected and that the effective date is not retroactive*, there is a narrow window still available for employers to grant stock options which will not be subject to the annual $100,000 Option Deduction cap. In particular, high tech and start-up businesses, as well as public companies, that grant stock options and view them to be a substantial part of the long-term incentive compensation of employees should consider whether planned stock option grants can be made before the effective date of this amendment. This will be a particularly important consideration for employees receiving large stock option grants where potential employment benefits could exceed the $100K proposed cap. In many instances, all stock option gains are realized in a single year, usually as a result of an exercise of the stock option just before a sale of the company's shares or business, such that gains that have built up over many years are all triggered in one year and potentially exceed the $100K threshold.
We therefore recommend that stock option granting employers seek advice and consider making planned new stock option grants prior to March 22, 2016.
Article co-authored with Kevin Wong CPA, CA, MNP LLP
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