There has been much speculation about the tax measures to be included in the new federal government's first budget that will be presented next week, on March 22. Of particular interest to the start-up and technology communities is whether the budget will introduce changes to the tax treatment of employee stock options. The Liberal party's election campaign promised reform in this area, but contained few details of the proposal.
Current treatment of stock options
An employee stock option grants an employee the right to purchase shares of its employer company at a stated exercise price. Upon exercise of the option, a taxable employment benefit is included in the employee's income, equal to the difference between the market value of the shares at that time and the option exercise price. If the employer is a Canadian-controlled private corporation, the benefit may be recognized when the employee disposes of the underlying shares. If certain criteria are met, the employee may deduct half of the taxable benefit, which results in a treatment similar to a capital gain.
Speculation and concern about the proposal
Based on the 2015 federal Liberal election platform, the government intends to cap claims for employee stock option deductions by high earners. The Department of Finance estimates that 8,000 high-income Canadians deduct an average of $400,000 from their taxable incomes due to employee stock options. This represents three quarters of the total $750,000 million cost of employee stock option deductions in 2014. The election platform was light on details, but indicated that employees with up to $100,000 in annual stock option gains would be unaffected by the new cap. Understanding the taxation of employee compensation packages can be an important aspect in a deal, and parties to transactions should become apprised of any changes to the stock option regime once announced.
Federal Finance Minister Bill Morneau stated in November that any change to the treatment of stock options would only affect options issued after the date of the announcement, and would exempt existing stock options.
The start-up and technology sectors have been vocal about their concern that the proposed changes to the current regime may hinder future innovation and drain top talent from Canada. Employee stock options are a key recruiting and compensation tool for many start-up companies, given their ability to compensate employees without tapping into company cash flow. The co-founder of the Council of Canadian Innovators, the members of which include leading technology entrepreneurs, is quoted as saying "[Fast-growing start-ups] are in a war for talent and we need to focus on policies that will help us find the people".
Prime Minister Trudeau and members of his government have indicated to the media a willingness to consider the concerns of the business community on the issue of stock options, but the outcome remains to be seen when details of the plan are finally announced.
The author would like to thank Sam Zadaeh, articling student, for his assistance in preparing this legal update.
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