Canada: Proposed Changes To Stock Option Tax Rules

On June 17, 2019, Canada's finance minister tabled a Notice of Ways and Means Motion regarding the taxation of employee stock options. This follows from the government's announcement in the 2019 Budget that it intended to limit the availability of the 50 per cent deduction on employee stock option benefits (i.e., the deduction that effectively provides capital gains treatment on qualifying options). For more details on the 2019 Budget, please see our March 2019 Blakes Bulletin: 2019 Federal Budget – Selected Tax Measures.

CHANGES TO TAKE EFFECT JANUARY 1, 2020

The proposed changes to the stock option rules are scheduled to take effect on January 1, 2020. Stock options granted prior to January 1, 2020 should remain subject to the existing deduction regime.

STOCK OPTION DEDUCTION CAPPED

The 2019 Budget proposed to limit the tax-preferred treatment of options for employees of "large, long-established, mature firms" and to allow "start-ups and rapidly growing Canadian businesses" to retain the unlimited ability to issue stock options that qualify for the tax-preferred treatment to reward employees. The government has deferred the difficult task of drawing the line between these two groups of issuers in a clear and readily understandable manner to the yet-to-be released regulations.

The proposed changes include a new C$200,000 limit on the amount of stock options that may vest for an employee in a year and continue to be eligible for the deduction. This limit will apply to options granted on or after January 1, 2020 by corporations or mutual fund trusts other than Canadian-controlled private corporations (CCPCs) and a yet-to-be defined category of "start-ups, emerging or scale-up companies" (Emerging Companies). The value of the stock option for purposes of the C$200,000 limit is to be calculated based on the fair market value of the shares under the option on the date of grant.

The C$200,000 limit will apply to stock options granted by the employer and any other corporation or mutual fund trust that is related to the employer. Thus, if an employee receives options from two corporations in the same corporate group, the employee will not be able to claim a deduction on C$200,000 worth of options from each corporation vesting in a year.

Employers will be required to notify employees at the time of grant and the Canada Revenue Agency at the time of filing their income tax return in writing if options granted are not eligible for the deduction because of the new rules.

EXCEPTION FOR CCPCs AND "START-UPs, EMERGING OR SCALE-UP COMPANIES"

CCPCs and companies that are classified as Emerging Companies in the proposed regulations (not yet released) will remain unaffected by the new rules.

The government is seeking input on how to define the characteristics of companies that should be considered Emerging Companies and will accept submissions until September 16, 2019.

In making such a determination, the government's stated objectives are (i) to make the employee stock option tax regime fairer and more equitable for Canadians, and (ii) to ensure that start-ups and emerging Canadian businesses that are creating jobs can continue to grow and expand.

The government is also interested in feedback on the administrative and compliance implications associated with putting such characteristics into legislation. We note that there appear to be a number of administrative complexities that will need to be addressed in the legislation, including, for example, the treatment of options granted by Emerging Companies as they grow and evolve over time.

CORPORATE TAX DEDUCTION

Under the new rules, an employer (other than a CCPC or an Emerging Company) will be eligible for an income tax deduction in respect of stock option benefits that are not eligible for the 50 per cent deduction (i.e., benefits arising under options that exceed the C$200,000 limit but otherwise meet the requirements for the deduction). These employers will also be able to designate specific employee stock options as ineligible for the 50 per cent deduction and instead (if certain conditions are met) deduct the stock option benefit in computing the employer's taxable income.

Based on the draft legislation, the corporate deduction will not extend to other types of equity compensation that would not have qualified for the 50 per cent deduction under the existing rules, i.e., there will be no corporate tax deduction for restricted share units, performance share units or deferred share units that are required to be settled in treasury shares, and no deduction for options granted at a discount by non-CCPCs, or granted to non-arm's length employees.

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