While the global pandemic has understandably been the focus in 2020, Canada’s federal government confirmed on November 30, 2020 that it plans to proceed in 2021 with previously-announced income tax changes which will amend the rules regarding employee stock options. In its Federal Fall Economic Statement 2020, the government said it would proceed with changes which will limit the availability of the existing (50 per cent) deduction limit on employee stock option changes.
When implemented, the amended rules will apply to stock options granted after June 30, 2021. (This schedule for implementation defers what had been announced in 2019). The existing rules would continue to apply to options granted before July 1, 2021.
The proposed changes will include a new CDN$200,000 limit on the value of stock options that may vest for an employee in a year and continue to be eligible for the current deduction. This existing deduction has the effect of allowing all of the stock option gain to receive capital-gains like treatment. The new CDN$200,000 cap will be measured based on the fair market value of the underlying shares at the time the options are granted. Options vest when they first become exercisable. The rules will include provisions intended to prevent the use of multiple corporations or related companies in an attempt to access the individual limit more than once.
In conjunction with the adoption of the new stock option rules, employers who operate options plans will be required to notify employees (at the time of an option grant) and the Canada Revenue Agency (at the time of filing of their income tax return) if any stock options which have been granted are not eligible for the 50 per cent deduction because of the new rules. In other words, employers will essentially be required to advise the government about all options, including whether or not the options are qualified or non-qualified options for the purposes of the CDN$200,000 individual limit.
In cases where an employee exercises a stock option that is in excess of the CDN$200,000 individual limit, the difference between the fair market value of the shares at the time the option is exercised and the amount paid to acquire the shares will be treated as a taxable employment benefit. The full amount of this employment benefit must be included in the employee’s income for the year when the option is exercised. This approach is consistent with what applies to other forms of employment income. In this scenario, the employee would not be entitled to the stock option deduction in respect of the employment benefit.
The new Canadian employee stock option rules also have implication for employers and their corporate tax and related obligations. For options in excess of the individual CDN$200,000 limit, the employer would be entitled to an income tax deduction in respect of the stock option benefit included in the employee’s income. As a result, employers subject to the new rules would also be able to choose whether to grant stock options under the existing treatment (up to the CDN$200,000 limit per employee), or whether to grant stock options under the new tax treatments (which would be ineligible for the employee stock option deduction, but be eligible for a deduction for corporate income tax purposes).
The 2020 Fall Economic Statement includes new information about which entities the new rules will apply to. The new rules will generally apply to employers that are corporations or mutual fund trusts. The new rules will generally not apply to Canadian-controlled private corporation (CCPCs). Further, based on a stated recognition that certain non-CCPCs could be start-ups or emerging companies, those employers whose annual gross revenue does not exceed CDN$500 million will generally also not be subject to the new rules.
The amended rules for Canadian stock options will invariably result in closer scrutiny by employers with respect to their compensation programs and related obligations. As a consequence, we can expect to see more activity on this in early 2021 and beyond.