Budget 2019: Stock Options Back in the SpotlightTuesday, March 19, 2019
Just when you think you are out, they pull you back in. In the 2016 election, the federal Liberal Party’s platform included a review of the taxation of stock options and a cap of $100,000 on options that could receive preferential tax treatment. This was followed by a backlash from the business community, including cash-strapped start-up technology companies who utilize stock options to incentivize employees. Backtracking, the Liberal Government subsequently said it would not change the taxation of stock options. However, the Liberal Budget delivered on March 19, 2019 (“Budget 2019”) announces a cap to the use of the current employee stock option tax regime, suggesting a move towards aligning with the U.S. tax system.
1. Current Regime
The current tax rules provide employee stock options with preferential personal tax treatment in the form of a stock option deduction (the “deduction”) which effectively results in the employment benefit being taxed at capital gains-like rates. This deduction can apply to options granted to Canadian employees of companies, both small and large, new or old. Provided the conditions for the deduction are met, the deduction is available to Canadian executives on the benefit triggered on exercise (or on disposition if the shares are of a Canadian- controlled private corporation).
2. New Proposals
Budget 2019 highlights that most of the stock option deduction is being utilized by executives earning over $200,000 (i.e., not the “middle class”). This does not blend with the Government’s policy rationale behind the stock option deduction, namely to support younger and growing Canadian businesses.
To combat the above, Budget 2019 proposes to apply a $200,000 annual cap on employee stock option grants (based on the fair market value of the underlying shares) that may receive tax-preferred treatment for employees of “large, long-established, mature firms.” For “start-ups and rapidly growing” Canadian businesses, employee stock options would remain uncapped.
For example, an executive of a “large, long-established, mature” company is granted stock options to acquire 100,000 shares of her employer at a price of $50 per share. Since the fair market value of the underlying shares ($5 million) exceeds the $200,000 cap, the amount of stock options that can receive preferential tax treatment will be capped. 4,000 options can continue to receive preferential tax treatment, while the stock options benefits associated with the remaining 96,000 options will be included in her income and taxed at full ordinary income rates and deductible for corporate income tax purposes. On a later exercise for shares worth $70, the executive would include $1,920,000 in ordinary income and $80,000 of the benefit will receive preferential personal income tax treatment. A difference in roughly a million dollars in tax from the current rules.
Further details will be released in summer 2019 and any changes will apply on a go-forward basis only and will not apply to employee stock options granted prior to the release.
This is a significant change for stock options generally and a huge increase in the tax on executives if they are granted more than $200,000 worth of stock options. The release of further details in summer 2019 will be closely watched for the meaning of “large, long-established, mature” and “start-up and rapidly growing” companies. Let the lobbying begin. If any companies are considering a big grant of options, these should be granted prior to summer 2019.
One notable change is the addition of a corporate tax deduction in the amount of the benefit on exercise that is not eligible for the preferred personal tax treatment. This is a change from the current tax rules which generally do not allow for a corporate tax deduction for the issuance of shares on the exercise of a stock option. This change closely aligns with the U.S. taxation of stock options which allow for a corporate deduction.
Stay tuned for our post following the Liberal Government’s release of further details in summer 2019.
If you have any questions with respect to the matters discussed above, please contact Katy Pitch by email at firstname.lastname@example.org.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.