Navigating Canada’s New Stock Option Regime LabyrinthThursday, December 10, 2020
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As one of the highlights to the Canadian Government’s Fall Economic Statement 2020 (the “Fiscal Update”, see our previous update on the Fiscal Update here), the Canadian Government released more modifications to the stock option tax regime. Recall that in Budget 2019, the Canadian Government announced its intention to limit some of the tax advantages for stock options for high income earners employed at “large, long-established mature firms” by proposing a $200,000 annual cap on stock options that would be eligible for the Stock Option Deduction (as defined below) (see our previous updates on this subject here and here). Draft legislation was introduced in June 2019 and Budget 2020 (which did not occur because of the pandemic) was supposed to outline revised rules based on consultation with affected stakeholders. Until the release of the Fiscal Update, the business community had been waiting on revised legislation outlining amendments to the proposed changes, as well as clarification as to which types of companies would be caught by the new rules.
Generally, if certain conditions are met, stock options receive beneficial tax treatment, as the employee can get a 50% deduction on the taxable employment benefit that arises on exercise (the “Stock Option Deduction”). It is this Stock Option Deduction that the Canadian Government is now proposing to cap for stock options granted by certain types of companies. To help guide you through the various permutations, below is a Q&A which aims to answer most of the relevant questions:
1. When do these new rules apply?
Stock options granted beginning on July 1, 2021 are subject to the new rules.
2. Who do the new rules apply to?
If the company (or mutual fund trust) is not a Canadian-controlled private corporation and has annual gross revenue (either alone or as part of a consolidated group) of over $500 million, that entity is caught by the new rules. This revenue requirement is meant to catch “large, long-established, mature firms.”
3. How do I figure out a company’s annual gross revenue?
If the company is part of a larger corporate group that prepares consolidated financial statements, one would look at the gross revenue from the most recent consolidated annual financial statements of the group (at the highest level of consolidation) as presented to shareholders prior to the date that the stock option is granted.
If the company is not a member of such a group, gross revenue would be reported in the company’s most recent annual financial statements prepared in accordance with generally accepted accounting principles as presented to shareholders.
4. How does the $200,000 annual cap work?
An employee will only be entitled to the Stock Option Deduction in respect of $200,000 worth of stock options that vest in the same calendar year. The $200,000 annual cap is determined by reference to the fair market value of the underlying shares at the date of grant. Stock options that go over this cap are treated as “non-qualified securities.”
5. How does vesting work? My stock options are exercisable only on a liquidity event.
A stock option vests when it first becomes exercisable and the determination of when a stock option vests is made at the time the stock option is granted. If the year in which the stock option vests is unclear (i.e. it does not vest until an unknown or contingent event occurs), the stock option would be considered to vest on a pro-rata basis over the term of the stock option, up to a five-year period.
6. How will I be taxed if my stock options go over the $200,000 annual cap?
The employee will not get the Stock Option Deduction for those stock options that vest in a particular year if the fair market value of the shares underlying those stock options is greater than $200,000 at the time of grant. For those stock options, the result is that the taxable benefit that is calculated at the time of exercise will be subject to such employee’s marginal tax rate.
7. What if I donate my publicly listed shares?
Under the current rules, where an employee donates publicly listed shares acquired under a stock option (or the cash proceeds from the sale of such shares) within 30 days of exercise of the stock option, to a qualified donee (which generally includes a registered charity), the employee will be eligible for an additional deduction equal to one-half of the taxable employment benefit. However, the new rules provide that if an employee donates publicly listed shares that have been acquired on the exercise of a stock option that is in excess of the $200,000 annual cap, the employee would still be eligible for the charitable donation credit, but not for the additional deduction that is otherwise available.
8. Can my company get a deduction for the issuance of shares over the $200,000 limit?
Yes, but there are certain conditions.
9. Can a company opt-in to the new rules if they do not technically meet the requirements?
No. A non-specified person such as a Canadian-controlled private corporation cannot opt-in to the new rules if it wants to claim a corporate deduction.
10. Can a company choose which type of stock options to grant?
If the company is subject to the new rules, it can choose to grant stock options under the current rules, (but subject to the $200,000 cap) or grant stock options under the new rules with the result that the Stock Option Deduction is not available to the employee, but the corporate deduction is available to the company. The company is responsible for notifying its employees in writing and the Canada Revenue Agency (the “CRA”) as to the tax treatment of the particular stock options.
11. What if my stock options are exchanged for new stock options?
For stock options that are issued before July 2021, if they are exchanged under the usual rules for option exchanges, they will not be treated as new stock options and will be subject to the legacy rules. As well, if an issuer of a legacy stock option amalgamates after June 2021, a pre-July 1, 2021 stock option exchanged on the amalgamation will not be treated as newly issued.
12. As an employer, what will I have to do?
For stock options that will be ineligible for the Stock Option Deduction, the employer will have to notify an affected employee in writing within 30 days of the grant. It is likely that this could be done in a stock option grant agreement. However, this may be difficult if the stock options vest based on a performance metric. The employer must also notify the CRA by the date that the employer’s tax return is due for the year of grant (hopefully in a new box on the T4 form).
If you have any questions with respect to the matters discussed above, please contact Katy Pitch by email at email@example.com.
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.