Provided certain conditions are met, employees may exclude 50% of the spread at option exercise for both federal and provincial tax purposes. However, in Quebec, the deduction has historically been limited to 25% for Quebec provincial tax purposes. Pursuant to recent changes, the 25% deduction has been increased to 50% provided:
- The options were granted after February 21, 2017,
- The shares are listed on a recognized stock exchange,
- The individual is an employee of a company with a Quebec payroll of at least $10 million per year at the time the option grant was made, and (4) the general requirements of the tax deduction are met.
We recommend assessing whether your employees qualify for the increased deduction and, if so, whether the tax withholding rate for employees in Quebec should be adjusted accordingly.
Local Tax Deduction Now Available for Time-based or Performance-based RSUs in Canada
In the past, the Canada Revenue Agency (CRA) generally has not allowed a local tax deduction for the cost of share-settled equity awards (although it may have been possible to take a deduction under very narrow circumstances where the issuer had complete discretion (i.e., it did not have any legal obligation) to decide whether shares would be issued to a grantee). However, based on a technical interpretation released by the CRA on April 12, 2017, the CRA appears to have updated its position for share plans such that a company should be entitled to a tax deduction for the cost of the awards if:
- it awards share-based compensation to an employee;
- it retains the discretion to determine whether the award will be settled in cash or previously unissued or treasury shares;
- it does not commit to delivering the shares at any time before settlement;
- it actually delivers shares; and
- where the award is granted by a non-Canadian parent company, the Canadian entity reimburses the parent for the cost of the award.
Although the interpretation is not law, but simply a non-binding clarification by the CRA, we believe that most companies may now be able to obtain a tax deduction in Canada for (time-based or performance-based) RSUs. By contrast, it would be more difficult to structure an option or purchase rights granted under an ESPP as being able to be settled in cash or shares. In either case, companies would need to confirm with their accountants whether retaining the discretion to settle the award in cash or shares will subject the award to liability accounting, i.e., mark-to-market accounting (rather than (fixed) equity accounting).
In addition, it is important to note that, if the award can be settled in cash or shares, it will be subject to the salary deferral rules in Canada. These rules provide that any portion of an award that is settled more than three years after the end of the year in which the services were rendered (for which the award is granted) is subject to tax at grant. Companies will need to review their vesting schedules to determine if they will be subject to the salary deferral rules and, potentially, adjust their vesting schedule to avoid taxation at grant.
Similarly, if companies tried to structure an option such that it can be settled in cash or shares (to enable a tax deduction), this discretion will eliminate the ability to rely on the 50% tax deduction that generally is available for stock options.