Senior executives in Canada will pay higher taxes when the new federal government implements the Liberal campaign platform.
The platform calls for the federal personal income tax rate to be reduced for taxable income between $44,701 and $89,400 and to be increased for taxable income over $200,000. After adding provincial tax, the top combined personal rate in Ontario, Quebec and some other provinces will exceed 50%.
The Liberal platform will also dramatically increase tax on many types of stock options. As background, here is a simplified summary of the existing tax regime for stock options:
- Provided certain conditions are met, the grant of a stock option is not a taxable event.
- In most cases, the employee is taxed as having received employment income on exercise of the option, equal to the amount by which the market value of the stock at that time exceeds the exercise price (Exercise Gain). Any subsequent increase or decrease in the value of the stock is treated as a capital gain or loss, with only 50% of net capital gains being taxed as income in the year of disposition.
- If the option is not ‘in the money’ when granted and other conditions are met, a deduction is available so that only 50% of the Exercise Gain is taxable as employment income.
- If the issuer of the stock is a Canadian-controlled private corporation, taxation of the Exercise Gain is deferred until disposition of the stock and, if the stock is held for at least two years after exercise, only 50% of the Exercise Gain is taxable even if the option was ‘in the money’ when granted.
The Liberal platform includes the following planned changes:
Conducting an overdue and wide-ranging review of the over $100 billion in increasingly complex tax expenditures that now exist, with the core objective being to look for opportunities to reduce tax benefits that unfairly help those with individual incomes in excess of $200,000 per year.
A starting point would be to set a cap on how much can be claimed through the stock option deduction. … Stock options are a useful compensation tool for start-up companies, and we would ensure that employees with up to $100,000 in annual stock option gains will be unaffected by any new cap.
No further details are available at this time, but this type of change would dramatically increase tax on stock options. For example, assume that in 2016 an employee of a public company is granted the option to buy 100,000 shares at $50 per share, when the shares trade at less than $50 per share. After the option vests, the shares trade at $55 per share and the employee exercises the option. The employee would have an Exercise Gain of $500,000, of which only $250,000 would be taxed in the year of exercise under the existing regime. The planned changes could tax $450,000 instead, resulting in almost twice as much tax. There has been no indication yet of changes in the deduction rules for the employer.
The new Finance Minister, Bill Morneau, provided reassurance on November 20, 2015 regarding existing stock options. As reported in The Globe and Mail :
“Any decision we take on stock options will affect stock options issued from that date forward,” Mr. Morneau said Friday …
“Any stock options that have been issued prior to that date will be under that taxation regime that was in effect prior to that date,” Mr. Morneau said.
Employers may wish to consider changes to the timing of their usual award of stock options. They will also need to monitor further developments and bear the changes in mind when determining compensation for senior executives and other employees. Alternative incentive compensation plans are available that may compare more favourably with stock option plans than in the past.