Proposed Changes to Preferential Tax Treatment for Employee Stock Options: Not a Viable Option
Budget 2019 announced the Government’s intention to limit the preferential tax treatment afforded to employee stock options. Currently, the Income Tax Act (Canada) (the “ITA”) provides for a stock option deduction which, where available, effectively subjects the taxable benefit resulting from the exercise of stock options or sale of the shares underlying the stock options (as applicable) to tax at a rate equal to one-half of the ordinary personal tax rate, which mirrors the capital gains rate.
The public policy rationale underlying this preferential tax treatment is to support younger and growing Canadian businesses which have limited ability to attract talent by paying competitive salaries. Instead, start-ups and other growing businesses can attract employees with stock options that offer employees a form of compensation linked to the future success of the business. However, this preferential tax treatment is also available to employees of large and mature businesses. Further, the Government is concerned with the disproportionate benefit of the preferential tax regime accruing to high-income individuals who often receive large percentages of their compensation through stock option benefits.
Budget 2019 proposes to introduce a $200,000 annual cap on employee stock option grants provided to employees of large and mature companies (based on the fair market value of the underlying shares at the time of grant) that will be eligible for the stock option deduction. Employee stock options granted by startups and rapidly growing businesses will be excluded from this annual cap.
For example, consider the taxation of an employee at a large, public company who is granted 100,000 stock options with an exercise price of $50, representing the fair market value of the shares on the date of grant, and such shares have increased in value to $70 at the time of exercise.