On 30 November 2020, the Canadian government introduced an updated proposal to cap the amount of the 50% stock option deduction for employee stock options granted on or after 1 July 2021.
Under current law, an employee is entitled to deduct for Canadian income tax purposes an amount equal to 50% of the stock option income (generally the spread at exercise), provided certain conditions are met (special rules apply in Quebec with respect to Quebec provincial taxes). Under the proposal, this deduction will be subject to a CAD 200,000 annual cap on options vesting in any year, calculated based on the fair market value of the underlying shares at grant.
The Canadian government initially proposed the cap on the stock option deduction in March 2019. The updated proposal clarifies that the cap would not apply to options that are both granted by and over shares of (1) Canadian-controlled private corporations; or (2) corporations whose annual gross revenue does not exceed CAD 500 million (determined on a consolidated basis, where applicable).
If the proposal is enacted, a corporate tax deduction may be available in relation to any options granted in excess of the CAD 200,000 limit where certain conditions are met.
In addition, companies could elect to grant ‘non-qualified’ stock options, which would not be eligible for the stock option deduction, but may be eligible for a corporate tax deduction. However, under the current proposal, it appears that ‘non-qualified’ options could only be granted by the Canadian employer (although the Canadian employer could grant options over shares of a parent corporation); therefore, it is not clear how feasible this approach would be for non-Canadian companies.
Companies granting employee stock options in Canada should follow this proposal closely. In particular, if the proposal is enacted, companies will need to be prepared to track which options qualify and do not qualify for the deduction at the time of grant so that the employer can satisfy its reporting and withholding obligations and comply with new notice requirements for non-qualified options.