Beginning January 1, 2011, virtually every stock option exercise by an employee or director will trigger employer tax withholding and remittance requirements. Stemming from the March 2010 Federal Budget, new rules were introduced into the Canadian Income Tax Act earlier this fall which "clarify" that, effective as of the new year, source deduction requirements apply to stock option benefits. These and other proposed amendments relating to taxation of stock options are summarized in detail in our related Tax Update. The change in policy in respect of withholding and remittance for stock options brings the Canadian tax regime essentially in line with the regimes of other countries, including the U.S. and U.K.
These developments impact both employers and those receiving stock options or similar compensation. Every corporation and every mutual fund trust that sponsors stock option plans to which these rules apply should review the existing terms of its plans, and related administrative procedures, to determine whether tax withholding and remittance can be accommodated in accordance with Canada Revenue Agency (CRA) rules. For public companies, existing stock option plans and agreements should also be carefully reviewed to determine whether shareholder approval is required for any necessary amendments.
The following series of questions and answers reviews these and other common issues that employers may face in dealing with these changes.
Do the new rules apply to our company?
The new rules generally apply to all Canadian employers, including non-Canadian employers who make stock options available to Canadian employees, subject to specified exceptions.The main exception covers Canadian-controlled private corporations (CCPCs) as defined in the Canadian Income Tax Act.
When will the new rules apply?
Withholding will be generally required for non-CCPC options exercised in 2011 or after, regardless of when the option was granted.
Are there any exceptions?
There is an exception for options granted before March 4, 2010 at 4:00 PM EST, where the options included a written condition to the effect that the optioned shares must be retained by the optionee for a period of time after exercise. Another exception also exists where the optionee donates the optioned shares to a registered charity within a short period of time after exercise.
What are the withholding rates applicable to stock option benefits?
The tax rates applicable to withholding on stock option benefits are the same as for regular employment income. Where an option is eligible for the one-half income deduction on the option spread on exercise, only one-half of the spread will be considered for purposes of determining the amount to be withheld.
Our stock option plan does not currently specifically address withholding or sale of shares on the employees’ behalf. What should we do?
Stock option plans or agreements may include general terms that permit withholding and remittance as required by law or may include specific terms governing how withholding and remittance requirements may be satisfied. Such specific terms may, among other things, either permit the sale by the employer on the employee's behalf of a sufficient number of issued shares to satisfy the tax liability or require that the employee pay an amount to the employer equal to the withholding obligation as a condition of exercise. The viability of available alternatives depends on a number of factors, including implementation from an administrative perspective (as discussed below) and the ability of optionees to fund their portion of the withholding obligation. Plan or agreement provisions should be carefully reviewed to determine if the appropriate alternatives are sufficiently covered, otherwise an amendment may be necessary. For public companies, such amendments would generally trigger shareholder approval requirements under stock exchange rules if not permitted under the existing amendment provisions of the company’s plan or agreement. In this regard, the TSX has confirmed in its Staff Notice 2010-0002, dated November 12, 2010, that it will generally consider amendments to option plans and agreements resulting from these rules to be of a “housekeeping” nature. This acknowledgement means tax-related amendments, where necessary, may generally be made under existing provisions that allow the board or a board committee to make amendments to plans or agreements of a “housekeeping” nature without shareholder approval. The Staff Notice further clarifies that if the plan does not contain such amendment provisions, the TSX will still allow companies to amend their plans and option agreements to comply with these rules provided that: (i) the amendments are limited to compliance with the Income Tax Act, (ii) the company adopts proper amendment procedures in its plan; and (iii) the amendments are submitted for security holder approval at the company’s next meeting. Public companies are also reminded that in either case, option amendments will still be subject Section 613 of the TSX Manual, which includes pre-clearance by the TSX and disclosure in proxy circulars.
How do we arrange for shares to be sold in the market to cover the optionee’s tax liability
Depending on your particular circumstances, the alternatives include arranging with a broker to sell the shares on the employee’s behalf or arranging with a third party service provider (such as a trustee or transfer agent) to administer the plan. Implementation of necessary procedures will need to be tailored to meet your specific needs and those of your optionees. In any case, discussions with all third parties should be initiated in advance to prepare for the January 1, 2011 deadline.
Instead of issuing all of the shares under option and then selling a sufficient number to raise cash to remit to Canada Revenue Agency in respect of the withholding obligation, can the corporation simply issue fewer shares to the employee and remit cash to CRA?
Satisfying the withholding obligation in this fashion may jeopardize the tax characterization of the option award, including the timing of taxation of the option award and the availability of the one-half income deduction on the option spread on exercise. We do not generally recommend this as a method of satisfying the withholding obligation. If the more common alternatives discussed above are not viable for your company you should speak with a tax advisor to consider other alternatives.
Do the new rules apply to directors of Canadian corporations who are not resident in Canada?
Although an individual’s tax situation will depend on a number of factors and can turn on specific facts, generally, the new rules will apply to non-Canadian resident directors who rendered services to the corporation in Canada at any time during the period from the date of grant to the date of exercise. The withholding amount will generally be determined based on the portion of the option benefit that is taxable in Canada.