New legislation proposed in the 2019 Federal Budget would limit the extent to which employees will be entitled to favourable Canadian income tax treatment on certain stock options.
The treatment of employee stock options is the subject of a special regime under Canadian income tax law. In very general terms, the following stock option rules currently apply when an employer agrees to sell or issue its shares to an employee:
- Granting the stock option is not a taxable event.
- The employee realizes a taxable employment benefit when: (a) if the employer is a “Canadian-controlled private corporation” when the stock options are granted, the time when the employee sells the shares acquired on the exercise of the stock option; and (b) in any other case, the time when the employee exercises the stock option.
- The amount of the employment benefit is computed as the difference between: (a) the fair market value of the underlying shares at the time of exercise, and (b) the exercise price.
- The employee may be entitled to a deduction in computing taxable income equal to one-half of the employment benefit (the “One-Half Deduction”) so that the stock option benefit is subject to a tax rate that is generally equivalent to the rate imposed on capital gains.
- The employer is not permitted to claim a deduction when a stock option is exercised.
The 2019 Budget proposes to impose a $200,000 annual cap on employee stock option grants (based on the fair market value of the underlying shares) that are eligible for the One-Half Deduction. Stock option grants in excess of this $200,000 threshold will be subject to tax at the employee’s marginal tax rate with no deduction. However, the cap would apply only to employees of “large, long-established, mature firms”. Stock options granted to employees of start-ups and “emerging” businesses would be exempt from the annual cap. No guidance relating to the standards which will be applied to identify which employer’s options will be subject to the annual cap is provided.
The 2019 Budget materials also seem to imply that an employer might be entitled to deduct an amount in respect of stock options which it grants in excess of the $200,000 annual cap. However, it is unclear whether such a legislative change is intended.
The 2019 Budget stated that additional detail regarding the changes to the employee stock option rules will be released before the summer of 2019. Such changes will only apply on a prospective basis. As a result, employee stock options granted before the announcement of legislative proposals to implement the new regime will be unaffected.