Proposed Changes to the Taxation of Stock Options Released
As part of the 2019 Federal Budget, the government indicated that it would table legislation to reduce tax deductions for employee stock options granted by ‘large, long-established and mature firms’ (see our blog post on the budget here). The draft legislation introducing the proposed changes was released on June 17.
The government wants to exempt “start-up, emerging, and scale-up companies” from the changes. The proposed rules already exempt all Canadian-controlled private corporations (“CCPCs”). The government has invited stakeholders to submit comments on what conditions other businesses should meet to be exempt from the changes. Comments should be submitted to the Department of Finance by September 16, 2019 to fin.ESO-OAAE.firstname.lastname@example.org.
If you are a company that is not a CCPC, these changes could materially affect how you incentivize your employees starting in 2020.
Currently, if an employee receives a stock option from their employer with an exercise price equal to the fair market value of the underlying share on the grant date, when the option is exercised, the employee can claim a deduction (the “Deduction”) equal to one half of the realized stock option benefit (the difference between the fair market value of the share on the date of exercise and the exercise price). For a more detailed discussion on the taxation of stock options, please see our blog here.
The new rules apply only to fair market value grants that would otherwise qualify for the Deduction. They restrict the value of stock options entitled to the Deduction to a limit of $200,000 per year of vesting (based on the value of the share on the grant date). Benefits realized on all other stock options (for “non-qualified securities”) will, when exercised, be fully taxable to the employee as ordinary income, but the employer will be able to deduct the stock option benefit as an expense. Stock option benefits are presently not deductible to the employer when the stock option is settled in shares. If some or all of a stock option grant is for “non-qualified securities”, the employer must notify the employee in writing. More details on the proposal and examples are outlined in the Backgrounder released with the draft legislation.
As stated above, the changes will not apply to CCPC’s, or corporations meeting ‘prescribed conditions’. Regulations setting forth the ‘prescribed conditions’ are expected following the end of the consultation process.
The proposed legislation is scheduled to come into effect on January 1, 2020, and will apply to all stock option grants made after 2019.
Do you have questions about how stock options are taxed, or how these changes may affect you? Contact us.