The federal government’s recent budget confirmed its intention to proceed with the new stock option regime previously announced in its November 30, 2020, economic statement — meaning the proposed changes will likely come into force on July 1, as planned.
As currently drafted, the changes impose an annual cap of $200,000 on employee stock options eligible for preferential treatment under the Income Tax Act. But for the first time, tax deductions will be available to employers for option benefits actually realized by employees.
Under existing legislation, an employee who exercises an option realizes a taxable benefit equal to the difference between the option price and the price paid for the shares. In certain conditions, the employee can claim a deduction that results in a preferential tax rate that matches the rate applicable to capital gains.
From the employer’s perspective, however, the granting of the option and the exercise of the shares by the employee have no tax impact under the current rules. The introduction of the deduction, then, represents a significant change in tax policy.
The new regime will apply to options granted on, or after, January 1, 2020. But it won’t apply to stock options granted by Canadian-controlled private corporations, or to non-CCPCs, with gross revenues of less than $500 million.
The budget, however, didn’t establish what changes, if any, the government will make to the draft legislative proposals included in the November 2020 statement.
“The budget confirmed the government’s intention to proceed with previously announced tax measures, as modified to take into account consultations and deliberations since their release,” says Colena Der, a tax partner in Osler, Hoskin & Harcourt LLP’s Calgary office, in an e-mail interview. “But the budget document did not indicate which of the listed tax measures will be amended to take into account further consultation and deliberations. The budget itself does not include any new changes to the stock option proposal.”
Chris D’Iorio, director of rewards and global mobility services at PwC Canada, in Toronto says it’s “not likely” that the final version of the changes will differ substantially from the existing draft. “The last draft incorporated amendments based on consultations that [had] already taken place,” he said in an email interview.
But that doesn’t mean nothing will change. “There’s always a chance that the government will make some amendments before finalizing,” says David Crawford, a Toronto-based partner at Hugessen Consulting Inc.
And that would only complicate what is already a burdensome regime. “The new rules, and the method and timing for assessing ‘qualified option’ status, will definitely increase the compliance and administrative burden of stocks options going forward,” Der said. “However, employers typically grant options annually, so we expect that the review of the ‘qualified’ status of prior year grants will be wrapped up into this annual process.”
Still, the details can be more than a little confusing. “The corporate tax deduction is delinked from the accounting cost in that the former is based on the option benefits at exercise, while the latter is based on grant date cost,” Crawford says.
And then there’s the introduction of notice requirements. “These new rules come with employer notice requirements, something that has not existed under Canadian tax rules before,” D’Iorio says. “A notice of the number of non-qualifying securities must be given to employees within 30 days of grant and the employer seeking the deduction must provide notice with its annual tax return.”
As it turns out, the new regime gives employers the right to opt out and grant only non-qualified options. But D’Iorio believes it’s unlikely that many employers will do so. “The $200,000 limit is still a valuable benefit. It seems relatively unlikely that employers offering options will simply take away the entire tax advantage from employees, especially considering that they will have the advantage of the new corporate deduction.”
There’s also no sign that employers are adopting alternatives to stock options in their compensation packages — at least not any more than usual. “Some affected businesses may discontinue their option programs in favour of other forms of equity incentive, but this has already been a trend for a number of years with investor pressure to move from options to performance-based awards,” D’Iorio says.