On June 17, 2019 Canadian Finance Minister Bill Morneau released draft legislation that proposes changes impacting the preferential tax treatment of employee stock options. The proposal seeks to impose a limit on the amount of employee stock options granted by certain employers that will benefit from the preferential tax treatment.
What are Stock Options?
Stock options give employees the right to acquire shares of their employer at a designated price. Stock options function as another form of compensation, and at present, they are given preferential tax treatment in Canada.
What is the Current Preferential Tax Treatment for Employee Stock Options?
The current preferential tax treatment allows employee stock options to be taxed at the preferential capital gains tax rate (i.e. the amount is 50% taxable as opposed to 100%).
This preferential tax treatment was initiated decades ago to assist smaller and growing companies to incentivize and attract talent during the early phases. This tax treatment was intended to provide alternative compensation incentives, particularly when small, growing companies are not making significant profits and do not have the cash flow to provide competitive salaries to their employees.
The reality is that this preferential tax treatment is also used by large, mature companies to provide C-Suite employees with a tax-preferred form of compensation.
The proposed changes, which will apply to options granted on or after January 1, 2020, will impose a $200,000 (CAD) limit on the amount of stock options that may vest to an employee in a year that qualifies for the preferential tax treatment. Under this new change, any stock options that vest above and beyond the $200,000 (CAD) limit will be ineligible for the preferential tax treatment.
In addition, under the proposed changes, employers will be subject to new reporting rules, requiring them to report all employee stock options granted in excess of the $200,000 (CAD) limit to both the CRA and the employee.
The Government is looking for stakeholder input on what corporate characteristics constitute as “smaller, growing companies” who would continue to qualify for the preferential tax treatment. The deadline for stakeholder input submissions on this issue is September 16, 2019.
The proposed changes may have a significant impact on the tax implications of employee compensation. Employees and employers who may be affected by this may want to consider opportunities for granting stock options prior to January 1, 2020, as the proposed changes are set to apply to stock options granted on or after January 1, 2020.