Limited Options: New Employee Stock Option Tax Rules Effective July 1, 2021
Published:
June 24, 2021
Author(s):
Many employers use equity compensation plans like employee stock option plans to attract, motivate, and retain talent. One reason stock options are attractive to existing and prospective employees is their favourable tax treatment. But proposed changes to the Income Tax Act, originally announced in the 2019 Federal Budget, have been on the horizon. These long anticipated changes will finally take effect on July 1, 2021. Under the new rules, favourable tax deductions remain consistent for small businesses and Canadian Controlled Private Corporate (CCPCs), but employees of large non-CCPCs will take a tax bite on future options. The new rules are detailed and complex, but here’s a snapshot of their impact on employees and employers.
Unaffected Employees. In implementing the changes, the government aimed to preserve the current stock option tax benefits of three distinct groups of employees. The option plans of these employees remain unaffected by the July 1, 2021 changes:
- Employees of CCPCs.
- Employees of corporations with an annual gross revenue that doesn’t exceed $500 million. This exception recognizes that some non-CCPCs might be “start-ups, emerging or scale-up companies.”
- Employees who are party to stock option agreements entered into before July 1, 2021.
Affected Employees. Employees of large and established corporations that aren’t CCPCs who receive stock options on or after July 1, 2021 will have new restrictions to contend with.
- Deduction Limit. Currently, there’s a 50% deduction available (effectively taxation at capital gains rates) provided certain criteria are met. Under the new rules, this deduction will be subject to a maximum allowable value of $200,000 yearly based on the fair market value of the security on the date of grant.
- Exceeded Limits. If an employee is granted a number of security options in a year that exceed the $200,000 limit, then the options first granted will be the first to qualify for the stock option deduction. The remaining options exceeding the limit, referred to as “non-qualified securities”, will be taxed as a regular employee benefit. Specifically, the difference between the value of the share at the time of acquisition, and the amount paid to acquire the share and the amount (if any) to acquire the option will be included in income in the year of acquisition (if not a CCPC) or in the year of disposition (if a CCPC), subject to certain conditions.
Employer’s Deduction. Employers can claim a tax deduction on the portion of employee option benefits in excess of the employee deduction limit, provided the employer meets certain notification requirements. Employers can also issue securities that are pre-designated as non-qualified securities. This designation means the employee isn’t entitled to a stock option deduction, and entitles the employer to a deduction for the value of the benefit the employee would have received. If a non-qualified security is to be issued under an agreement, the employer must notify both the employee no later than 30 days after the day the agreement is entered into, and the Canada Revenue Agency (CRA).
Please contact your McInnes Cooper lawyer or any member of our Tax Solutions Team @ McInnes Cooper to discuss this topic or any other legal issue.
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