January 30, 2020
NOTE: The new tax rules for employee stock option plans take effect on July 1, 2021. Learn more at Limited Options: New Employee Stock Option Tax Rules Effective July 1, 2021.
Employee stock option plans, like all equity compensation plans, can be a valuable and versatile tool for corporations (particularly startups), to attract, incentivize and retain talent. The value of employee stock option plans can, however, be impacted by their tax treatment – and right now, the tax treatment of employee stock options is in limbo.
In Budget 2019, the federal government proposed changes to the tax rules applicable to employee stock options. The Department of Finance released the details of the proposed changes on June 17, 2019: intended to take effect January 1, 2020, stock options granted before January 1, 2020 would have been subject to the current (more favourable) tax rules, and options granted on and after January 1, 2020 would have been subject to the new (less favourable) tax rules. On December 19, 2019, however, the Finance Department announced it has postponed implementation of the new tax rules for employee stock option plans, with no indication of a new effective date. While it’s still expected the new rules will, in some form, ultimately be implemented on a future date, it won’t be January 1, 2020. In the meantime, employee stock option grants remain subject to the current – and more favourable – tax rules. And that means that, at least for now, employers (or prospective employers) contemplating employee stock option grants still have the option of doing so under the current tax rules. But best to do so sooner rather than later: it might not be an option for long.
Current Rules. For Canadian-controlled private corporations (CCPCs) dealing at arm’s length from the employee, the employee stock option benefit is taxable in the year in which the shares are disposed of. Otherwise, the benefit is generally taxable in the year in which the employee acquires the shares (in other words, when the employee exercises the option). Under the current rules, there is a deduction equal to one-half of the benefit, effectively resulting in capital gains treatment. This deduction is available if certain conditions are met, including all of the following:
For CCPCs, if an employee holds the shares for at least two years, this deduction is available even if it’s not a prescribed share or the amount payable by the employee to acquire the share is less than the fair market value of the share at the time the option was granted.
Proposed Rules. On June 17, 2019, the federal government tabled proposed new rules for the tax treatment of employee stock options, including:
Implementation Timing. It’s not known when the now postponed proposed changes to the employee stock option tax rules will take effect. However, the government has stated it will introduce revisions to the proposed rules with Budget 2020. It’s likely these will include an effective date that will give individuals and businesses time to review and adjust to the new rules. The government announced the postponement in implementing the new rules after hearing from affected businesses on the proposed changes to the rules. Specifically, the government had requested feedback on what should qualify as a startup or emerging company for the purpose of qualifying for the proposed preferred tax treatment. Until the new rules take effect, however, employers and employees can continue to take advantage of the existing tax benefits of issuing stock options to compensate employees.
Please contact your McInnes Cooper lawyer or any member of our Tax Law Team @ McInnes Cooper to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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