Consultation and Proposed Changes to the Tax Treatment of Employee Stock Options
Aug 2019 Charity & NFP Law Updat
On June 17, 2019, the Government of Canada tabled in the House of Commons a Notice of Ways and Means Motion to amend the Income Tax Act (the “NWMM”) to limit the use of the current employee stock option regime for high-income individuals employed at large, long-established, mature firms. The Government also published a Backgrounder document expanding on the commentary provided in Budget 2019, including a short commentary dealing with charitable donations, and launched a public consultation seeking stakeholder input on various aspects of the proposed changes.
Budget 2019 and the Backgrounder state that the preferential personal income tax treatment provided as a “stock option deduction” was intended for smaller and growing companies, such as start-ups, to attract and retain talented employees with a form of remuneration that is linked to the future success of the company.
The conditions of this “stock option deduction” are described in paragraph 110(1)(d) of the ITA, which effectively results in the employee stock option benefit being taxed at a rate equal to one-half of the normal rate of personal taxation – the same rate as capital gains. The employee may be eligible for an “additional deduction” equal to one-half of the employee stock option benefit if the employee donates to a qualified donee, such as a registered charity, publicly listed shares acquired under an employee stock option agreement within 30 days of the exercise of the option, or the cash proceeds from the sale of such publicly listed shares, pursuant to paragraph 110(1)(d.01) and subsection 110(2.1) of the ITA. As a result, where both the stock option deduction and the additional deduction for a donation to a qualified donee are available, the entire employee stock option benefit is effectively excluded from income.
However, Budget 2019 and the Backgrounder state that the employee stock option deduction claims are disproportionately benefiting a very small number of high-income individuals employed at large, mature companies. As such, the NWMM proposes that, starting on January 1, 2020, the employee stock options granted by certain employers be subject to a $200,000.00 annual vesting limit determined by the fair market value of the underlying securities on the date that stock option is granted. Where the fair market value of the underlying securities in any given vesting year exceeds the $200,000.00 annual vesting limit, such securities above the annual vesting limit will be deemed to be non-qualified securities in computing the stock option deduction under paragraph 110(1)(d) of the ITA. Since the additional deduction for charitable donations requires that the taxpayer be entitled to the stock option deduction pursuant to the condition in subparagraph 110(1)(d.01)(iv) of the ITA, the direct consequence of the new rules would be to disallow the additional deduction for charitable donations of securities acquired under an employee stock option agreement above the vesting limit of $200,000.00. The Backgrounder explains that any capital gain that has accrued since the shares were acquired under the stock option agreement would continue to be eligible for exemption from capital gains tax, subject to existing rules for donations of publicly listed securities. For those in the sector who wish to comment on the proposed amendments contained in the NWMM, the last day on which to make a submission to Finance is September 16, 2019.