On June 29, 2021 Parliament passed legislation (Bill C-30) to implement measures from the 2021 Federal Budget. One of those measures is a long-anticipated change to the employee stock option deduction limit for stock options issued by non-CCPC’s, whereby the 50% stock option deduction will be limited to $200,000 worth of shares. These changes took effect beginning July 1, 2021.
Stock options issued by Canadian-controlled private corporations (CCPCs) and corporations whose annual gross revenue does not exceed $500 million, are not subject to the new rules, and therefore the treatment of employee stock options for these corporation remains unchanged.
For many corporations, equity-based compensation has become a major way to motivate, retain and attract top talent and for employees it was often a preferred compensation option due to preferential income tax treatment. Prior to these recent changes, employees were eligible for a deduction of 50% of the benefit realized on the exercise of an employee stock options, provided certain criteria were met.
Under the new rules, the 50% deduction will be capped at a $200,000 worth of shares (annual vesting limit), calculated based on the fair market value of the underlying shares at the time of grant. Any options that exceed this cap would be deemed as “non-qualified securities” and will not qualify for the deduction.
As a quick illustration, assume that an employee is granted 100,000 shares and the fair market value per share at time the agreement is entered into is $5 and all shares vest in one year. Under the new rules, 40,000 shares ($200,000 / $5) would qualify for the preferential treatment (50% deduction), while the remaining 60,000 shares would be considered as non-qualified securities. The Department of Finance, provides several detailed illustrations on the application of the new rules, and can be accessed here.
The new legislation provides a definition of what qualifies as a vesting year, and in general, the stock option will be considered to vest in the calendar year in which the right to acquire the underlying share becomes exercisable as specified in the option agreement. Where the vesting year is not specified in the option agreement, the option will be considered to vest on a pro-rata basis from the day the option agreement was entered into until the earlier of 60 months after the day the agreement is entered into; or the last day the right to acquire the security could be exercisable.
Bill C-30 also establishes new reporting requirements for the employers that are subject to the new rules. For any stock option agreements entered into on or after July 1, 2021, employers will need to inform the employees in writing as to which shares are considered “non-qualified securities” no later than 30 days after the agreement is signed. In addition, the employers will need to notify the CRA of the securities that are non-qualified, using a prescribed form. To date, CRA has not developed a prescribed form for this notification process.
The new rules would allow an employer to claim a tax deduction in computing its taxable income (provided certain criteria are met) in situations where the employee exceeds the $200,000 annual vesting limit and is not eligible for the stock option deduction.
Going forward, employers that fall into the new rules will need to track and keep detailed records of all options granted and vested in order to ensure that proper tax withholding and remittance calculations are done for employees at the time of income inclusion.
Please note that this is a high-level overview of the recently enacted legislation, as at July 2021 and covers the topic in general terms. Please contact us if you would like to discuss your specific situation and how the new rules would impact you and your business.