Prior to July 1, 2021 paragraph 110(1)(d) of the Income Tax Act generally allowed employees to claim a 50%[1] deduction off the taxable benefit arising from the exercise or disposition of an eligible employee stock option to reduce an individual’s taxable income for the year. On June 29, 2021, Bill C-30 received long-awaited Royal Assent, such that new rules apply for options granted on or after July 1, 2021, which could limit the ability of employees to claim the 50% stock option deduction on their income tax return.
New Legislation
The old rules still apply for the eligibility of certain options for the 50% deduction under paragraph 110(1)(d); for example, the options must be granted at FMV to an employee which deals at arm’s length with the employer and must be on prescribed shares.[2] Conversely, the employer cannot claim an employer deduction for shares issued under a stock option grant.
However, in addition, the new rules would also cap the availability of the 50% employee stock option deduction for “nonqualified securities” to a $200,000 annual vesting limit. These additional new requirements do not apply to exempt options granted by Canadian Controlled Private Corporations (CCPCs)[3] or non-CCPCs with consolidated group revenues of $500 million or less.
Further, for non-exempt options that are subject to the $200,000 deduction limit, the new legislation also allows employers to choose whether to grant stock options under such new tax treatment (i.e. employees are eligible for the 50% deduction but subject to the $200,000 deduction limit), or choose to issue the stock options as a “non-qualifying security”. In the latter option, the employee does not benefit from the 50% deduction (even within the $200,000 limit) but the employer may take a corporate tax deduction in the year of exercise.
Options granted before July 1, 2021 continue to be taxed under the old rules (that do not provide a $200,000 limit for the stock option deduction and do not allow employers to elect to override the employee’s eligibility in favour of the employer deduction).
To date, Revenu Quebec has not made any announcements concerning legislation that limits the availability of the stock option deduction for Quebec tax purposes. As such, there is a potential misalignment in the stock option treatment on the Canadian and Quebec income tax returns, as well as added tracking and reporting complexities for employers.
Impact to Employees
This new $200,000 limit will apply to an employee on a calendar year basis, for each consolidated employer group. Therefore, employees exercising stock options from multiple non-arm’s length employers will receive multiple $200,000 limits. The $200,000 limit is measured based on the FMV of the shares on the date of grant (i.e., the exercise price),[4] and there is a separate $200,000 limit for each tranche of options that first become exercisable (i.e., “vest”) in a particular year.
Example:
An employer grants an individual 100,000 shares on July 1, 2021 that vest 25% per year over four years. The exercise price is $50/share.
In this example, only 4,000 stock options will qualify for the 50% employee stock option deduction per year. The taxable benefit on the remaining 21,000 shares worth per year of $1,050,000 (21,000 options x $50/share) will not qualify for the 50% deduction and will be taxed fully at the individual’s marginal tax rate.
Impact to Employers
As mentioned earlier, for stock options below the $200,000 threshold, certain employers have the choice to issue stock options that are eligible for the employee’s stock option deduction or not. Such an employer needs to either be a non-CCPC or be a member of a group with consolidated gross revenues greater than $500 million.
As part of the new legislation, employers are required to do the following:
Determine whether to designate options as non-qualifying for option grants below the $200,000 vesting limit and to keep track of these stock option grants;
Within thirty days of granting non-qualifying options, notify the employee and the Canada Revenue Agency (CRA) in writing that the shares granted are non-qualifying. These notifications will apply to both options that exceed the $200,000 annual vesting limit and if the option grants were designated as non-qualifying;
Ensure that the payroll tax withholdings are deducted at the proper income tax rates based on whether the option grants qualify for the stock option deduction or not.
Considerations for Employers and Employees
For employers, there is an added administrative burden to ensure compliance with the new regulations. Clear communications also need to be made to employees to notify them about which stock options received qualify for the stock option deduction or not.
For employees, receiving non-qualifying stock options would result in higher personal tax liabilities. In order to receive the same amount of after-tax income, more options can be granted by the company to cover the employee’s increased tax burden resulting from non-qualifying options.
Questions about how the employee stock deduction changes may affect you? Contact our tax professionals at info@trowbridge.ca
Authors:
Peter Megoudis, Senior Technical Director | Private Client Individual Tax Services
David Ho, Manager | Global Mobility
[1] The deduction is generally 25% for Quebec tax purposes. [2] In addition, if options are settled for cash, instead of shares, the employer needs to waive its right to an employer deduction for the cash payment in order for the employee to claim their 50% deduction. [3] Note that CCPC options have two separate and alternative regimes for eligibility for the 50% deduction – (a) the non-CCPC regime under 110(1)(d) plus (b) the CCPC regime under 110(1)(d.1), which requires a two-year holding period. The new rules do not affect the rules under the (b) regime. [4] The limit is not based on the taxable benefit. For example, if the limit stipulates that only $200,000 worth of options, measured as of the share value on the date of grant, can qualify for the 50% deduction, and those options are exercised for a spread (between the FMV of the shares on exercise and the exercise price) of $1,000,000, then the 50% deduction can still apply on that $1,000,000 of benefit, subject to the employer election.