On April 19, 2021, the federal government tabled its budget bill, Bill C-30, An Act to implement certain provisions of the budget tabled in Parliament ("Bill C-30"), which contained amendments to the Income Tax Act (Canada) enacting new limits on the favourable employee stock option tax rules. Bill C-30 has now received Royal Assent and is effective for new employee stock option agreements made on and after July 1, 2021.
The legislative amendments were first announced in draft form on November 30, 2020 and previously reported here.
For simplicity, this summary assumes that the employer of an employee is also the entity that grants the option and issues corresponding shares. The new rules will apply with necessary modifications if the issuer does not deal with the employer at arm's length, such as a foreign parent corporation.
What Has Changed?
The new rules place an annual maximum on the underlying shares subject to a stock option that will be, upon exercise, eligible for the employee-favourable 50% deduction (akin to capital gains treatment). The new limit will be based on the portion of underlying shares with a fair market value in excess of $200,000, valued as of the date the option agreement is made, per "vesting year" of the option. A "vesting year" is generally defined as the first year that the option agreement provides that the option (or portion thereof) becomes exercisable. Special rules apply when the option agreement ties vesting to a future contingency the timing of which cannot reasonably be foreseen at grant, such as the sale of a business. Shares that will no longer qualify for the 50% deduction are referred to as "non-qualified securities". A single option grant may have multiple "vesting years", but multiple grants with the same "vesting year" are aggregated for purposes of the overall $200,000 limit.
Although employees will no longer be eligible for the 50% deduction upon the exercise of an option for non-qualified securities, the rules provide for a new employer deduction to the extent of the taxable benefit realized by the employee on exercise for non-qualified securities. An employer may also elect to designate shares that would otherwise be eligible for the 50% deduction (for example, because they fall within the $200,000 cap) as "non-qualified securities", thereby increasing the potential deduction available to the employer but with a corresponding elimination of the 50% deduction for the employee.
What Has Stayed the Same?
The new rules will not apply to options granted by Canadian-controlled private corporations ("CCPCs") or corporations whose gross annual revenues do not exceed $500 million as reported in their most recent financial statements (or consolidated financial statements, if reported on a group basis). CCPCs and corporations that do not exceed the annual revenue threshold are not permitted to designate shares as non-qualified securities in order to access the corporate tax deduction noted above. Essentially, the stock option rules applicable to these corporations remain status quo.
What Is Next?
For option agreements made on and after July 1, 2021, employers subject to the new rules now need to inform employees in writing as to which shares underlying an option grant are non-qualified securities. The notification must be made within thirty (30) days of the option agreement being made. No particular form of notification is currently prescribed.
The employer will also need to inform the Minister of National Revenue (through the Canada Revenue Agency) as to which shares underlying an option grant are non-qualified securities. In this case, the notification must be made in prescribed form no later than the filing-due date for the employer's taxation year in which the option agreement is made. To date, no form has been prescribed.
In practice, in addition to the above notification requirements, employers will generally need to track options through their lifecycle, the shares underlying each and their "non-qualified security" status. Special rules will generally deem the employee to exercise an option first for subject shares that are eligible for the 50% deduction and only once these have been exhausted for any remainder that are non-qualified securities. To ensure the appropriate tax withholding and calculation of the appropriate employee income inclusion and corporate deduction, employers subject to the new rules are expected to have new detailed record-keeping requirements going forward.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
