2019 federal budget – stock option changes
On March 19, 2019, Liberal Finance Minister Bill Morneau tabled his fourth and final federal budget, leading up to the election in October. The following is a summary of the budget’s proposed changes to employee stock options.
Employee stock options are an attractive, alternative form of compensation for start-ups and large, mature companies. Through the issuance of stock options, employers experience an increase of employee engagement while providing the employee with the opportunity to directly benefit from the growth of the business. For the employee, stock options may be eligible for a preferential tax treatment at the time the employee exercises his/her options.
Employees of public companies are subject to personal income tax on the stock option benefit at the time the option is exercised. The stock option benefit is computed as the difference between the value of the shares at the time the options are exercised, in excess of the stock option price. If, however, the exercise price of the stock option is greater than or equal to the value of the shares at the time the option is granted, the employee is only subject to tax on 50% of the stock option benefit.[1]
To illustrate the current tax treatment of stock options, assume an employee of a public company is granted stock options to acquire 100,000 shares at a price of $50 per share (the fair market value of the shares on the date the options are granted). If the price of the shares has increased to $70 at the time the employee exercises his/her options, 50% of the stock option benefit of $2 million ($70 per share, less exercise price of $50 per share, multiplied by 100,000 shares) is subject to tax at ordinary rates. For an employee living in Ontario, this would amount to approximately $535,000 of personal income tax in 2019.
For employees of Canadian controlled private corporations (CCPCs), the timing of personal tax on stock options is deferred until the stock is sold. Furthermore, the employee may be eligible to claim a deduction equal to 50% of the stock option benefit, if the employee holds the shares for two years.[2]
The 2019 federal budget indicates that the policy rationale for the current preferential tax treatment of stock options is to promote growth for Canadian start-up businesses, and that stock options should not be used as an alternative form of compensation for executives of large, mature companies.
To address this policy objective, the Budget proposes to apply a $200,000 annual limit on employee stock options for employees of “large, long established, mature firms”. This annual limit is based on the market value of the underlying shares at the time the option is granted. Stock options that are granted in excess of the $200,000 annual limit, will be subject to personal income tax on the entire stock benefit.
Using the figures in the example above, because the fair market value of the underlying shares at the time of grant (total of $5 million, being $50 per share, multiplied by 100,000 shares) exceeds the annual $200,000 limit, only a limited number of stock options will be subject to the preferential tax treatment. The stock option benefit associated with 4,000 shares ($200,000 limit divided by $50 per share) will receive the preferred tax treatment, while the stock option benefit associated with the remaining 96,000 shares will be fully taxed at the employee’s ordinary tax rate. For an employee living in Ontario, this amounts to approximately $1.05 million of personal income tax in 2019 – a significant increase from the taxes paid under the current rules.
The Budget indicates that further details will be released in the upcoming months. The Budget does not include a proposed implementation date but does indicate that the new measures will be applied prospectively.
Contact us today for more information on how the proposed changes to employee stock options from the 2019 federal budget may affect your personal tax situation.
[1] This preferential tax treatment for the employee is available if the employer forgoes its deduction for issuing the shares.
[2] Similarly, this preferential tax treatment for the employee is available if the CCPC employer forgoes its deduction for issuing the shares.