Canadian Tax and Estate Planning

Employee stock options are a form of compensation that allow an individual to purchase a fixed quantity of shares at a fixed price. Stock option agreements granted after June 30, 2021, may be affected by new taxation rules proposed under Bill C-30. First announced as part of the 2019 Federal Budget, Bill C30 was later revisited in the government’s Fall Economic Statement 2020 and became law on June 29, 2021. The new rules, where applicable, impose a limitation on the 50 per cent stock option deduction to $200,000 worth of shares per vesting year.

Who is affected?

Employers

• The new rules apply to options granted on or after July 1, 2021, by a specified person. A specified person is generally, a non-Canadian Controlled Private Corporation (non-CCPC) with annual consolidated revenues over $500 million. Canadian Controlled Private Corporations (CCPCs) and non-CCPCs with a consolidated annual revenue under $500 million do not meet the definition of a specified person and are not subject to these new rules.

Employees

• Employees who are granted stock options on or after July 1, 2021, issued by a specified person could have their 50 per cent stock option deduction limited or eliminated.
• This could result in an increased tax burden at the individual level, where they otherwise would have qualified for the 50% stock option deduction.

Status quo rules

When an employee exercises their stock options and acquires shares, the transaction may result in a taxable benefit. The taxable benefit is the difference between the Fair Market Value (FMV) of the shares at the acquisition date and the price that they paid to acquire them. Where the issuer is a CCPC, this taxable benefit can be deferred until the shares are sold.

Under the status quo rules, where a person has an income inclusion relating to an employee stock option, they may be allowed a deduction equal to the 50 per cent of the full amount of the taxable benefit. Various criteria must be met to qualify for the stock option deduction, but until recent changes, there was no upwards limitation on the value of the options that could qualify for this deduction.

For any options not subject to these new limitations (e.g., options issued by CCPCs), the status quo stock option rules remain unchanged, even where they are granted after June 30, 2021.

New rules

Options granted after June 30, 2021, by specified persons will be subject to the new annual vesting limit. This may potentially restrict the amount qualifying for the 50 per cent stock option deduction, even where the securities would have qualified otherwise under the status quo rules.

Qualifying vs non-qualifying options

Stock options granted by specified persons will be designated as either qualifying or non-qualifying securities.

Non-qualifying securities: Securities whose fair market value exceeds the $200,000 vesting limit in any vesting year

The fair market value of the securities is determined on the date into which the agreement is entered. No 50 per cent stock option deduction will be available for securities designated as non-qualifying. The $200,000 vesting limit is shared between agreements issued by the employer and other non-arms length employers.

Qualifying securities: Limited to $200,000 worth of shares per vesting year.

Where a person is eligible to claim the 50 per cent stock option deduction under the status quo rules, they will be able to claim it for qualifying securities.

The designation of non-qualifying options is determined each vesting period. Issuers who are specified persons has the discretion of choosing to designate securities that would have otherwise been qualifying as non-qualifying.

Ordering rule

If a person has entered multiple stock option agreements with an employer or persons not dealing at arm’s length with their employer, an ordering rule will determine which securities will be designated qualifying vs non-qualifying. Where multiple agreements vest in the same year, the securities vesting from the oldest agreement will count towards the $200,000 vesting limit first. If they entered into the agreements simultaneously, the allocation is discretionary.

Employer deduction

Employers can claim a tax deduction equal to the benefit received by the employee in respect to the non-qualifying securities. Various conditions must be met for an employer to qualify for the deduction, including:

• The employer must notify employees in writing if any shares are designated as non-qualifying within 30 days of entering the stock option agreement.
• The employer must notify the Canadian Revenue Agency (CRA) in prescribed form in the year the option agreement is entered into.

Failure to comply with any of the conditions set out in the Income Tax Act could result in the employer’s deduction being limited or eliminated.

Example: Annual vesting limit

An individual enters a stock option agreement with their employer who is a Non-CCPC with consolidated annual revenues over $500 million. The FMV of the securities on the grant date is $550,000, with the grant date being July 15, 2021. $300,000 worth of shares will vest in year 2, while the remaining $250,000 will vest in year 3. Assume the securities would otherwise meet the general criteria to claim the stock option deduction.

The securities will be subject to the $200,000 annual vesting limit because the issuer meets the definition of a specified person, and the grant date is after June 30, 2021.

The FMV of the shares is determined at the grant date (a point in time), while the annual vesting limit is calculated each vesting year.

The value of non-qualifying shares is calculated by taking the FMV of the shares vesting in the year, and subtracting the $200,000 vesting limit, as illustrated below.

The result is a total of $150,000 worth of non-qualifying securities and $400,000 qualifying securities. It is important to note the employer has the discretion of choosing to designate the $400,000 worth of qualifying securities as non-qualifying.

How we can help

It will be important for employers and employees to be aware of when and if these new rules apply to stock option agreements. If you think these rules might apply to your business or have any related tax inquiries, the Tax Group at Fuller Landau can help answer your questions.

About the authors

Georgia Simpson is a Junior Tax Specialist in our Tax group. She can be reached at 647-417-0434 or gsimpson@fullerllp.com.

Kimberley Pahl is a Manager in our Tax group. She can be reached at 416-645-6501 or kpahl@fullerllp.com.