Employee Stock Options: New Tax Rules Implementing $200,000 Annual Limit

As part of the 2019 Federal Budget, the Government of Canada proposed new rules which would generally limit certain existing deductions associated with stock options to an annual amount of $200,000 (see our earlier blog on the 2019 budget here). On June 17, 2019, the Government released additional details on the proposal, giving greater information on its application. The purpose of this post is to provide an overview of those details.

1. Who will this impact?

The new rules can potentially impact any corporation issuing stock options to an employee where the value of the shares underlying the options exceeds $200,000. The two critical times for analysis are the grant date (which is used to determine the “value of the shares”) and the date the options vest (which is used to determine the particular tax year to which the analysis applies). On the valuation question, this seems to be entirely determined with reference to the publicly-traded price of the corporation’s shares. On the vesting question, in determining the date that an option vests, the new rules provide that the date specified for vesting in the particular option agreement will be relevant for the rules. However, if the vesting date is set with reference to some “event that is not reasonably foreseeable at the time the [option] agreement is entered into”, then the vesting date (for purposes of these rules) will be the first calendar year in which the option is reasonably expected to be exercised.

Summarized then, if an individual stands to have options vest in a given calendar year, and the value of the shares underlying those options exceeds $200,000, then the new rules may apply.

Critically, these new rules do not apply where either:

• The corporation is a Canadian-controlled private corporation (CCPC) (generally this means that (i) the corporation is not publicly-traded, and (ii) the corporation is not controlled by non-residents of Canada); or
• The corporation is not a CCPC but meets certain prescribed conditions for being a “start-up, emerging or scale-up company” (these conditions have not yet been released as the Government has invited stakeholder comment on this definition – comments are open until September 16, 2019 and can be emailed to fin.ESO-OAAE.fin@canada.ca)

2. How does it work?

For employees, where they exercise an option that exceeds the $200,000 limit, they will incur a taxable benefit equal to (i) the fair market value of the share at the time the option is exercised, less (ii) the amount paid by the employee to acquire the share. That benefit will be taxed in the employee’s income for the tax year in which the option is exercised. Notably, the employee will not be entitled to any stock option deduction in respect of that benefit.

For the employer, they still retain a deduction for options granted in excess of the $200,000 limit. That deduction can be claimed in the employer’s tax year that includes the day on which the employee exercised the option. As a result of these new measures, employers that are either CCPCs or “start-up, emerging or scale-up companies” will not have recourse to this deduction.

For an example comparing the employee’s tax treatment under the “old rules” and under these “new rules”, see our prior blog post here. You can also find examples used by the Government here.

3. When do the proposals come into effect?

The proposals will apply to any stock issuance agreement entered into after December 31, 2019.

4. What can I do now?

At this time, corporations are encouraged to review their stock issuance policies to ensure they do not trigger the new rules. For many start-up companies, their private (i.e. not publicly-traded) status coupled with Canadian-control will ensure the new rules do not apply to them. On the matter of control, corporations should pay particular attention to any shareholders’ agreements that may give non-residents of Canada voting control over the corporation (notwithstanding that the non-resident holds less than 50% of the voting shares of the corporation). For non-CCPC companies, they may well benefit from the “start-up, emerging or scale-up company” characterization; however, there is no definition for this term yet and it may not cover all conceivable foreign-controlled startups. For those companies particularly, they may be well served to provide comment to the Government prior to September 16, 2019.

The lawyers are McKercher have a depth of experience acting on behalf of public and private corporations assisting them with their equity incentive planning. Our lawyers have experience in general corporate/commercial, corporate governance, tax, and corporate finance matters that are crucial to the proper analysis of this type of planning. We would be pleased to discuss any equity incentive planning with you and assist with the impacts of these new rules on your corporation.

About the Authors:

Joe is a partner in the Saskatoon office where he practices in the areas of corporate finance, securities, mergers & acquisitions, and taxation.

About the Entrepreneur/Start-up Group:

McKercher LLP’s Entrepreneur and Start-up Group provides innovative local legal services for Entrepreneurs and Start-ups.

About McKercher LLP:

McKercher LLP is one of Saskatchewan’s oldest, largest law firms with offices in Saskatoon and Regina. Our deep roots and client-first philosophy have made our firm rank in the top 5 in Saskatchewan by Canadian Lawyer magazine (2017/18). Integrity, experience and capacity provide innovative solutions for our clients’ diverse legal issues and complex business transactions.

This post is for information purposes only and should not be taken as legal opinions on any specific facts or circumstances.  Counsel should be consulted concerning your own situation and any specific legal questions you may have.