On June 17, the Department of Finance (DOF) released long-awaited draft legislation that will limit the current preferential tax treatment of stock options in an effort to create a “fairer” tax regime. According to the DOF, the tax benefits of the current employee stock option deduction “disproportionately accrue to a very small number of high-income individuals”.
Here are the key takeaways:
When : The new tax regime will apply to options granted on or after January 1, 2020.
Finally, employers must notify employees in writing, at the time of grant, whether options are subject to the new rules, and must notify the Canada Revenue Agency in prescribed form.
The following is a simple illustration with one grant in two different exercise scenarios.
Facts: On January 1, 2020, Employer XCo grants Employee 200,000 options having an exercise price equal to $25 (i.e., the FMV of the share on the date of grant). The options will vest in equal parts over four years. Each year, 8000 options are qualified options ($200,000 limit / $25 FMV at grant) and 42,000 options are non-qualified.
With fewer options qualifying for preferential (employee) tax treatment, employers may want to re-visit their current long-term incentive (LTI) vehicle mix.
Organizations may look at this as an opportunity to focus on vehicles that are most in line with their business strategy and competitive practice. For example, employers may consider using fewer options and instead establishing longer-term share unit plans (i.e., beyond the typical three-year performance period) that would be settled with treasury shares. It is unlikely the proposed legislation will result in stock options disappearing as a popular LTI vehicle; notably the U.S. has a similar stock option tax regime (in that preferentially-taxed “incentive stock options” are subject to a FMV $100,000 annual vesting limit while the more-popular “non-qualified stock options” are fully taxable) and options continue to remain a viable element of executive compensation.
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