Stock Option Taxation Update

The newly elected federal Liberal government ran on the promise of several personal income tax reforms. The majority of the personal income tax reforms promised by the Liberals focus on addressing income inequality between high-income earners and the middle class – as evidenced by the proposed high-income tax bracket, the reduction in the Tax Free Savings Account contribution limit, the removal of family income splitting, and an over-haul of the current tax treatment of stock-options.

Currently, the rules relating to employee stock option taxation in Canada, generally provide for no tax payable at the time that options are granted and only result in the employee recognizing 50% of the benefit or gain arising from the exercise of the qualifying stock options issued by public companies. This amount is taxed in the year of such exercise. Stock options issued by a Canadian-controlled private company (CCPC), provided certain conditions are met, are eligible for a further benefit in that the tax payable by the employee is deferred until the employee disposes of the shares acquired through the stock option. The result is a “capital-gains” like tax treatment of the increase in the value of the shares. This treatment is implemented by way of a deduction from employment income rather than taxing the stock options as a capital gain.

The Liberals have stated that they will limit the amount that can be claimed by a taxpayer under the available stock option deductions to $100,000 in annual stock option gains.  The Liberals did not differentiate between public company options and CCPC options so it is not clear if the proposed limit will affect both types of stock options.

It is unclear when the Liberal stock option plan will be enacted, however, Minister of Finance Bill Morneau indicated on November 20, 2015, at a press conference, that any changes with respect to the taxation of stock options would only take effect on the date they are announced, and would not affect stock options issued prior to that date. It is still unclear what the precise changes to the stock option regime will be, however, Finance Minister Morneau’s announcement indicates that current option holders would be cautioned not to exercise options prematurely in a rush to avoid the new Liberal stock option regime.

According to the Liberal Fiscal Plan, the purpose of the proposed change to the current stock option regime is that the Liberals believe that the current tax treatment of stock options permits senior executive employees and wealthier Canadians to benefit disproportionately from the favourable tax treatment of stock options. The Liberal Fiscal Plan notes that the Department of Finance estimates that 8,000 very high-income Canadians deduct an average of $400,000 from their taxable incomes in respect of stock option tax benefits.  This represents three-quarters of the fiscal impact of the stock option deduction which, in total, cost $750 million in 2014.  Furthermore, the Liberals have suggested their changes to the tax treatment of stock options, including the $100,000 limit, would raise $500 million or more in government revenue.

Opponents of the proposed changes contend that the current tax treatment of stock options is vital to the Canadian start-up sector. Start-up companies depend on the current stock option regime to attract talented employees because their budgetary constraints prevent employers from offering competitive salaries. In the start-up sector, employees are generally willing to assume financial insecurity and lower pay in exchange for stock option incentives, which they hope to exercise in the future at a significant gain. As a result, opponents believe that the proposed changes to the taxation of stock options, put forth in the Liberal Fiscal Plan, would have a significant negative impact on the growth of the Canadian start-up sector.

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Christopher Steeves is the Leader of Fasken Martineau's Tax practice group and is based in Toronto.