Employers in Canada’s emerging industries like cannabis, psychedelics, and agritech are concerned about how upcoming changes to the taxation of stock options will impact their ability to recruit top talent. Traditionally, stock options are among the most enticing incentives used to attract senior talent; particularly the type of executives who are equipped to drive growth in global markets as a company expands.
Though the Canadian government has claimed that the upcoming changes are aimed mainly at mature firms, younger companies in emerging industries will not be protected from the new legislation. Let’s take a closer look at the new regulations.
For a non-Canadian Controlled Private Corporation (CCPC), currently under the Income Tax Act (ITA), when employees exercise stock options, they are generally taxed as taxable benefits on the difference between the value of the stock and the exercise price that they paid. In the case of a CCPC the benefit is taxed at the time of the sale of the stock. If specific conditions are met, the employee can claim a deduction of 50% of the taxable benefit, essentially reducing their tax on the benefit by half – a huge savings! Under current rules, there is no limit on the dollar amount.
Stock options granted, in certain instances, after June 30, 2021 will face a new annual vesting limit of $200,000, applying to an employee for every calendar year, for each employer. If the value acquired in a year by an employee exceeds $200k, the stock option deduction won’t apply to taxable benefits that are realized on any portion related to those options. The new rules also state that if an employee chooses to donate publicly listed shares that were acquired under stock options exceeding the $200k limit, they will not be eligible for the stock option deduction. That being said, the employee will be able to claim the charitable donation tax credit, covering the full amount of the donated shares.
How it works
Stock options vest in a year that, pursuant to the stock option agreement, the employee earns the right to exercise the options. Generally stock options will vest over a number of years pursuant to the stock option agreement entered into at the grant date. The stock option agreement generally will state the vesting period (e.g. 20% of the options granted will vest in each year over the next 5 years.) The new rules state that if the agreement doesn’t specify the vesting period (i.e. x amount each year) then the stock options will be considered to have been vested equally over the period of time between the grant date and the final exercise date, with a maximum period of five years. The $200k annual vesting limit is based on the value of the option’s underlying shares at the time of the grant.
If an employer complies with the notification requirements, the employer can deduct the portion of the employee’s stock option employment benefit that does not qualify Employers can additionally apply to have this same treatment on stock options less than $200k. It is important to note, for tax purposes, the benefit or the value of an option is equal to the difference between the stock price and the exercise price per share at the date of exercise.
These rules apply to employers who, at the time the options are granted:
– Are a corporation or mutual fund trust (excluding CCPCs); and
– Belong to a group with consolidated gross revenues exceeding $500 million.
The new legislation restricts the employer’s ability to deduct stock option expense in certain situations where an employee resides outside of Canada.
What actions do employers need to take?
Though options granted prior to July 1, 2021 will continue to be taxed under the old rules (and thus will not be subject to the limit or eligible for deduction by the issuer), employers who will continue to grant options past that date will need to:
– Determine whether to designate any options as non-qualifying below the $200k vesting limit.
– Notify employees of any options that exceed the $200k limit, and if their options will not qualify for the deduction, within 30 days of the stock option agreement being entered into.
– Notify CRA in a yet-to-be-prescribed form of any option grants that will have non-qualifying securities.
– Track options and make sure that payroll tax withholdings are conducted at the right income tax rate for any non-qualifying issued securities.
– Track option exercises and amount information for the purpose of a corporate tax deduction.
How will this affect hiring?
Though younger talent may find lifestyle factors like gym memberships, education budgets, and remote work to be sufficient reason to join a team, more senior executives typically consider stock options to be among the most attractive incentives. For companies in Canada’s emerging industries, attracting leadership with global connections can change the profit trajectory. So when the Canadian government introduces changes to taxation such as these, it potentially makes Canada a less appealing option for executives who might otherwise travel north.
If your company is concerned about how changes to stock option taxation may affect your hiring practices, contact Zeifmans today. Together we can build a strategy to attain compliance and attract top talent as your business gains momentum.