Canada’s Federal Budget 2024: More Changes to the Stock Option Rules = More Headaches for Employers
Much of the talk about Canada’s federal budget released on April 16, 2024 (“Budget 2024”) has been concentrated on the increase to the capital gains inclusion rate, highlighted by criticism from the business community that these increases will harm more than people than promised. However, what has not been discussed is the knock-on effect that the changes to the capital gains inclusion rate have on the taxation of stock options.
In 2019, the federal government proposed changes to the taxation of stock options to target high-income earners employed at large, established companies by capping the availability of the Stock Option Deduction, as defined below. Traditionally, when one exercises stock options, provided certain conditions are met, the employee can avail herself of a 50% deduction (the “Stock Option Deduction”) on the employment benefit (the difference between the fair market value of the shares on the date of exercise minus the exercise price) that is triggered on exercise. The 2019 announcement regarding the potential limiting of the Stock Option Deduction caused an uproar from Canadian businesses, concentrated mainly in the technology sector, who use stock options to attract top talent, and, subsequently, the rules were softened. In July 2021, the new rules became applicable, placing an annual cap of $200,000 on the value of stock options eligible for the Stock Option Deduction, specifically limited to those issued by non-Canadian controlled companies with gross annual revenue over $500 million.
Since July 2021, employers that are subject to these new rules have to designate and track stock options that are (i) “qualified” (and eligible for the Stock Option Deduction) or (ii) “unqualified” (and not eligible for the Stock Option Deduction). In addition, the employer must notify the affected employee in writing of the status of the stock options and notify the Canada Revenue Agency (CRA). The employer must ensure that it is withholding correctly – while taking into account the availability of the Stock Option Deduction – and remit such amounts in a timely manner to the CRA.
Fast forward to Budget 2024. With the capital gains inclusion rate increasing from 50% to 662/3% on the portion of capital gains realized in the year that exceeds $250,000 for individuals beginning on or after June 25, 2024, there is also a corresponding change to the amount of the Stock Option Deduction. Budget 2024 will modify the Stock Option Deduction from the current 50% to 331/3% to reflect the new capital gains rate. An employee will be entitled to a 50% Stock Option Deduction up to a combined annual limit of $250,000 for both employee stock options and capital gains. The changes to the Stock Option Deduction do not appear to be limited to non-Canadian controlled private corporation shares, as the changes in 2021 were limited.
It will continue to fall to an employer to withhold the correct amount of tax that is applicable to stock options. The $250,000 will be personal to each employee, meaning that the employer will need to take into account each employee’s personal circumstance and whether they have triggered any capital gains in any given year. Adding in the fact that there will likely need to be transitional rules for stock options that vest over several years straddling the June 25 date, this will add another layer of complexity for employers to an area of tax law that has gone through significant changes in the past few years.
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