Employee stock options: Are you exempt from new tax rules?

Liberals want to limit the advantages high-income earners receive from the tax system

Employee stock options: Are you exempt from new tax rules?

Startups, scaleups and emerging businesses – which have played a critical role in generating jobs across Canada – may be exempted from the new tax rules that will govern employee stock options by July 2021.

Employee stock options are often incorporated into a company’s compensation strategy in an effort to attract and retain high-calibre talent. This is a common practice, especially among smaller high-growth businesses that are not yet able to reward top employees with competitive salaries.

Canada’s current tax regime offers stock option deductions, taxing these benefits at a preferential rate – the same rate as capital gains – at half the normal rate of personal taxation.

Read more: Why tech startups matter in Canada's recovery

This system, however, is “regressive,” according to the Liberal government, which introduced changes to the tax regime in last year’s federal budget.

“High-income individuals disproportionately [benefit] from this preferential tax treatment,” they said in their fall economic statement released this week.

Now, the government wants to limit the advantages that high-income earners receive from the special deductions.

In 2017, for example, more than 2,300 million-dollar earners received over $1.3bn in employee stock option deductions. These employees can often be found at “large, long-established, mature firms”.

By 2021, the Liberals will set a cap of $200,000 a year on stock option grants taxed at the preferential rate. “This limit will be based on the fair market value of the shares underlying the options, at the time the options are granted,” the government said.

Read more: The pros and cons of offering employee stock options

However, employee stock options granted by Canadian-controlled private corporations (CCPCs) will be exempted from the new rules.

Non-CCPC employers with annual gross revenues of $500m or less, which include startups, scaleups and other high-growth small and midsize enterprises, will also be excluded from the cap.

“This approach will ensure that startups and emerging Canadian businesses that are creating jobs can continue to grow and expand and attract key talent, while limiting the benefit of the employee stock option deduction for high-income Canadians who work in mature companies,” they said.

“These new rules will make the employee stock option tax regime fairer and more equitable for Canadians and, once fully in effect, are expected to generate about $200m in federal tax revenues each year.”

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