November 2, 2024
The taxation of stock options in Canada has seen significant changes over recent years, with critical adjustments introduced in the 2021 tax ruling and further modifications recently proposed in the 2024 federal budget. This brief article provides Laulima’s analysis of these changes, their implications, and potential considerations for corporations, employees and executives.
The 2021 tax ruling capped the amount of stock options that could benefit from capital gains-like tax treatment to an aggregate nominal[1] value of $200,000 at the time of vesting. Only stock options granted on or after July 1, 2021, are affected. Stock options that, in aggregate, have a nominal value below $200,000 are termed “Qualified Options”. The remaining options, whose nominal value surpasses the $200,000 threshold, are subject to full marginal rates and are termed “Non-Qualified Options”. Canadian Controlled Private Corporations (“CCPCs”) and non-CCPC employers with consolidated group revenues below $500 million are exempt from the vesting limits and thus can benefit from more favourable tax treatment.
Budget 2024 is slated to take effect on June 25th, 2024 and proposes increases to the inclusion rate for any capital gains that exceed $250,000 annually. In effect, the proposed changes do not impact Non-Qualified Options since they are currently subject to taxation at full marginal rates under the existing rules. However, Qualified Options are now subject to the existing 50% (half) inclusion rate on gains up to $250,000 and a higher 66.66% (two thirds) inclusion rate on any gains exceeding $250,000 annually. Unlike the 2021 rules, this proposed change would apply retroactively to all outstanding stock options.
Although the 2024 proposal is expected to minimally affect new option grants at larger corporations, where most options are non-qualified and subject to full marginal tax rates, it could significantly impact option grants at high-performing companies, particularly where pre-2021 options remain outstanding. Some (or many) option holders may choose to exercise their vested options before June 25, 2024, to align with the current, more favourable 50% income inclusion rate, which can in turn reduce shareholder alignment.
This proposal will also affect smaller companies, which frequently use stock options as a cost-effective compensation tool. It can also impact lower-level executives and employees who are much more likely to hold Qualified Options.
We expect companies, especially smaller, high-growth companies, to reassess their long-term incentive (LTI) mix and evaluate the continued effectiveness of stock options. New mechanisms will also need to be developed to more accurately estimate the tax implications and withholding requirements.
Careful consideration will be required as these tax changes progress from proposal to law. Executives and companies must stay informed and be prepared to communicate the facts and potential implications to affected employees.
For more information, contact us at info@laulimaconsulting.com.
[1] The 'nominal' value of stock option awards is defined as the number of options at vesting multiplied by their respective strike prices.
