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Several amendments to the employee stock option rules under the Income Tax Act (the “Act”) that were originally proposed in the March 4, 2010 federal budget have recently been enacted and have effect as of March 4, 2010. These amendments mainly affect publicly listed companies and their employees and include: limited deductions on stock option cash-out payments; the repeal of the election to defer the taxation of stock option benefits; special relief for those who made elections to defer the taxation of stock option benefits; and employer withholding tax requirements in respect of stock option benefits.
An employer has the obligation to withhold and remit tax on an employee benefit, including a stock option benefit. Under the former rules, an employer could be relieved of its obligation to withhold and remit tax where doing so would cause undue hardship, especially where the employee benefit is non-cash. Historically, the CRA had issued a number of administrative positions to exempt employers from withholding and remitting tax on stock option benefits in certain cases.
The new rules clarify that beginning on January 1, 2011, an employer that is not a “Canadian-controlled private corporation” must withhold and remit tax in respect of stock option benefits. The new rules explicitly impose withholding and remittance obligations on the employer for stock option benefits as if the employer paid a cash bonus to the employee. Consequently, every stock option exercise by an employee or director of a public company will generally trigger employer withholding and remittance requirements.
Employers may need to consider amending stock option agreements to include terms that permit withholding and remittance as required by the Act. Specific terms may include, among other things, a requirement that the employee pay a sufficient amount to the employer, or allow the disposition of a sufficient number of shares by the employer on the employee’s behalf, to satisfy the withholding and remittance requirement. For purposes of the latter, an arrangement could be made with a 3rd party service provider, such as a trustee or transfer agent, to administer the stock option plan.
The new rules do not apply in respect of stock options granted before 2011 pursuant to a written agreement entered into before 4PM on March 4, 2010 where the agreement included, at that time, restrictions on the disposition of the optioned stock.
Employees who exercise stock options realize a taxable employment benefit (the “stock option benefit”) to the extent the fair market value of the shares acquired at the time the stock option is exercised exceeds the exercise price paid by the employee. Under certain conditions, the employee is entitled to deduct 50% of the stock option benefit (the “50% stock option deduction”) realized at the time the stock option is exercised.
Some stock option plans contain cash-out provisions that allow the employee to elect to dispose of the stock option, rather than exercising it, and receive a cash-out payment in an amount equal to the stock option benefit that would have otherwise been realized from exercising the stock option. The cash-out payment is treated as a taxable employment income. Under the former rules, two deductions were permitted in respect of the same benefit amount - the employer could deduct the cash-out payment as an expense and the employee could claim the 50% stock option deduction in respect of the cash-out payment (provided that all of the required conditions for claiming the 50% option deduction were met).
The new rules, which apply to disposition of employee stock options for cash-out payments that occur after March 4, 2010, prevent the two deductions in respect of the same benefit amount. Under the new rules, the employee cannot claim the 50% stock option deduction unless the employer files an election in prescribed form with the Canada Revenue Agency (the “CRA”) agreeing to forgo its deduction for the cash-out payment.
An employer might consider an election to forgo its deduction for the cash-out payment in the situation where the employer is in a loss position and does not need the deduction. Otherwise, if an employer elects to forgo its deduction for the cash-out payment in order to maintain the attractive pre-amendment tax treatment of the 50% stock option deduction for its employees, the incentive plan will become more expensive due to the non-deductibility of the cash-out payment.
Under the former rules, employees of public companies could elect to defer the taxation of the stock option benefit until the tax year in which the related stock is disposed of (subject to certain limitations) (the “stock option deferral election”). This stock option deferral election has been eliminated effective for stock option benefits realized after March 4, 2010.
As a result of the economic downturn in recent years, many employees who made the stock option deferral election are in the position where the fair market value of the relevant stock is less than the deferred tax liability on the stock option benefit.
New rules provide special relief for employees who made the stock option deferral election before March 4, 2010. A special election can be made that will ensure the tax liability in respect of the stock option deferral election does not exceed the proceeds received from the disposition of the related stock.
In order to qualify for this special relief, the employee must have made a stock option deferral election in the past, dispose of the relevant stock before 2015 and file the election for special relief on or before the due date of the tax return for the relevant tax year the disposition of the stock is made. If the employee disposed of the relevant stock before 2010, the deadline for filing the election for special relief is the due date for the 2010 tax return (generally, on or before April 30, 2011).
For more information, please contact Kevin Wong, CA, MNP Taxation Services or contact your local MNP advisor.
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