Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax/Pension & Employee Benefits, October 2010
On August 27, 2010, the Department of Finance released draft legislative proposals for the Income Tax Act (Canada) (the ITA). Related Explanatory Notes were made available on September 10, 2010 and additional draft legislative proposals, addressing many of the same provisions of the ITA as the August 27 proposals, were released on September 28, 2010. If enacted, many of these proposals will take effect as of 4:00 p.m., Eastern Standard Time, March 4, 2010 (the Announcement Time). For a discussion of the stock option amendments as announced earlier this year, please see our March 2010 Blakes Bulletin: Canadian Federal Budget Announces Changes to Employee Stock Option Rules.
These legislative proposals include significant tax changes with respect to employee stock options. These proposed tax changes mean that some corporations and mutual fund trusts that provide employee security options (generally referred to in this bulletin as "stock options") may need to amend existing option plans and/ or grant agreements before December 31, 2010. These tax changes were first announced in the March 4, 2010 Federal Budget (the Budget) and include:
the requirement, commencing in 2011, for the withholding and remittance of tax in respect of an employment benefit realized by an employee exercising a public company stock option; the requirement that on a cash-out of a stock option right, the employer must elect to forego a tax deduction of the cash-out amount for the employee to be subject to capital gains equivalent tax rates in respect of the cash-out amount; and the repeal of the election which allowed employees exercising public company stock options to defer including an amount in income until the shares were sold. Grantors of stock options should review their option plans and grant agreements to determine whether amendments should be made prior to 2011 in light of the proposed changes to the ITA. If a grantor of options determines that amendments to its stock option plan or grant agreements are advisable, it should review the amending and other provisions of its plan or grant agreements, as the case may be, and the requirements of any stock exchange on which its securities are listed. Of particular concern for public companies is that, in certain circumstances, board and/or securityholder approval may be required to effect the amendments. The timeline for obtaining such required approvals should be considered in light of the changes to the ITA becoming effective as of January 1, 2011.
MANDATORY WITHHOLDING ON STOCK OPTION EXERCISE
Under the ITA, an employee stock option is generally taxable to the optionholder at the time the option is exercised. When an employee exercises the option, there is a deemed employment benefit equal to the in-the-money value of the exercised option (essentially the difference between the exercise price paid by the employee and the fair market value of the shares at the time of exercise). Provided certain conditions are met, the employee can claim a 50% deduction against the amount of the deemed employment benefit, effectively resulting in the stock option benefit being taxed at capital gains rates.
The proposed amendments include significant changes to the rules relating to the obligation of a person providing a stock option benefit to withhold and remit tax in connection with the exercise of stock options after...