The federal government announced in its 2019 budget that it plans to change the rules governing employee stock option deductions by limiting the tax-preferred treatment to a maximum $200,000 annual cap for employees of large, long-established firms, while stock options for employees of start-ups and rapidly growing businesses would remain uncapped for tax purposes.
The Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada points out that, since the budget announced the overall policy direction but no actual details or proposed legislation, it couldn’t provide comprehensive comments on the plan. But that doesn’t mean it has nothing to say.
The Committee points out that the compensation determination process can be lengthy, and requires a long lead time from the time compensation decisions are made until the options are ultimately granted. Both the employer and employee have to take tax implications into account when negotiating or setting the level and mix of compensation, and so any change in regulations should respect their expectations.
Before legislation is drafted, the Committee says, the Finance Department should release the details of its planned approach, then consult with stakeholders. Next in the appropriate sequence would be releasing draft legislation based on the consultation, then tabling the implementing legislation in Parliament. This last step is what would “start the clock of the transition period, assuming the implementing legislation is ultimately enacted,” the Committee says in a letter to the Department of Finance. “This approach should minimize the period of uncertainty for employees and employers.”
The Committee also points out some technical difficulties with drawing a line between “large, long-established, mature firms” and “start-ups and rapidly growing Canadian businesses.”
“The references to ‘start-ups’ and ‘long-established’ suggest factors having to do with time and age, while the reference to ‘rapidly growing Canadian businesses’ suggests a more functional approach that is not limited by age,” the Committee says.
Long-established businesses, however, can undergo changes to orientation and focus, develop new products with tremendous growth potential, or house an emerging business under a corporate roof that also contains mature businesses, and it’s not clear how those situations would be treated. Industry sector may also be relevant, as sectors spending a lot on research and development “may also ‘not have significant profits and may have challenges with cash flow’ regardless of their ages,” the Committee points out.
“Any uncertainty with respect to these definitional elements of the proposed changes will result in more disputes between taxpayers and the CRA and will simply discourage the use of stock options as employee compensation, even by firms that, from a policy perspective, are intended to be protected from the application of new restrictions.”
Other concerns include:
- the need for an approach to deal with companies in transition from “rapidly growing” to “large and mature”
- a methodology for distinguishing between options within and outside the $200,000 cap where only a portion of the options are exercised
- legislation should clearly provide a codified deduction for the stock option benefit and provide that the deduction is available notwithstanding other provisions of the Act
As well, the Committee notes that in the past it has written to the Department recommending amendments to the Income Tax Act regarding prescribed shares, and it says now would be a good time to make those changes. “To undertake a significant alteration to the employee stock option rules without addressing these shortcomings would be unfortunate, as the natural time to revisit technical issues is in the context of a broader review.”