In Canada, employees who exercise stock options receive enviable tax treatment. As in most countries, the spread between the exercise price and the market value of the shares on the exercise date is subject to tax at ordinary income rates. However, in a significant difference from the usual tax treatment, when the exercise price equals the fair market value of the stock at grant, employees are allowed to deduct 50% of the "option benefit" (i.e. the spread) when computing taxable income (Quebec residents can deduct only 25%).
The favorable tax treatment of stock options in Canada has kept them popular there, in contrast to the decreasing use of options in the United States, but it has attracted political opposition. For example, the New Democratic Party (NDP), a leader among Canada's minority parties, opposes the 50% deduction and would like it to end (see an article in Toronto's newspaper The Globe and Mail).
The Liberal Party, which won Canada's recent national election and forms the new government, does not go that far. Nevertheless, the Liberals have indicated that they do want to change the treatment of tax-preferred stock options. In statements made during the election campaign, the Liberal Party indicated that while it respects the useful role of stock options, it wants to place a limit on the amount of income from an option exercise that can be subject to the standard tax deduction. Amounts above the income threshold will not be eligible for the deduction, though the deduction will remain for lower amounts. While the income limit has not yet been finalized, the Liberals have stated that it will be at least C$100,000. (For some background and commentary on the government's proposed changes, see a memo from the Canadian law firm Torys.)
It remains unclear whether the Liberals' proposed limitation of the option tax deduction would truly raise additional revenue in the long term or merely serve to discourage the use of options. In general, the Liberal Party has made it clear that its top fiscal priority is lowering taxes on the middle class and raising tax rates for those with higher incomes, and that it wants new tax laws in place by the start of 2016. Other potential tax changes being eyed by the Liberal Party include higher rates on income above C$200,000 (from 29% to 33%), as discussed in a commentary from the website Advisor.ca.
What does the Liberal government's stance on option taxation mean for optionholders in Canada? An article in the Financial Post points out that employees with vested options may want to take quick action: it is possible that the change in tax law may be immediately effective (without any grandfathering) from the announcement date, which could occur as early as December 3, when parliament is recalled. The article's author says that exercising options before that date would "pretty much guarantee" the 50% tax deduction, assuming the tax changes will not be applied retroactively. (Of course, optionholders should also consider whether exercising options now makes good financial sense for them.)
For the tax treatment of equity compensation in Canada and related insights, see the Canada section of the Global Tax Guide at myStockOptions.com.
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