On June 17, 2019, the Department of Finance released draft legislation to implement the proposals. They are scheduled to apply to options granted after 2019 − if the Liberals are re-elected in October.
The draft legislation clarifies that the one-half inclusion rule will not apply to stock option benefits of an employee that reflect more than $200,000 worth of stock annually, the $200,000 value being determined at the time the option is granted. The limitation applies for each year in which the option “vests”, which is the year in which the option becomes exercisable. The vesting year is not necessarily the same year as the year of the grant of the option.
For example, if an employee receives an option in 2020 to acquire shares that are worth $400,000 at that time, but the option partially vests in 2021 to acquire half of the shares and the rest of the option vests in 2022 to acquire the remaining shares, the entire benefit will qualify for the one-half inclusion rule. This will be the case regardless of the year in which the option is exercised and the benefit is actually realized. (Obviously, if the option is not exercised, there will be no benefit.)
On the other hand, if the above option fully vested in 2021, only 50% of the benefit (200,000/400,000) will qualify for the one-half inclusion, while the rest of the benefit will be fully included in taxable income.
The draft legislation provides that the limitation does not apply to options granted by a Canadian-controlled private corporation (CCPC), regardless of the size of the corporation.
The upside of the draft legislation is that the amount of benefit for which the one-half inclusion for the employee is denied will be generally deductible for the employer in computing its taxable income. That differs from the current rule, which provides that stock option benefits are not deductible for the employer. However, the deduction for the employer is allowed only if the following conditions are met:
- the employee must deal at arm’s length with the employer at the time the option is granted;
- the exercise price of the option cannot be less than the fair market value of the share at the time the option is granted; and
- the share must be a “prescribed share”, which generally includes most common shares and other shares that are similar in nature to common shares.
(The above conditions are the same that must be met in order for the employee to otherwise qualify for the one-half inclusion rule, where it is applicable.)