Q&A Re Employee Stock Options

On February 26, 2001, the CCRA released a series of questions and answers concerning the new rules affecting employee stock options that were proposed in the February 28, 2000 federal budget. See CCH Special Report No. H094, dated March 16, 2001, for the draft legislation implementing these proposals.

Reproduced below are the questions and answers on the proposed tax deferral rules for employee stock options.

Deferral of taxation on employee stock options

Q1: How does the proposed legislation change the taxation of employee stock option benefits?

A1: Existing legislation requires that the taxable benefit arising from the exercise of stock options to purchase publicly listed shares be included in income in the year the options are exercised. Under the proposed legislation, eligible employees may elect to defer the taxable benefit arising from options exercised after February 27, 2000, to acquire eligible securities. The taxable benefit may be deferred until the earlier of:

• the year in which the eligible employee disposes of the shares,
• the year in which the eligible employee dies, or
• the year in which the eligible employee becomes a non-resident of Canada.

Q2: Who is considered to be an eligible employee?

A2: An eligible employee is one who, at the time the option is granted, deals at arm's length with the employer and related corporations, and is not a specified shareholder (i.e., one who generally owns at least 10% of any class of the corporation's shares) of any of these corporations.

Q3: What securities are eligible with respect to the deferral election?

A3: An eligible security is a common share of a class listed on a prescribed stock exchange in or outside Canada or a unit of a mutual fund trust. In addition, the total amount payable to acquire the security cannot be less than its FMV at the time the option was granted.

Q4: Is there a limit to the amount of taxable benefit that can be deferred?

A4: There is no limit that applies directly to the amount of taxable benefit. However, the deferral election is subject to an annual vesting limit of $100,000. This limit is based on the year in which the options vest (i.e., first become exercisable), and on the fair market value of the underlying securities when the options were granted. For options vesting in a given year, an employee will be able to defer taxation on the acquisition of securities having a total fair market value (determined at the time the options were granted) not exceeding $100,000.

Q5: What exchange rate should be used if an employee receives stock options from a U.S. parent, valued in U.S. dollars?

A5: The exchange rate in effect at the date that the options are granted must be used. The exchange rate information may be obtained either from the company issuing the options or the Bank of Canada at 1-800-303-1282 or 613-782-8111 (Ottawa area). This information is also available on the Bank of Canada Web site.

Q6: Who is required to keep track of the $100,000 annual vesting limit?

A6: Since the employee may be in receipt of options from more than one employer, or more than one company in the corporate group, the employee is considered in the best position to accurately keep track of whether the $100,000 annual vesting limit has been exceeded. It is expected that, upon request, the employer will be able to provide assistance in furnishing the employee with information relevant to the limit.

Q7: How does an employee who wishes to defer taxation of a stock option benefit file the election?

A7: In order to take advantage of the deferral provision, the employee must submit a letter to the party designated to report the benefit (usually the employer) containing the following information:

• confirmation that the employee was a resident of Canada at the time of the share acquisition,
• confirmation that the $100,000 annual vesting limit has not been exceeded, and
• the amount of the benefit related to qualifying shares purchased under the option agreement after February 27, 2000 that the employee wishes to defer.

Q8: When must the employee file this election?

A8: Normally, in order to take advantage of the provision, the employee must file the election no later than January 15th of the year following the purchase of the qualifying shares. For share purchases in 2000, however, the employee will have until February 15, 2001 to file the election. In the future, if the employee files the election at the time of share purchase, the employer will be permitted to reduce the employee's income tax withholding by the amount of tax related to the benefit being deferred.

Q9: Will the employer be required to ensure compliance with the $100,000 annual vesting limit?

A9: No. The employee will have the responsibility to ensure compliance with the limit. The employee may be in receipt of options from more than one employer, or more than one company in the corporate group, therefore, the employee is considered in the best position to accurately keep track of whether the $100,000 annual vesting limit has been exceeded. When an employer accepts the election from the employee, the employer must be satisfied that the conditions for a valid election have been met. Unless the employer has reason to believe otherwise, it is reasonable for an employer to rely on certification made by the employee that the $100,000 annual limit criterion has not been exceeded with the election being made.

Q10: Will the employer be required to confirm the residency status of the employee at the time shares are acquired?

A10: No. In accepting the election from the employee the employer must be satisfied that the conditions for a valid election have been met. Unless the employer has reason to believe otherwise, it is reasonable for an employer to rely on the certification made by the employee that the residency criterion has been met.

Q11: Can an employee revoke an election to defer the taxation of stock option benefits?

A11: Yes. An employee who wishes to revoke an election to defer may do so by filing a written notification to this effect with the person with whom the election was filed. The deadline for filing such a notice in respect of shares acquired in 2000 is 60 days after the day on which this legislation receives royal assent. Thereafter, the deadline is January 15 of the year following the year in which the share is acquired.

Q12: Will the deferred stock option benefit be subject to deductions at source?

A12: If the employee files the election at the time of share purchase, the employer will be permitted to reduce income tax withholding by the amount of tax related to the benefit being deferred. The proposed legislation includes an amendment to the Canada Pension Plan (CPP). This proposed amendment ensures that deferred stock option benefits are included in pensionable earnings for the calculation of CPP contributions, in the year in which the shares are acquired rather than in the year in which the shares are disposed of. The Canada Customs and Revenue Agency (CCRA) is currently preparing amendments to the Income Tax Regulations to ensure that a non-cash remuneration is not included in insurable earnings for the calculation of employment insurance premiums.

Q13: How will the deferred stock option benefit be reported to the CCRA?

A13: The responsibility for reporting the stock option benefit and its tax deferral rests with the employer (or the company who granted the option or the company from whom the shares were purchased, if they are not the same as the employer). The stock option benefit and the deferral of the benefit will be reported on a T4 information slip.

Q14: Is the employee who elects to defer the taxation of employee stock options required to submit any information to the CCRA?

A14: An employee who elects to defer the taxation of employee stock options is required to file prescribed Form T1212 Statement of Deferred Stock Option Benefits with his/her tax return for each year during which he/she has an outstanding balance of deferred stock option benefits. This form must be filed regardless of whether or not the employee has deferred any stock option benefits or disposed of any securities relating to a deferred stock option benefit in the taxation year for which the return is being filed.

The company tracks, explains and analyzes tax and business related law, annually producing over 250 publications in print and electronic form for tax, accounting, legal, human resources and financial planning professionals.