Proposed amendments to the stock option rules

08 July 2019


Leading up to the 2015 federal election, the current government's platform contained a pledge to cap or limit the availability of the employee stock option deduction provided for in the Income Tax Act (Canada) (the "ITA"). However, the federal budgets introduced in 2016 through 2018  were silent on the issue.  Budget 2019 revisited the issue and announced the government's intention to impose an annual $200,000 limit on the stock option deduction for employees of large, long-established, mature companies, but few details were provided in the Budget 2019 materials.  On June 17, 2019, the Minister of Finance tabled a Notice of Ways and Means Motion that contains the proposed amendments, which are intended to be effective for options granted after 2019.  This article examines and comments on the proposed changes.

The Current Rules

Under the current rules, a deduction may be available equal to 50 per cent of the benefit derived from exercising or disposing of an employee stock option. This 50 per cent inclusion rate results in taxation to the employee at capital gains-like rates. The current rules do not include limits based on the income level of the employee claiming the stock option deduction, the number or value of the options granted or on the size, maturity or profitability of the company granting the option. The current rules generally deny a deduction to the employer in respect of the grant or the exercise of the option.

The current rules differentiate between options granted by a Canadian-controlled private corporation ("CCPC Options") and options granted by other corporations and mutual fund trusts ("Non-CCPC Options"). 

For Non-CCPC Options, an employee will generally be entitled to the 50 per cent deduction where:

  • The exercise price of the option is no less than the fair market value ("FMV") of the underlying security at the date the option is granted;
  • The employee deals at arm's length with the grantor of the option immediately following the time of grant; and
  • The share underlying the option satisfies the "prescribed share" tests set out in the regulations under the ITA, which seek to ensure that the underlying share is a "plain vanilla" common share.

For CCPC Options, an employee will generally be entitled to the 50 per cent deduction where:

  • The grantor is a CCPC at the time of the option grant;
  • The employee deals at arm's length with the grantor of the option immediately following the time of grant; and
  • The option is exercised and the shares acquired and held for two years prior to a disposition or exchange of the shares.

An employee holding CCPC options can also claim the deduction by meeting the more rigorous test for Non-CCPC Options.

The Proposed Amendments

The proposed amendments do not alter the current rules for CCPC Options.  Further, the proposed amendments will not apply to options granted by "start-ups, emerging or scale-up companies".  These latter terms are not defined in the proposed amendments and the government is engaging in a public consultation with a view to determining the parameters of these terms.  It will be interesting to see whether the government proposes distinctions based on objective criteria such as maturity of the business, number of employees, revenues, profits, etc., or more subjective criteria or perhaps even Ministerial discretion. In any event, options granted by CCPCs or start-ups, emerging or scale-up companies (referred to herein as "Non-Specified Persons") will continue to be governed by the current rules described above.

For all other options, being those granted by "Specified Persons", the proposed amendments introduce significant changes, for employees and employers.

Annual Cap

The concept of a $200,000 annual vesting limit is proposed.  An employee will only be entitled to the 50 per cent deduction in respect of $200,000 worth of options that vest in the same calendar year, with the $200,000 determined by reference to FMV of the shares underlying the options.  Any options that exceed this cap will be treated as "non-qualified" options. If an individual is employed by more than one employer, and those employers deal with each other at arm's length, the employee will have a separate annual cap in respect of each employer.

For example, assume an employee is granted options to acquire 10,000 shares which have a FMV at the date of grant of $80 per share, and all the options vest and are exercisable immediately.  The $800,000 underlying-share value is four times the annual cap, with the result that ¾ of the options will be "non-qualified" options.  Assume further that the employee exercises the options at a time when the share value has increased to $90 per share, such that a stock option benefit of $100,000 arises.  The employee will be entitled to the 50 per cent deduction only in respect of one-fourth of the benefit, or $25,000, with the remaining $75,000 of benefit taxed at full rates.  If, instead, the 10,000 options were to vest over a four-year period, each of those four years would have a separate $200,000 annual cap, with the result that none of the options would be "non-qualified".

The annual cap approach is an interesting policy choice.  In the Backgrounder released with the proposed amendments, the government states that the current rules unfairly benefit the wealthiest Canadians, with six percent of claimants receiving two-thirds of the $1.3 billion in stock option deductions.  However, rather than impose an annual cap based on the income level of the claimant, the proposed amendments impose the annual cap on all claimants who receive options from Specified Persons. This arguably penalizes employees who do not count themselves amongst the "wealthiest Canadians" but for whom the 50 per cent deduction is an important part of their compensation package.

Determining the Vesting Year

If the option grant specifies the calendar year in which the right to exercise arises (otherwise than as a consequence of an event that is not reasonably foreseeable at the time of grant), then the year so specified will be the vesting year for purposes of applying the annual cap.  In any other case, the vesting year will be the first calendar year in which the right can reasonably be expected to be exercised.  It is not clear that an option grant that is silent on the issue of vesting, and thus is technically immediately exercisable, can always reasonably be expected to be exercised in the year of grant. Consider also how vesting criteria other than time-based criteria will be interpreted for the purposes of this rule.

Ordering Rules

Where an employee holds options that include qualified and non-qualified options, the employee will be treated as having exercised the qualified options first.

Employer Deduction

The proposed amendments provide a Specified Person with the ability to claim a corporate deduction in respect of non-qualified options, in an amount equal to the stock option benefit derived by an employee.  The deduction is provided for in the computation of taxable income, rather than by amending
paragraph 7(3)(b) of the ITA which has traditionally been the source of the denial of a corporate deduction in respect of employee stock options. The Specified Person must satisfy the notification requirements (discussed below) in order to claim the deduction.  The deduction will only be available if the optionee is the employee of the Specified Person, such that no deduction will be available to a Canadian subsidiary corporation in respect of non-qualified options granted by a foreign parent corporation.  As well, Non-Specified persons cannot "opt in" to the new regime in order to claim a deduction.

In addition, the option must otherwise have been eligible for the 50 per cent deduction but for having exceeded the annual cap.  Accordingly, the option must have satisfied the tests set out above under "current rules" for Non-CCPC Options.  Thus, no deduction will be available for, inter alia:

  • options with a strike price that is less than the FMV of the underlying shares as at the date of grant;
  • equity-based arrangements that rely on the "stock option" rules but do not qualify for the 50 per cent deduction under the current rules (such as restricted share units); or
  • options for which the underlying shares are not prescribed shares, presumably with the prescribed share test being applied at the time of exercise of the option. 

With respect to the latter bullet, consider whether the proposed amendments might lead to a disqualification for preferential tax treatment for both the Specified Person and the optionee.  For example, if the option has a FMV strike price but is a non-qualified option due to the annual cap being exceeded, the optionee would not be entitled to the 50 per cent deduction. However, if, prior to exercise, there is an event that causes the underlying shares to cease to be prescribed shares, the employer would be disqualified from claiming the corporate-level deduction.  As a result, both parties would be denied the preferential treatment.  

The proposed amendments also provide that the "limitation on expenditure" rules in section 143.3 of the ITA do not apply to prohibit the corporate deduction.

The proposed amendments also expand the definition of "non-capital loss" in the ITA to treat a loss created by claiming a corporate deduction in respect of a non-qualified option as a non-capital loss.

Designation as Non-Qualified

The proposed amendments permit the grantor of an option to designate one or more options as non-qualified options for purposes of the new rules, effectively denying the employee the 50 per cent deduction even though the options would otherwise meet the tests for the deduction and would not exceed the annual cap.  This would open the door to the ability to claim a corporate-level deduction in respect of the option.  Interestingly, the designation can only be made where the grantor is the direct employer the employee.  Accordingly, no designation can be claimed where a Canadian subsidiary corporation regularly reimburses its foreign parent for the cost of granting options to employees of the Canadian subsidiary corporation.  This is consistent with the drafting of the employer deduction provisions discussed above.


The proposed amendments include a number of notification requirements.  First, the grantor of the option must notify the employee in writing where the option is a non-qualified option by virtue of exceeding the annual cap.  This notification must be made on the date the option is granted but no particular format appears to be required. 

Further, if the grantor chooses to designate one or more options as non-qualified, the designation must be set out in the grant document, effectively providing notice to the employee.  Finally, the grantor must also notify the Canada Revenue Agency ("CRA") that the option is a non-qualified option for any reason, in a form to be prescribed for this purpose and filed with the grantor's tax return for the year in which the option grant is made. The notification is essential if the grantor intends to claim a corporate-level deduction.  Consider how these notifications will be made by a foreign parent corporation of a Canadian employer corporation, where the foreign parent does not file Canadian income tax returns.


  • No impact to CCPC options;
  • Application to options granted after 2019; Non-CCPCs that rely on the current rules as part of their incentive packages may wish to consider granting additional options prior to 2020;
  • Waiting for results of public consultation for details on what constitutes a "start-up, emerging or scale-up" company;
  • Internal procedures for tracking each employee's annual cap will be required;
  • What will the next Parliament do with these proposed amendments?

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