On November 30th, 2020, the Honourable Chrystia Freeland, Deputy Prime Minister and Minister of Finance, released the Fall Economic Statement 2020 (the "Statement"), which contains certain proposals to amend the Income Tax Act (Canada) (the "ITA") and the Excise Tax Act (the "ETA").
Income Tax Measures
Employee Stock Options
The Statement proposes rules related to the tax treatment associated with the exercise of employee stock options. The rules will generally disallow the 50% stock option deduction by the employee if the stock option vests more than $200,000 worth of stock in a calendar year, if the employer is not a Canadian-controlled private corporation (CCPC), and if the employer has an annual gross revenue of not less than $500 million.
First announced in Budget 2019, the Department of Finance had asserted that the public policy rationale for the preferential tax treatment of employee stock options is to support younger and growing Canadian businesses and stated that it does not believe that employee stock options should be used as a tax-preferred method of compensation for executives of large, mature companies. These new stock option rules come after draft legislative proposals were released in June 2019 and a consultation process with stakeholders ended in September 2019. On December 19, 2019, the Department of Finance confirmed that it would move forward with the measure in 2020.
These new rules will apply to employee stock options granted after June 2021. The existing rules would continue to apply to options granted before July 2021 (including qualifying options granted after June 2021 that replace options granted before July 2021).
The $200,000 Limit
The new stock option rules will limit the amount of employee stock options that can vest in a calendar year to $200,000 in order to qualify for the 50% stock option deduction. The amount is based on the fair market value of the underlying shares at the time of the option grant. An option is considered to vest when it first becomes exercisable, generally determinable in accordance with the terms of the grant agreement or the option plan. If not clear, the option would be considered to vest on a pro-rata basis over the term of the agreement, to a maximum 5-year period.
Employers that are Subject to the New Stock Option Rules
The new stock option rules would generally not apply to CCPCs. Non-CCPC employers with annual gross revenue not exceeding $500 million would also generally not be subject to these new rules.
The annual gross revenue for these purposes would generally be the gross revenue reported in the employer's most recent annual financial statements prepared in accordance with generally accepted accounting principles prior to the date that the stock option is granted. If the employer is a member of a corporate group that prepares consolidated financial statements, gross revenue would be as reported in the most recent consolidated annual financial statements of the group prior to the date that the stock option is granted, at the highest level of consolidation.
In the case of options to acquire shares of a corporation or units of a mutual fund trust that does not deal at arm's length with the employer, the new rules would apply if either such entity or the employer would otherwise be subject to the new rules.
Employers that are not subject to the new rules would not be permitted to opt into these rules.
Tax Treatment from the Employer's Perspective
For employee stock options that are subject to the new rules, the employer will be entitled to a deduction in respect of the stock option benefit in the taxation year that includes the day that the option was exercised. In order to be deductible, the existing conditions for the employee stock option deduction (i.e., pursuant to paragraph 110(1)(d)) must also be met.
Employers that are subject to the new rules could either choose to grant employee stock options under the current rules (subject to the $200,000 limit) or grant employee stock options under the new rules with the result that the 50% stock option deduction is not available to the employee but the employer would be eligible for the deduction for corporate income tax purposes. Such employers would be responsible for ensuring compliance under the relevant regime, including notifying its employees in writing and the CRA as to the tax treatment of the particular options.
Tax Treatment from the Employee's Perspective
Where an employee exercises an employee stock option that is in excess of the $200,000 limit, the full amount of the taxable employment benefit (i.e., the difference between the fair market value of the share and the amount paid to acquire the share) is included in the income of the employee for the year the option is exercised. The employee would not be entitled to the 50% stock option deduction in respect of this employment benefit.
If applicable, these new rules will generally apply to all stock option agreements between the employee and the employer or any corporation that does not deal at arm's length with the employer. An employee that deals with two or more separate employers that are arm's length with each other would have separate $200,000 limits for such employers.
The new rules will also affect those employees who donate publicly listed shares within 30 days of being acquired under a stock option agreement to take advantage of the additional deduction of 50% (for a total deduction of 100%) for gifts of securities. Under the new rules, if an employee donates a publicly listed share acquired under a stock option that is in excess of the $200,000 limit, the employee could be eligible for the charitable donation tax credit but would not be eligible for any deduction on any associated employee stock option benefit. Any capital gain that has accrued since the share was acquired under the stock option agreement would continue to be eligible for the full exemption from capital gains tax, subject to the existing rules.
Sales and Excise Tax Measures
The Statement also includes proposed rules affecting Canada's federal value-added tax (the "GST/HST"), including: (i) the GST/HST treatment of certain masks and face shields; and (ii) the collection, reporting, and remittance obligations of non-resident vendors of digital products and services, operators of distribution platforms, and operators of short-term rental accommodation platforms. In particular, the Government has proposed:
1. Face Masks and Face Shields – The temporary zero-rating of face masks and face shields designed for human use and meeting certain requirements. This means that suppliers will not have an obligation to collect GST/HST in respect of the supply of such masks (but may still claim input tax credits to recover GST/HST expenses relating to the supply). The proposed change would affect supplies of certain face masks and face shields made after December 6, 2020 (and until the use of such face masks and face shields is no longer broadly recommended by public health officials for the COVID-19 pandemic).
2. Cross-Border Digital Products and Services – New requirements for non-resident vendors and online distribution platform operators that do not carry on business in Canada. Under the proposed rules, non-resident vendors and platform operators may be required to register for, collect, and remit GST/HST if the vendors/platforms make, or facilitate the making of, taxable supplies of digital products and services (including traditional services) to non-registered recipients who ordinarily reside in Canada.
3. Operators with Fulfillment Warehouses – New requirements for operators of online distribution platforms that store goods in fulfillment warehouses. Under the proposed rules, an operator of a distribution platform may be required to register for, collect, and remit GST/HST if: (i) the operator facilitates sales of goods made by non-registered vendors (resident or non-resident) to customers in Canada; and (ii) the goods are located or placed in fulfillment warehouses in Canada or shipped from a place in Canada to a purchaser in Canada.
4. Short-Term Accommodation Platforms – New requirements for operators of online platforms that facilitate short-term accommodations. An operator of an accommodation platform may be required to register for, collect, and remit GST/HST if: (i) the operator facilitates the making of short-term accommodations located in Canada; and (ii) the suppliers of such rental accommodations are not registered for GST/HST. A taxable "short-term accommodation" would include a rental of a residential complex or a residential unit to a person for a period of less than one month (if the price of rental is more than $20/day). The operator may also be required to collect GST/HST in respect of related accommodation and service fees.
5. Simplified Registration Process(es) – New simplified registration process(es) for non-resident vendors, operators of distribution platforms, and operators of accommodation platforms.
The aforementioned changes, with the exception of the temporary zero-rating for face masks and face shields, will generally take effect on July 1, 2021.