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Fairvest reported in its Corporate Governance Review Volume 12, Number 1, that federal Finance Minister Paul Martin was proposing to change the way the capital gains tax is levied on exercised options. The new tax laws will charge a capital gains tax when the underlying shares are sold instead of the current situation where the capital gains tax is levied upon the exercise of options.
The following is excerpted from a report produced by Watson Wyatt & Company and is reprinted with their permission. Their report also included a section on stock option tax treatments when optionees do or do not hold other company shares and tandem stock appreciation rights. This articles focuses on the implications of the recent federal tax law changes.
Public Company Stock Option Taxation in Canada
In our experience, executives of publicly traded companies frequently sell all the common shares they acquire when they exercise their stock options on the same day. There are many reasons for this phenomenon, including possible insider trading restrictions if the shares are sold at a later date, a need for investment diversification, the out of pocket cost to the executive of purchasing the shares and, of course, the taxes that will have to be paid on the stock option gains.
It should be noted that two different sets of tax rules come into play with options – one set of rules that apply to the exercise of the options and the other to the actual sale of the shares, even if the same date applies.
$100,000 Stock Option Taxable Benefit Deferral
The February 28, 2000 federal budget proposed that the stock option gain realized on the exercise of public
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company employee stock options after February 27, 2000 will be subject to tax when the common shares are disposed of (or when the employee dies, if earlier), rather than when the options are exercised. (The $100,000 exemption does not apply to stock options granted by companies which were private on the grant date.)
One of the advantages of the proposal is that it will allow an employee who has unrealized gains on stock options to defer the tax beyond the expiry date of the options. However, the maximum taxable benefit that may be deferred until the shares are sold will be only the gains on those options that vest in a given calendar year and whose exercise cost to the individual is $100,000 or less. (Note that it is the exercise cost, not the gain that is compared to the $100,000 exemption.) This annual limit will apply to options that have already vested in prior calendar years, as well as to options that vest in the year 2000 or later. Thus, if for example an employee had options which vested each year over three different tax years from 1998 to 2000, then the total tax deferral opportunity would be the gains on options costing a total of as much as $300,000 to exercise. The taxable benefit on the exercise of those vested options which exceed the annual exercise cost limit of $100,000 for a year will not be eligible for deferral, however, and thus will be currently taxable in the year in which the option is exercised (not when the shares are sold). Our understanding is that the employer will be responsible for reporting the portion of the stock option benefit that the employee wishes to defer to the Canada Customs & Revenue Agency in the year that the option is exercised. The employee will then be responsible for including the benefit in income in the year that the shares are ultimately sold, or on his or her death if earlier. |