As of December 2024, Canada had not signed into law the tabled legislation that would reduce the employee stock option deduction for stock option benefits that exceed the annual limit. However, the Canadian tax authorities have started to administer the rules as if they were in force, despite a lack of clarity on several matters.
Under current Canadian law, employees who exercise qualifying stock options can deduct 50% of the benefits realised, if certain conditions are met. Canada’s 2024 federal budget announced a proposal to decrease the stock option deduction from one-half to one-third of the benefit, to align with proposed changes to the capital gains inclusion rate. (For prior coverage, see Canada - 2024 budget proposes changes to capital gains and stock option benefit taxation - BDO). However, individuals would continue to benefit from a deduction of one-half of the taxable benefit from the exercise of stock options, up to a combined CAD 250,000 for both employee stock options and capital gains.
Employers have not been provided with guidance on whether payroll withholdings should be deducted on a stock option benefit assuming that the lower stock option deduction is in effect, or whether it is possible for employees to certify that they will qualify for the higher deduction.
If income tax withholding is processed based on a higher option deduction, penalties could potentially be imposed for failure to withhold the correct amount; to avoid these potential penalties, some employers are withholding based on the assumption that the lower stock option deduction applies. However, this could result in cash flow disadvantages for employees and a potential disposal of too many employer shares in a sell-to-cover situation.
In addition, it is anticipated that changes will be needed to the year-end T4 payroll form to separate option exercises that took place after the date the law becomes effective (retroactive to June 25, 2024, per the current draft legislation) but these changes have not yet been announced.
The fact that the Canadian tax authorities are starting to administer the proposed legislation as if it were law, but have failed to provide guidance to employers on key practical issues is causing a significant burden on companies -- both from an administrative and an employee communications standpoint. Additional guidance is sorely needed and would be welcome before employers have to process their final year-end payroll obligations for 2024.
Marie Neill
BDO in Canada
Under current Canadian law, employees who exercise qualifying stock options can deduct 50% of the benefits realised, if certain conditions are met. Canada’s 2024 federal budget announced a proposal to decrease the stock option deduction from one-half to one-third of the benefit, to align with proposed changes to the capital gains inclusion rate. (For prior coverage, see Canada - 2024 budget proposes changes to capital gains and stock option benefit taxation - BDO). However, individuals would continue to benefit from a deduction of one-half of the taxable benefit from the exercise of stock options, up to a combined CAD 250,000 for both employee stock options and capital gains.
Legislation Still Pending
Employers have not been provided with guidance on whether payroll withholdings should be deducted on a stock option benefit assuming that the lower stock option deduction is in effect, or whether it is possible for employees to certify that they will qualify for the higher deduction.If income tax withholding is processed based on a higher option deduction, penalties could potentially be imposed for failure to withhold the correct amount; to avoid these potential penalties, some employers are withholding based on the assumption that the lower stock option deduction applies. However, this could result in cash flow disadvantages for employees and a potential disposal of too many employer shares in a sell-to-cover situation.
In addition, it is anticipated that changes will be needed to the year-end T4 payroll form to separate option exercises that took place after the date the law becomes effective (retroactive to June 25, 2024, per the current draft legislation) but these changes have not yet been announced.
BDO Insight
The fact that the Canadian tax authorities are starting to administer the proposed legislation as if it were law, but have failed to provide guidance to employers on key practical issues is causing a significant burden on companies -- both from an administrative and an employee communications standpoint. Additional guidance is sorely needed and would be welcome before employers have to process their final year-end payroll obligations for 2024.Marie Neill
BDO in Canada