The cap on employee stock options — part of the tax changes in the federal Liberal’s 2019 budget — are vaguely defined and will lead to confusion and litigation, say tax lawyers.
In the budget, released March 19, the government proposed placing an annual cap on stock options for employees of “long-established, mature firms” at $200,000. Those working at “startups and rapidly growing” businesses will not be subject to this change. Currently, employee stock options get special tax treatment, allowing for an income inclusion deduction, which makes the income incurred from the option taxable at close to the capital gains rate, and this can be realized by employees at any type of company.
The problem lies in the definitions, say tax lawyers. What a startup, a rapidly growing Canadian business and a mature business are may be hard to translate into legislative language, says TaxChambers LLP counsel and University of Ottawa law professor Vern Krishna.
“I can assure you that the legislation enacting that provision will be long, complex and uncertain, and uncertainty and complexity lead to litigation,” Krishna says.
“The underlining policy proposal is understandable and one is sympathetic to the objectives, but the implementation of it will be complicated, he says.
To interpret how these rules will apply, there will likely be a standard capital threshold, age of company and number of employees determined by the government, says Katy Pitch, a partner at Wildeboer Dellelce LLP.
“It’ll create a lot of work for tax lawyers, so I’m not upset about that,” she says.
It will be difficult to be sufficiently precise, however, as there are many different types of companies and situations that will need to be evaluated, she says.
When the Liberals were first elected and included a cap on stock options in their platform, there was stiff opposition from the tech and startup communities, which said their businesses lack cash and rely on stock options to entice employees, she says.
Wildeboer Dellelce represents many clients in the startup scene, from entrepreneurs and smaller companies to cannabis, tech, fintech and blockchain.
“Our clients are really concerned with stock options and employee compensation, because they need employees to get off the ground and they don't have a lot of cash,” she says.
Another change in stock-option compensation is that there is now an available corporate tax deduction for the company on the issuing of shares to the employee and their exercise of the option. This aligns Canada with the U.S., which grants tax deductions for the issuance of shares. This change was included in the examples that accompany the explanations on budget items, included in the budget document, says Pitch.
“To me, to bury it in an example was very unusual,” Pitch says.
This means that, instead of the employee getting the deduction on the option for their personal taxes, the company will get it on its corporate taxes.
“It will be a decision to be made at the time the options are granted — what’s more valuable? Are we going to let the employees take the deduction or is the company going to get the deduction? It’s going to be much more of a conversation at the beginning once the options are granted,” she says.
Last August, Chartered Professional Accountants Canada released a pre-budget consultation calling on the feds to “undertake a comprehensive review” of the tax system. The CPA suggested broadening the tax base by eliminating targeted tax preferences, raising consumption taxes and dealing with tax avoiders in the digital economy.
The budget comes during a slowdown in the Canadian economy. After a three-per-cent GDP growth in 2017, it relaxed to 1.8 per cent in 2018 and fourth-quarter growth was the slowest since 2016, according to Statistics Canada. In 2018, U.S. GDP grew by 2.9 per cent in 2018.
The Liberals promised during the election that they’d have a balanced budget by 2019; however, in December, they amended that date to 2040. The budget projects a deficit of $14.9 billion for 2019 — down to $9 billion in 2023-2024.
There is another $217 million for the Canada Revenue Service, after the nearly billion-dollar infusion it has received since 2016. The investments are largely aimed at countering aggressive tax avoidance. The government forecasts these resources will add $369 million to its coffers. Krishna is skeptical there is that much revenue to be had.
“Why stop at that amount? If you're going to bring in so much more through curtailing aggressive tax avoidance from a financial point of view, I wonder why one would be restrained in that measure,” he says.
Krishna would like to see those investments put toward decreasing the “enormous delays” experienced by middle-income tax payers who are objecting to their assessments.
Pitch is pleased to see the CRA investment earmarked for technology, which she says is necessary for the burgeoning crypto-currency world.
“I think there's some money to be made there,” she says.