QUEBEC: PROPOSED CHANGE TO 25% STOCK OPTIONS DEDUCTION RATE, DEFERRAL OF DEEMED DISPOSITION TAX
Updated: Oct 5, 2022
On February 21, 2017, Finance Quebec proposed that it will introduce three new tax measures; two of which are the subject of this article.(1) These two measures will (a) increase the Quebec stock option deduction from 25% to 50% for options on certain large publicly traded Quebec corporations, and (b) allow an individual or trust to defer the Quebec tax payable on a deemed disposition of a “large block of shares” of certain Quebec public corporations. Note that these rules do not impact the Canadian federal tax on the same type of transactions, only the Quebec tax. (A) The Quebec Stock Option Deduction
Employees who exercise or dispose of eligible (2) stock options are entitled to a Canadian federal (and provincial, for provinces outside Quebec) deduction of 50% of the benefit realized on the date of exercise/disposition; with the benefit being the spread between the FMV of the shares on the date of exercise/disposition and the exercise (or option) price. This effectively makes eligible options taxable at capital gains rates.
However, for the same type of eligible options (3) granted on or before February 21, 2017, the deduction for Quebec tax purposes was generally limited to 25%. (4)
The new proposal, however, extends the 50% Quebec deduction rate to certain options granted after February 21, 2017. These options must be on shares that are listed on a recognized stock exchange, and must be granted to the employee by a corporation that had (either at the time of grant or the time the share is acquired) Quebec wages of at least $10 million. (5)
This will now allow employees of large Quebec public companies the same effective capital gains rates (6) on stock options as is currently provided by Canada federally, as well as the other provinces.
Unfortunately, this tax break will not apply to private companies, nor to public companies with a small presence in Quebec. For these cases, there will still be a discrepancy between the Canadian and Quebec stock option deduction rate. (B) The New 20 Year Deferral of Certain Quebec Deemed Disposition Taxes
Currently, both Canada and Quebec allow taxpayers to defer the tax attributable to a deemed disposition of assets that arise because the taxpayer has ceased to be a resident of Canada/Quebec. In certain cases, the taxpayer has to post security with the CRA (and potentially Revenu Quebec) to defer the payment of the tax. If such a deferral is elected, the tax is due when the assets are disposed of (ex., through a sale, gift, death, or return to Canada).
Quebec is now proposing to offer Quebec taxpayers a new ability to defer paying the Quebec tax arising from certain other types of deemed dispositions of qualified shares (the Information Bulletin 2017-3 refers to deemed dispositions imposed on the death of an individual, or the 21st anniversary of a trust or estate) that arise after February 21, 2017.
As with the residency departure tax, security is required to be posted, (7) and this tax will be payable when the shares are disposed of or the security becomes inadequate. However, the tax will also become payable when the shares cease to qualify for this special treatment, or on the 20th anniversary of the deemed disposition of the qualified shares. So, basically, it is a deferral of up to 20 years (though there is some limited ability to defer past the 20th anniversary if the shares have decreased in value).
To qualify for this deferral, the shares must be of a publicly traded corporation that has its head office (i.e., “principal place of business”) in Quebec, and that has not had huge fluctuations in its Quebec payroll in the three years leading up to the deemed disposition event. Further, the deferral is limited to owners who possess a “large block of shares” (which is defined as owning, either alone or together with related persons, more than 33 1/3% of the corporation’s voting rights.(8) This requirement reflects the policy behind the proposal: which is to ensure that Quebec shareholders with significant interests in Quebec corporations are not forced to sell their interests due to a liquidity crunch arising from the imposition of a deemed disposition tax.
Where it is a trust that has experienced a deemed disposition (ex., on its 21st anniversary), its deferral election will be cease being effective when it distributes the qualifying shares to a beneficiary. One interesting wrinkle here though is that such a distribution will now cause the beneficiary receiving the distribution to be liable for the Quebec deemed disposition tax that arose on a prior year deeming event (apparently even if the beneficiary is not otherwise taxable in Quebec or even Canada, and may even be subject to a separate Canadian tax on the distribution). (9) It will be interesting to see how Quebec will enforce such a transfer of tax liability.
Of course, the above deferral is only available for Quebec tax purposes, and not for Canadian federal (or other provincial) tax. References: (1) See Finances Quebec Information Bulletin 2017-3, dated February 21, 2017. (2) The Income Tax Act and Regulations contain a series of conditions that options must satisfy to be eligible for the deduction. Generally, the options must be granted by a corporation at FMV on the date of grant, must be granted on shares with the typical attributes of common shares, and must be granted to an arm’s length employee. (3) Quebec generally has the same conditions of eligibility for its 25% deduction as applies to the Canadian 50% deduction. (4) The 25% rate was increased to 50% in certain limited cases (ex., options granted after March 13, 2008 by a corporation which (in the year of grant) carried on business in Quebec through a Quebec establishment, had assets of less than $50 million in the prior year, and was granted a refundable R&D tax credit in the year or for one of the prior 3 years). (5) The corporation’s “Quebec wages” are to be measured by the same criteria of what forms a company’s wage base for purposes of the Quebec health Services Fund levy (i.e., one looks at employees who either report to work at an establishment of the employer in Quebec or, if they are not required to report to work at any of the employer’s establishments, are paid from a Quebec establishment. (6) As with Canada, Quebec only taxes 50% of a taxpayer’s capital gains. (7) Though here the security may not be less than 120% of the deemed disposition tax covered by the deferral election. (8) Note though that shares of a private corporation that itself controls more than 33 1/3% of the voting rights of the public Quebec corporation will also qualify, even if the other shareholders of the private corporation are not related. (9) For example, Canadian resident trusts that distribute assets to non-resident beneficiaries are deemed to have distributed such assets at their FMV on the date of the transfer, thus potentially triggering a Canadian tax, under Part XIII of the Act, in the hands of the beneficiary – subsections 107(2.1) and (5) of the Act.