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Company Stock Options by Canadian Private Companies
Stock option plans have significant benefits for privately owned Canadian companies and offer a great way to bring employees in as shareholders.
- The employees’ interests are aligned to business growth and performance, as stock option plans for non-executive employees provide compensation and an incentive to employees to build and increase total enterprise value.
- The increase in enterprise value passes through to employees through gains in the value of stock options and shares in the company that the employees own.
- For the Company, the stock options are a non-cash performance based compensation or award.
- An arm's length employee pays no immediate tax upon either receiving the stock options or when the options are exercised for shares in a Canadian-controlled private corporation (“CCPC”).
These rules specifically apply to CCPCs and employees, and not to consultants or contractors. There are other restrictions and general income tax implications that should be considered for CCPC employee stock option plans.
The specific provisions of the Income Tax Act (“Act”), which govern the taxation of employee stock options, generally provide that when a corporation has agreed to sell or issue its shares to an employee (option is granted), a benefit is realized in the year that the shares are acquired by the employee (option is exercised) equal to the amount by which the value of the shares at the time of acquisition exceeds the amount paid by the employee (the option price).
Provided that the option is granted by a CCPC and the employee deals at arm’s length with the company immediately after the option is granted, the income inclusion for the deemed benefit is deferred to the year in which the employee disposes of the shares.
A person will be at arms length with a company as long as:
- They do not control the company
- They are not part of a related group that controls the company
- Or they are not related to a person described in 1 or 2 above
Individuals connected by blood relationship, marriage, or common-law partnership or adoption will be considered related persons.
There are related provisions in the Income Tax Act that provide for a deduction equal to one-half of the benefit included in the employee’s income (discussed above) when calculating the employee’s taxable income. Generally, this deduction is available where the shares are prescribed shares and the value of the shares when the stock option was granted was not more than the exercise price.
In the case of CCPC shares, the deduction is also available if the employee held the shares for at least two years. The effect of the deduction is to tax the deemed benefit at capital gains rates, however it is not a capital gain and therefore not eligible for the capital gains deduction.
From the perspective of the employer corporation, no tax deduction may be claimed in respect of stock option benefits granted to its employees, even though the stock option benefit is included in the employee’s income from employment.
Where an employee chooses to forgo the purchase of CCPC shares and to receive instead a cash payment from the employer equal to the CCPC stock options’ value, the employer may deduct the cash payment; however, the employee will not be eligible for the one-half deduction (discussed above). The employer must elect to forgo its deduction to allow the employee access to the one-half deduction.
Typically there would be a requirement for the employer corporation to withhold and remit taxes on a stock option benefit received by an employee. However, there is a specific provision in the Income Tax Act that provides an exception when the benefit is related to CCPC shares.
Loss on sale shares
Where the CCPC shares held as a result of exercising an option are subsequently sold for a value less than at the time of exercise, the employee’s taxable benefit is fixed at the amount discussed above (value at time of exercise, less exercise price). A capital loss would be realized for the difference between the proceeds and the value at time of exercise, which can be applied against capital gains, if any, but not against the taxable benefit.
It is possible that the tax on the taxable benefit may exceed the proceeds received; therefore consideration should be given to this risk when holding on to CCPC shares that are issued on the exercise of options.
 Defined in subsection 248(1) of the Income Tax Act (the “Act”) to include an officer. Officer is defined in the same subsection to include a person holding the office of a corporation director.
 Subsection 7(1) of the Act.
 Paragraphs 110(1)(d) and (d.1) of the Act
 As defined in section 6204 of the Income Tax Regulations, and are typically common shares without special rights.
 Subsection 153(1.01) of the Act.
For further information about the tax treatment of stock options or other tax issues relating to private companies please contact Joseph Bonvillain, CPA, CA or Wendy Seet, CPA, CA at 604-714-3600.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.