November 5, 2020
Stock Option Accounting & Taxation
A Broad Overview of Employee and Contractor Stock Option Awards
In this post, our experts will take a closer look at stock option accounting, taxes, and how they differ between employees, consultants, and non-residents.
It is very common for public companies to have a stock option plan. The Company may seek to retain and hire talented individuals and reward their efforts and contribution to the success of the Company by issuance of stock options.
Whether stock options are granted to supplement salary or as a reward, there are key tax treatment issues that arise under certain circumstances.
In this article, we attempt to highlight the accounting and tax differences between the receipt of options by employees and consultants.
Employee Stock Option (“ESO”)
ESO agreements grant the employee or consultant rights to acquire shares of the Company at a fixed price, typically called the option price. Usually, entities have these vest and become exercisable either immediately or over a period of time or if certain performance conditions are met.
The ESO may have an expiry date before which the stock option must be exercised. Alternatively, the option can be left to expire or can be canceled before the expiry date.
Accounting Treatment
Stock option accounting treatment of an ESO varies depending upon if these are issued to an employee or consultant.
Accounting for ESO’s is more straight forward for employees. However, if ESO’s are issued to a consultant, and the vesting period is over a period of time, the Company needs to re-value the share-based compensation at each reporting period.
The tracking of stock options and recording of share-based compensation can get quite complex, particularly if the Company has issued a significant number of ESO’s. This can often lead to errors being identified during the audit process.
The tax treatment of an ESO also varies depending upon if the recipient is an employee or a consultant.
Tax Treatment for Employees
Currently, when an employee is granted an ESO there isn’t any tax. Should an employee exercise the option, the difference between the fair market value of the share at the time the option is exercised and the amount paid by the employee to acquire the share is treated as a taxable employment benefit.
No corporate income tax deduction is available for the taxable employment benefit. A deduction equal to one-half of the taxable employment benefit can be taken by the employee, resulting in the taxable benefit being taxed similar to a capital gain.
Certain conditions need to be met in order to claim the deduction.
Tax Treatment for Contractors
Stock options granted to contractors such as consultants will give rise to a potential immediate income inclusion equal to the value of the option award.
When the stock option is exercised, the increased value realized (the difference between the market value of the share less the aggregate of the exercise price plus the value included in income at the grant date) will be included in the contractor’s or consultant’s income.
This incremental value realized on exercise of the options may be business income or a capital gain depending on the particular facts and circumstances.
CCPC Tax Rules for Non-Residents
Tax rules for Canadian-controlled private corporations (“CCPC”) and the tax treatment for non-resident recipients differ and the above has been written in general terms and should be seen as broad guidance only.
Please note, the federal government announced an intention to limit the current tax treatment on stock options benefits in the federal budget released in March 2019.
The Department of Finance released legislative proposals on June 17, 2019 that will apply to employee stock options granted on or after January 1, 2020.
However, in a news release dated December 19, 2019, the Government announced the proposed changes will not come into force on the proposed date of January 1, 2020. The Government is to announce details on how it intends to move forward with the measure in Budget 2020, which has been delayed due to the COVID-19 pandemic.
Please feel free to contact your Manning Elliott professional if you have questions.
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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.