Many employers grant options to their employees to buy stock of
the employer as a form of compensation. Employee stock options are
favorably taxed under the Income Tax Act (Canada).
When a corporation grants an employee the right to buy its
shares, the price at which the employee can buy the shares (the
exercise price) is usually equal to the fair market value of the
employer's shares at the date the option is granted. No taxable
event occurs when the option is granted. If the underlying shares
increase in value after the option is granted; the employee will
typically exercise the option, pay the exercise price, acquire the
shares, and enjoy a benefit equal to the difference between the
value of the shares on the date of exercise and the exercise price
(known as the in-the-money amount).
For tax purposes, the in-the-money amount is reported as a
taxable benefit and included in the employee's income when the
option is exercised.1 The employee is entitled to deduct
50% of the benefit in computing his or her taxable income under a
deduction for qualifying stock options in two cases:
the shares receivable under the
options must be ordinary common shares with no fixed entitlements
under the share terms or any related agreements, and the option
exercise price cannot be less than the fair market value of the
shares at the date of the option grant (i.e., the options must not
have been in-the-money when granted);2 or
the shares received under the options
are shares of a CCPC, and the employee holds those shares for at
least two years.
In either case, the employee receives a benefit of which only
half is taxable, such that the effective rate of tax is 50% of what
it would otherwise be.3 The employer cannot claim a
deduction for any part of the value of the shares issued to the
employee,4 and must make normal payroll remittances on
the taxable income arising from exercising the options even if the
employee receives no cash.
In the October 2015 federal election campaign, the Liberal Party
of Canada included a commitment to limit the amount qualifying for
the 50% stock option deduction to $100,000 per
"A starting point would be to set a cap on how much can be
claimed through the stock option deduction. The Department of
Finance estimates that 8,000 very high-income Canadians de¬duct
an average of $400,000 from their taxable incomes via stock
options. This represents three quarters of the fiscal impact of
this deduction, which in total cost $750 million in 2014. Stock
options are a useful compensation tool for start-up companies, and
we would ensure that employees with up to $100,000 in annual stock
option gains will be unaffected by any new cap."
New Liberal Finance Minister Bill Morneau subsequently announced
that any changes to the taxation of stock options would not be
retroactive, saying to reporters, "I would like those
Canadians who are concerned about this issue to understand that any
decisions we take on stock options will affect stock options issued
from that date forward."6
As such, there would not appear to be any need to take action on
existing stock options, although companies using stock options to
compensate Canadian employees may wish to ensure that any new
option grants are made before the date of the upcoming federal
budget, which is anticipated to be delivered the week of March
21.7 Companies will also want to consider the
possibility of examining other forms of employee compensation that
are tax-deductible, a possibility that does not seem to have been
incorporated into the government's estimate of the fiscal
impact of capping the 50% stock option deduction. In fact, one
study suggested that as employers respond by moving to
tax-deductible forms of executive compensation, restricting the 50%
stock option deduction might actually cost the government
money.8 The government's treatment of this issue
will be watched carefully by business community.
1. If the option is to acquire shares of a
"Canadian-controlled private corporation" (CCPC), the
taxable benefit is not included in the employee's income until
the shares acquired by exercising the option are sold.
2. The details of these qualifying conditions are more
complex, and should always be reviewed carefully.
3. This is sometimes referred to as "capital gains
treatment", although this is not quite true: the taxable
benefit is not a capital gain and so cannot be offset by capital
4. Where the stock option is surrendered for a cash
payment instead of being exercised, the employer must agree not to
claim any deduction for the payment in order for the employee to be
able to claim the 50% stock option deduction.
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