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Offering employees stock options can be a way to incentives them via a remuneration that is aligned with the objectives of shareholders, including increased share value and profitability of the organization.
Stock options give employees the right to purchase shares in the corporation at a set price before an expiry date which allows them a future steak in the ownership of the company. If the value of the shares exceeds the option price before the expiry of the option, the employee may exercise the option to purchase the shares and may also sell those shares immediately to realize a profit. Understanding the tax treatment of stock options will allow for a true understanding of this benefit.
Section 7 of the Act deems a benefit to the employee when the stock option is exercised. However, the taxable benefit may be deferred to the date the shares are sold only if the corporation is a Canadian Controlled Private Corporation (CCPC) and deals at arm’s length with the employee.
Calculating the Benefit
The benefit is calculated at the fair market value of the shares at the time the option was exercised minus the option price and related costs.
Section 110(1) of the Act allows one-half of the benefit to be deductible in computing the employee’s taxable income if the conditions in subsection 110(1)(d) or (d.1) are met. These conditions include the following:
- The employee received common shares,
- The employee deals with the CCPC at arm’s length, and
- The employee stock option price was not less than the fair market value of the shares at the time the option was granted.
- The shares were held for a minimum of two years, and
- The employee did not claim any other stock option deduction in association with the benefit.
Limitations of the Deduction
There are new rules effective July 1, 2021. These new rules do not affect the following:
- Employees of CCPCs,
- Employees of corporations with annual gross revenues of less than $500 million, or
- Employees with stock option agreements entered before July 1, 2021.
Effective July 2021, employees receiving stock options from corporations that are not in the above exemptions are subject to a limit on the one-half deduction due to amendments to subsection 110(1). The one-half deduction will have a limit of $200,000 per vesting year. Options with a benefit of more than $200,000 (based on the date of grant) will no longer have a one-half deduction, resulting in full taxation to the employee for the excess amounts. Where excess amounts are exercised, the employer may take a deduction for the realized amount of this benefit only if proper notice was provided to the employee and the CRA after the grant date.
In addition, ‘non-qualified securities’ (including corporations and groups with more than of $500 million in revenues) will no longer be eligible for the 50% deduction. As such, the total tax benefit of the option will be fully taxable to the employee. Where non-qualified securities are exercised, the employer may take a deduction for the realized amount of this benefit.
Employers can also issue stock option benefits that are pre-designated as non-qualified securities. This designation allows the employer a deduction for the value of the benefit and the employee would not be allowed the stock option deduction. Both the employee and the CRA must be notified of this designation no later than 30 days after the option is granted.
After July 1, 2021, employers subject to the new rules are required to inform employees that are issued stock options which shares in the option grant are non-qualified securities. This must be done within 30 days of the option agreement being made.
Employers are also required to inform the CRA as to which shares in the options granted are non-qualified securities in a prescribed form before the filing-due date for the employer’s taxation year in which the option agreement is made. However, the prescribed form has not yet been made available.
The new rules will require corporations issuing stock options to keep track of options eligible for the 50% deduction along with non-qualified security’ status. Employees will also need to exercise options that are eligible for the 50% deduction and after those are depleted, to use the remaining non-qualified securities.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2022 Shajani LLP.
Shajani LLP is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services.