Tax Considerations for Attracting & Retaining Key Employees – Stock Options

Tax Considerations for Attracting & Retaining Key Employees – Stock Options

By Nizam Shajani, CPA, CA, MBA

September 11, 2020

As governments consider a revision to stock option plans – as of today, this is still a viable option to attracting and retaining key employees.

In an environment of low cash flow, attracting and retaining talent can be a formidable challenge. A company that develops a model that makes its employees feel engaged with an opportunity for advancement will likely be more successful in retaining its talent and have an edge on its competition. There are a number of different arrangements available to Canadian Controlled Private Corporations (CCPC’s) that can be considered and undertaken with the appropriate professional advice.

For example, stock options are a popular option as an increase in the value of a corporation over time will benefit both existing shareholders and employees owning stock options. Stock options are granted under an agreement to issue securities, whereby a corporation provides its employees with a right to acquire securities of the corporation or another corporation that it does not deal at arm’s length. For a CCPC, an employee does not have any taxes in the year in which the options are exercised and shares are acquired. This is a significant incentive compared to employees of public corporations who have a taxing event that arises at the time the employee acquires the shares.

For an employee of a CCPC, taxes are deferred until a subsequent period when the employee disposes of the shares. The difference in the share price from the acquisition date to the date of disposal of the share will result in a taxable gain or loss. If the CCPC is dealing at arm’s length with the employee and if the employee holds the shares for at least two years, a 50% deduction is available against any employment income inclusion for the benefit arising from the stock option which is the same as income taxed as a capital gain. This is the second significant incentive to this type of arrangement.

Some other significant benefits can be realized from the perspective of the CCPC as an employer from a stock option plan:

• develop employee loyalty and give the employee an interest in the well-being of the business
• allow funds to be raised for the business
• provide an exit strategy for the founder of the business through a natural succession plan
• encourage employee retention where equity ownership is a significant portion of compensation

However, there can be some pitfalls to be aware of in structuring a stock option benefit plan for key employees of a CCPC:

• a CCPC cannot claim a deduction for the issuance or exercise of the stock option
• if shares are issued to employees at less than Fair Market Value (FMV) and later sold at a loss, tax on the deferred benefit would still be payable
• there may be a requirement to obtain a valuation particularly if the Canada Revenue Agency decides to launch a challenge
• if it is determined that a deemed benefit arises if shares are issued for less than FMV, there is a tax withholding requirement that the CCPC could be subject to with respect to the benefit
• Once options are exercised, employees become shareholders and are entitled to shareholder rights including access to financial information

In addition – there is the risk that plans put in place are not grandfathered in within new budget proposals to be introduced in the coming months.

If you are considering setting up a stock option plan, contact your Shajani LLP advisor to help you determine how this strategy will apply to you and if so, to help you take advantage of it.

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. © 2020 Shajani LLP