Did you receive stock options from your Canadian employer? If yes, then it’s highly recommended that you go over the points in this article. In this article, I explain how the “Taxation of Stock Options for Employees in Canada” directly affects you.
Stock options or employee stock options is an option in which the employer gives an employee the right to buy shares in the company in which they work usually at a discounted price specified by the employer. There are different types of stock options that can be issued to employees – more information can be found on the Canada Revenue Agency website.
If you’re working here in Canada, and received stock options from your employer, then read on. For employers who are looking to sell their company through their shares, please have a look at our article regarding asset sale and stock sale.
Here, you will find out just about all you need to know regarding the taxation of stock options for Canadian employees. To make it easier to follow, I’ll break this article into two parts.
First, we’ll cover CCPCs (Canadian Controlled Private Corporations), and then public companies. This is because the tax rules are different. For those of you who don’t know, a CCPC, or Canadian Controlled Private Corporation, is a company that’s incorporated in Canada, whose shares are owned by Canadian residents, and is not listed on a public stock exchange like the New York Stock Exchange or the Toronto Stock Exchange.
Taxation of Stock Options for Employees in Canada in CCPCs:
Let’s start off assuming that you work for a CCPC. The most common question that I get asked is, “Do I have to include anything in my income when I receive the stock options?” The short answer is, no. You don’t have to include anything in your income when you:
• Enter into the stock option plan
• When the options are granted to you, or
• When you exercise the options
The next question that I often get asked by my clients is, “Do I have to pay tax at the time of exercise, or at the time of the sale of the shares?” The answer to this one is, at the time of the sale of the shares. Let’s take a numerical example to simplify things.
Let’s assume that the exercise price is $3 a share, and the market value of the share is $10. The benefit of when you exercise and immediately sell is, therefore, $7 ($10 minus $3). This is known as the employment benefit which would be included in your income at the time of the sale of the shares.
The third question that I often get asked is, “What is this 50% deduction about?” Well, you are entitled to a deduction equal to 50% of the employment benefit (that we calculated as being $7 in the previous example), if you meet one of two conditions:
- You have held the shares for at least two years after you have exercised them
- The exercise price is at least equal to the fair market value of the shares when they were granted to you
Taxation of Stock Options for Canadian Employees in Public Companies:
Now, let’s move to public companies. Let’s assume you work for a public company like Coca Cola and you are granted stock options. The most common question I get asked is, “Do I have to pay tax at the time of exercise, or at the time of the final sale of the shares?”
The answer is, at the time of exercise, which is different than the rules for CCPCs. Let’s take a numerical example.
Let’s assume you work for Coca Cola Canada and the fair market value of the shares today is at $30. According to the option agreement, you can exercise or buy the shares for $10. Therefore, the employment benefit that will be included in your income at the time of exercise is $20. Here’s a quick piece of advice – please don’t hold on to the shares for too long because if the price of the stock drops, let’s say, in a worst case scenario to $0, you’re still on the hook for the tax on the employment benefit.
So if you have a low risk tolerance, it makes sense to sell the shares immediately after you exercise, so you have enough cash available to pay for the tax.
Are you entitled to the 50% deduction if you work for a public company and receive stock options? The answer is yes, if you meet three conditions. Unlike CCPCs, you have to meet all these three conditions in order to be entitled to the 50% deduction.
1. You receive normal common shares upon exercise
2. The exercise price is at least equal to the fair market value of the shares at the time the options were granted
3. You deal at arm’s length or on a third party basis with your employer (an example of when you would not deal on a third party basis with your employer would be, let’s say, if you were the spouse of the president of Coca Cola).
The Cash Out Option (for Public Companies):
The final point we look at here is the Cash Out option for public companies. Assume you’re working for Coke and under the option agreement you have the ability to cash out. So instead of having to buy the shares for $10, and then sell them for $30, your employer offers you the ability under the option agreement to simply receive a cheque directly from your employer for $20. This is known as cashing out on your stock options.
When you cash out, the amount of money you receive will be included in your income as an employment benefit. Once again, you may be entitled to a 50% deduction equaling to half of the employment benefit reported on your tax return. The rules for the 50% deduction for the cash out are fairly complex, so I’m going to cut them out of this article.
I hope you found this article about taxation of stock options for employees in Canada helpful, and if you wish to know more, please don’t hesitate to ask us a question or leave us a comment by posting in the comments section below.
About the Author – Allan Madan
Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation . Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.
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