Employee Stock Option Benefits
It is increasingly common for employers, both private companies and public companies, to grant to their employees an option to acquire shares of the employer. Benefits realized by employees from being granted an option to acquire shares of their employer are not taxable on grant, even if the exercise price is less than the fair market value of the shares, provided the option is granted to the individual by virtue of his or her employment.
Employees who are granted an option to acquire shares of a public corporation have a taxable benefit from employment in the year they exercise their employee stock option. The taxable benefit is the difference between the option price (sometimes called the “strike price”) and the fair market value of the shares on the date the option is exercised. (If the employee has paid to acquire the option, the taxable benefit is reduced by the purchase price of the option.) If the employer simply grants the employee shares, that is essentially granting the employee an option to acquire shares for $nil so the employee stock option rules discussed herein still apply. If the employee is granted an option to acquire shares of a “Canadian controlled private corporation” (CCPC) and the employee was dealing at arm’s length with the employer immediately after the agreement was made, the employee stock option benefit, although calculated at the time the option is exercised, is taxable in the year the shares are sold. It does not matter if the employer is no longer a CCPC at the time the shares are sold.
In the case of a public company, an employee may be entailed to claim a tax deduction equal to 50% of the employee stock option taxable benefit provided all of the following conditions are met:
- The employee dealt at arm’s length with his or her employer immediately after the agreement was made;
- The stock option agreement with the employee permits the employee to acquire shares that meet the definition of “prescribed shares” as found in the Income Tax Act Regulations (basically common shares without special rights and restrictions); and
- The option was not less than the fair market value of the shares on the date the agreement was made.
The 50% deduction means an employee stock option is taxed at the same rate as a capital gain, but it is not a capital gain. The employee stock option benefit cannot be offset by the individual’s “capital gains deduction” or capital losses.
For eligible securities of public companies acquired by employees under a stock option agreement entered into between February 27, 2000 and March 4, 2010, the employee’s taxable benefits was determined when the option was exercised (when the shares were acquired) but the benefit was taxed only when the shares were sold. This income deferral was subject to an annual limit based on the fair market value of the eligible shares. For the year in which the employee stock option was exercised and the shares acquired and in each subsequent year the shares are held, the employee must file a Form T1212 Statement of Deferred Security Options Benefits with his or her personal income tax return to have the tax deferral in effect. This form is part of the e-filed tax return.
If an employee is granted an option to acquire shares of his or her employer at the time the employer was a CCPC, the employee stock option benefit is taxed in the year the shares are sold. The employee can claim a deduction in that year equal to 50% of the taxable benefit if:
- The employee held the shares for at least two years prior to sale, or
- The option price was not less than the fair market value of the shares on the date the option was granted and the four conditions for the 50% deduction on non-CCPC stock options benefits are satisfied (outlined above).
The “adjusted cost base” (ACB) of the shares acquired under an employee stock option plan is the fair market value of the shares on the date the option is exercised. The ACB is not reduced for the 50% deduction.
The rules related to stock options are complex, have changed considerably over the years, and are currently under review by the Department of Finance. You should consult a Chartered Professional Accountant to see how these rules may apply to you.