Section 5 – Employees
An employee who acquires shares in the employer’s corporation8 under a stock option plan is deemed to have received a taxable benefit in the year equal to the amount by which the FMV of the shares when they are acquired exceeds the price paid for them.
However, the employee is generally entitled to a 50% deduction for federal purposes (25% for Quebec purposes9), of the benefit if the amount paid to acquire a share is at least equal to its FMV at the time the option was granted. Any increase (decrease) in value subsequent to the date of acquisition will be taxed as a capital gain (loss) in the year of disposal.
8 Or a company not at arm’s length with the employer. The same tax treatment applies to options granted by mutual fund trusts. 9 50% if the option is granted (1) after March 14, 2008 by an “innovative SME”, i.e. in general a corporation whose total assets are less than $50M and that has been entitled to certain SR&ED tax credits over the past few years or (2) after February 21, 2017 by a listed large corporation with a significant presence in Quebec, that is, a corporation with a base payroll attributable to its establishment in Quebec of at least $10M.
Shares of Canadian-Controlled Private Corporations
If a stock option plan pertains to shares of a Canadian controlled private corporation (CCPC), the amount of the benefit is normally taxable as employment income in the year of disposal of the shares. In such a situation, the employee is entitled to the above-mentioned deductions provided the shares are kept for at least two years, even if the price paid for the shares is less than their FMV at the date the stock option is granted.
Example: On December 20, 2014, ABC Ltd. (a CCPC) grants John, its employee, the right to purchase 1,000 shares for $10 per share, i.e. their FMV at that time. In June 2015, John exercises his option. The FMV of the shares at that time was $15 per share. On May 1, 2020, John sells all of his shares for $12,000.
Tax consequences: There are no tax consequences in 2014 when the option is granted. There is no taxable benefit for John in 2015 because ABC is a CCPC and the gain on the shares qualifies for the deferral. In 2020, when the shares are sold, John has to include a taxable employment benefit of $5,000 ($15,000 – $10,000) in his income. He can also claim a deduction of $2,500 ($5,000 × 50%) for federal purposes and $1,250 ($5,000 × 25%) for Quebec purposes, and a deductible capital loss of $1,500 (($12,000 – [$10,000 + $5,000]) × 50%). Unfortunately, the loss on the disposition of the shares cannot be applied to reduce the taxable benefit.
In 2019, the federal government released draft legislation to amend the stock option tax regime. The draft legislation provides that the preferential treatment would be subject to an annual limit of $200,000 per employee, based on the value of the underlying shares at the time the options are granted. These new rules would not apply to options granted by a CCPC, start-ups, emerging or scale-up companies. The government confirmed its intention to release an update of these proposals, including their application date, in connection with its 2020 budget. At the date of publication, these measures have not been published since the 2020 budget was postponed due to the COVID-19 crisis.
This document is up to date as of September 3, 2020 and reflects the status of legislation, including proposed amendments at this date.