Many businesses use stock options to attract and reward good employees. If the stock options are structured properly, the employee can enjoy the benefit on a tax-effective basis. Employees typically receive stock options, granting them the right to purchase shares of the employer corporation at a fixed price the exercise price on a future date.
The granting of the stock option does not create an immediate tax event for the employee. A taxable employment benefit is triggered when the employee exercises the options and acquires shares of the company. The benefit is equal to the amount, if any, by which the fair market value FMV of the shares at the time the employee acquires them exceeds the amount paid by the employee for the shares the exercise price.
The employee may also be entitled to an offsetting deduction equal to 50 per cent of the amount of the employment benefit if certain conditions are met. The deduction results in the employment benefit being effectively taxed as if it were a capital gain, notwithstanding that the benefit is income from employment. Where the stock option plan provides an employee the choice to receive cash in lieu of shares, and the employee opts to receive cash, the employer is permitted a deduction for the cash payment.
However, the employee may not claim the 50 per cent deduction on the employment benefit amount at the same time unless the employer files an election to forego the deduction on the cash payment. The above rules are even more advantageous when the employer is a Canadian-controlled private corporation CCPC , a private company that is not controlled by any non-Canadian residents or public companies. The timing of the taxation of the employment benefit is deferred to the taxation year in which the employee sells the shares, as opposed to the taxation year in which the employee acquired the shares.
The employment benefit will be calculated as discussed above. Moreover, the employee may also claim the 50 per cent offsetting deduction as long as the individual holds the shares of the CCPC for at least two years before selling them.
There is no requirement that the exercise price be at least equal to the FMV at the date of grant, nor any requirement that the shares qualify as prescribed shares in order to be eligible for the deduction. If the issuing company is not a CCPC, Bob will pay tax on the employment benefit when he exercises his options and acquires the shares in If the issuing company is a CCPC, Bob will not have to pay tax on the employment benefit until he disposes of the shares in Because Bob held the shares for more than two years after the options were exercised, he will also be able to claim a deduction equal to 50 per cent of the benefit.
If Bob had held the shares for less than two years, he would still be able to claim the 50 per cent deduction of the employment benefit since the other conditions are met i. Although the employment benefit is afforded the same tax treatment as a capital gain, it is not actually a capital gain.
If you are considering establishing a stock option plan in the coming months, contact your Collins Barrow advisor for more information and guidance. Information is current to October 23, The information contained in this release is of a general nature and is not intended to address the circumstances of any particular individual or entity.
Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Collins Barrow is urging the Canadian government to delay the enactment of measures that profoundly change the taxation of private corporations and their shareholders, as proposed in draft legislation introduced July 18, CB National and all 26 member firms unanimously recommend all measures be delayed for, at minimum, one year to accommodate more detailed analysis.
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