Q: What are the tax implications of issuing stock options to employees?
A: Stock options are a great way to attract and retain employees - especially for high growth technology businesses. There are several advantages to offering employee stock options, however, businesses should be aware of its tax implications for the employer and the employee. If you are considering offering stock options to your employees, here are a few things you should know.
There are varying implications, depending on whether or not you are a Canadian-Controlled Private Corporation (CCPC).
For a company that is a CCPC
Grant stock options this way to realize a preferred tax treatment:
- Stock options should be granted with an exercise price at or above fair market value (FMV) of common shares at the time of grant in order to realize preferred tax treatment. In this case and upon exercise, the taxable benefit associated with the spread between the exercise price and the FMV at the time of exercise is deferred until the option shares are sold.
You're ready to exercise stock options. Now what?
- The taxable benefit (the spread as noted above) is included in the employee's income as a stock option taxable benefit. The employee would receive a stock option deduction reducing the taxable benefit to one half of the original amount, effectively treating the stock option taxable benefit as a capital gain.
- If the stock options are granted with an exercise price below FMV, the stock option deduction is still available. The employee must hold on to the stock option shares after they are exercised for a period greater than two years
Understand your tax reporting requirements:
- As the stock option benefit is a taxable benefit, the employer in normal circumstances is required to withhold and remit source deductions including any employee health taxes.
- Stock options issued by CCPCs are not required to withhold and remit source deductions (except EHT). The employer is required to report the taxable benefit on the employee's T4 which remains in effect even if the employee leaves the company.
- If there is a desire to withhold and remit source deductions, the employer would need to seek approval by the employee and obtain a waiver from CRA, which could be facilitated through an updated TD1 Form.
Determine your company's FMV:
There are different options to use to determine FMV, and each provides a different amount of evidence to support your FMV:
- Perform a recent funding activity,
- Complete an analysis of share value at the time of the grant, or
- Perform a formal valuation (in certain situations).
For a company that is not a CCPC
The rules differ slightly when you're not a CCPC. When the stock option is exercised, the employee will be taxable on the stock option benefit in the year of exercise and not deferred until the time the stock option share are sold. In certain circumstances, the employee could be eligible for a stock option deduction. Unlike a CCPC, the employer is responsible to withhold and remit source deduction in addition to reporting the stock option benefit on the employees T4.
For additional questions or further information on this topic, contact:
Paul Walker
Senior Manager, Domestic Tax
pwalker@bdo.ca
If you have any questions, email technology@bdo.ca or tweet @bdo_canada and use #techtips.