An employee stock option (ESO) grants employees the right to acquire shares of the employer at a fixed price and provides a long-term incentive in which employees benefit from the success of their employer, and likewise, employers benefit from long-term, loyal employees.
On March 19, 2019, the Federal Government proposed to implement an annual cap of $200,000 on employees eligible for the “Stock Option Deduction that are employed at “large, long-established, mature firms” (which has yet to be defined). The annual cap of is based on the fair market value of the underlying shares at the time that the options are granted to an employee. Options granted to an employee beyond the $200,000 will not be eligible for the Stock Option Deduction.
In order to determine how this impacts employers moving forward, here is a summary of the current rules for Canadian Controlled Private Corporations (CCPC) and public corporations. You may want to familiarize yourself with the following terminology commonly used in ESO agreements:
- Grant price/exercise price/strike price – the agreed upon price at which the employee can buy the stock for;
- Fair market value – the current price of the stock;
- Vesting date – the date you can exercise your options according to the terms of the ESO plan; and
- Exercise date – the date you do exercise your options.
Rules for CCPCs
A CCPC is a private company incorporated in Canada owned by Canadian residents and is therefore not publically traded. When an ESO is granted, there is no tax implication and no amount is included into the employee’s income at that time.
When the ESO is exercised, a taxable benefit should be included into the employee’s income equal to the difference between the price the employee paid to buy the shares (i.e. grant price/exercise price/strike price) and the fair market value of the shares at the time of purchase. For CCPCs, this taxable benefit can be deferred until the shares are sold and provided certain conditions are met by the employee, this taxable benefit may be reduced by one-half.
Rules for Public Companies
Similar to the treatment of ESOs of a CCPC, there are no tax implications on the date shares are granted to an employee. However, what differentiates public companies shares from CCPS shares is that when the shares are exercised, the employee will recognize a taxable benefit equal to the difference between the grant price/exercise price/strike price of the shares and the fair market value of the shares on that date. Once again, provided certain conditions are met by the employee, this taxable benefit may be reduced by one-half.
Once the options are exercised, withholding taxes will be deducted on the taxable benefit realized so you may want to consider selling the shares. If you choose not to sell and hold onto the shares which then go “underwater”, the employee is still liable for the taxable benefit realized on the exercise date.
Please contact your DMCL advisor to discuss how these changes can affect you and your business.