How are stock options taxed in Canada?

Many companies offer employee stock options, which often lead to employees buying shares in the company at a discount. Employee stock options can provide a big incentive for employees to join and stay at a company, as well as work towards the company’s success.

But how do employee stock options work? And how are stock options taxed in Canada? We look at the various stock option programs in place, stock option benefits, the different tax implications and stock option capital gains.

How do employee stock options work?

Companies often give their employees the option to buy shares at a set price (called the exercise price), during a set period of time. If the company’s shares rise in value over that period, employees can buy them at the lower exercise price: they can then choose to either sell them to make an immediate profit or hold onto them, in the hope that they rise even more in value.

When the employee receives the option to buy the shares, there are generally no tax consequences until they exercise the option — that is to say, when they buy the shares at the discounted rate. How stock options are taxed in Canada will depend on several circumstances, such as where the shares are held and the kind of company the employee works for.

The ways that stock options are taxed in Canada

If you bought your employer’s shares at the exercise (discounted) price, there is a taxable employment benefit, which is equal to the number of shares bought, multiplied by the difference between the shares’ fair market value on the exercise date, minus the exercise price. 

If you work for a Canadian-controlled private corporation (CCPC), you wouldn’t need to pay tax until you chose to sell your shares. A company is classed as a CCPC if it’s privately owned, with shares that don’t trade on public stock exchanges. There are also other stipulations, such as that the company can’t be controlled by non-residents or publicly owned corporations.

If you work for a company other than a CCPC (for example, a public corporation), you would be taxed on the benefit in the year that you bought the stock.

If you continue to hold the shares after you exercise your options, there could be a capital gain or loss. Keep in mind that half of capital gains are taxable, unless they’re held in a registered account, such as an RRSP or a TFSA.

How stock option tax in Canada is calculated

When it comes to calculating the employment benefit included in your income (from exercising employee stock options), there is often a 50% stock option deduction available. There are some stipulations for this for employees who work for non-CCPCs, including:

• The employee received prescribed shares (these are common shares that have no fixed redemption value and no fixed dividend).
• The employee dealt with the employer at arm’s length.
• The exercise price wasn’t less than the fair market value of the shares when the option was granted.

For employees who work for a CCPC, the conditions are less stringent. Even if the exercise price was less than the fair market value on the option grant date, the stock option deduction is generally still available, as long as you owned the shares for at least two years before selling them.

Rules were put in place (which are effective for stock options granted after June 30, 2021), to restrict the amount of stock option deduction that is available in certain circumstances. Options that can qualify for the 50% employee stock option deduction are limited to $200,000 annually (based on the value of the shares on the date the option was granted).

The new rules do not apply to CCPC employees or non-CCPC employees whose company’s revenue is $500 million or less.

Here’s an example of an employee stock option purchase:

• An employee is granted an option to purchase 100 shares of their employer (a public company), at an exercise price of $30 per share.
• Two years later, the employee exercises the option when the value of the shares is $50/share.
• The employment income inclusion is $2,000 (($50-$30) x 100).
• If the stock option deduction is available, this would provide a deduction of $1,000 to apply against the employment income inclusion.

The amount of tax that the employee would have to pay would depend on their marginal tax rate. If, for example, their marginal tax rate was 35%, they would pay $700 (or $350 if the stock option deduction was available).

We strongly encourage you to reach out to your tax advisor to determine if the stock option deduction is available in your particular circumstances.

Employee stock options and capital gains

When an employee sells their shares at a profit, they make a capital gain. If they hold their shares in a Tax-Free Savings Account (TFSA), there won’t be any tax payable on that gain.

If the shares are held in unregistered accounts, they could be subject to a capital gains tax. This, however, could lead to double taxation: therefore, employees can adjust the tax cost of the bought shares to account for the employee benefit that has already been taxed. Here’s an example:

An employee buys shares worth $150 at the share option price of $100 and then sells them later for $170.

The employee benefit, for tax purposes, would be $25 ([$150 - $100] ÷ 2).

However, for capital gains purposes, the full employee benefit (not half) is used in calculations.

The tax cost of the shares would therefore be $100 + $50, making a capital gain of $20 (half of which would be taxable).

Fitting your employee stock options into your overall financial plan

For many people, exercising an employee stock option can be an easy decision, particularly if you receive your company’s shares at a discounted rate. However, you still have to pay for those shares and, like any assets in your portfolio, there are several things to consider, including whether you plan to sell the shares or hold onto them.

How these shares will affect your portfolio’s diversification is also a key concern. Shares of a single company shouldn’t generally account for a large percentage of your portfolio’s assets. Also, holding shares in your employer can be dangerous if the company hits hard times. You could lose your job at a time when your savings (in the form of your company shares) have lost value.

I can help advise you on how to integrate shares from employee stock options into your portfolio and your overall financial plan. Contact me today to discuss your employee stock options.