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Stock Options – An Incentive Tool for Private Corporations in Canada

19/06/2013


In today’s competitive market, stock options are a great tool to help privately-owned Canadian companies attract and retain top talent. In short, employees are provided with an opportunity to purchase shares of their employer at a determined price (often below fair market value). This in turn provides an incentive to see the business prosper and may increase employee commitment to building their career with you. These options are even more attractive and eligible for special tax attributes when a company meets the definition of a Canadian Controlled Private Corporation (CCPC) as per section 248 of the Income Tax Act.

The CCPC Benefits

When stock options are issued to an employee of a public company, there is no immediate tax consequence. When the option is exercised (i.e. the share of the public company is purchased) by the employee, there is a taxable employment benefit applied to cover off the difference between the value of the share and the purchase price. This causes the employee to owe taxes, who then often has to liquidate some shares to pay the resulting tax bill.

In a CCPC, the calculation of the benefit is the same; however, the benefit is not taxed until the shares are sold. Because shares of a private company are not easily sold, it would be difficult for the employee to obtain the funds to pay taxes resulting from exercising the shares.

In addition, where the shares come from a CCPC, the employment benefit can be reduced by half where:

  • The shares were worth less than the exercise price when the option was issued; or
  • The employee holds the shares for at least two years before the shares are sold.

With the deferral and potential reduction to the benefit, stock options can be a simple way of bringing employees in as shareholders, without the employees needing a significant amount of available funds to buy their way in. Plus, the two-year holding period provides an additional financial incentive to stay with the company.

Other Opportunities with Stock Options

Issuing stock options requires a plan by the directors of your business. This plan should establish criteria such as:

  • Vesting period – the length of time before the employee owns the shares outright. If their employment terminates prior to the vesting date, the shares can be repurchased at cost by the company.
  • Eligibility – the directors can establish who is eligible based on position, employment duration or other criteria.

One caveat to the advantages of stock options is that once exercised, employees are shareholders and entitled to shareholder rights, such as access to financial information.

Despite this, stock options may be a beneficial way to attract and retain key employees. However, there are a number of technical considerations for both tax and financial reporting. If you are interested in using stock options in your business, contact your local MNP advisor.