Tax Tip[] Stock Options

Special Update on Taxation of Stock Options

“Only new stock options affected by tax changes”, says Minister Morneau.

Today new Federal Finance Minister Morneau said that any changes to the taxation of stock options will only affect stock options issued from the date the changes are announced.  “Any decisions we take on stock options will affect stock options issued from that date forward,” said the Minister.

Any stock option issued prior to that date will be treated under the tax regime that was in effect at the time.

Although the wording in this announcement is not “crystal clear”, it appears that stock options granted before the date of any announced changes to the taxation of stock options will remain subject to the old rules.  Currently, if certain conditions are met, a deduction of 50% of the benefit realized on exercise of a stock option can be taken as a deduction.  This essentially means that only half of the stock option benefit is subject to tax.

During the Federal election campaign, the Liberals announced that the deduction allowed for stock options would be limited to $100,000 annually, because stock options are widely used as a tax perk by wealthy Canadians, and are not normally available to the middle class.  There has been considerable speculation as to how the proposed changes would be implemented, and even more significantly, when they would apply.  Many people thought that stock options exercised in 2015 would benefit from the full 50% deduction, whereas if exercised in 2016, the deduction might be limited to $100,000.  Consequently, many people had been exercising stock options, or at least considering this, before the end of the year.

The Minister’s announcement seems to provide some comfort that existing stock options and those created before any changes are announced, whether exercised or not, will continue to benefit from the full 50% deduction, where eligible, and that only stock options granted after a date in the future on which the new rules will be explained in more detail will be affected.

In any event, because of the proposed tax rate increase, which may apply from 2016 onwards, of 4% for high income individuals (taxable income over $200,000), it may still be beneficial to exercise stock options in 2015 rather than 2016.

It should be noted that the tax considerations are only one factor in determining whether or not to exercise stock options.  There are other issues to consider, such as whether to hold the shares or sell the shares, which is a financial and investment decision.  There is also the funding of the amount necessary to exercise the stock options and corresponding taxes payable on benefits realized.  Lastly, it should be noted that if the stock decreases in value from the price on the exercise date, the decline in value will be a capital loss.  The stock option benefit is considered employment income, and a capital loss cannot be applied to reduce employment income.

A by-product of the Minister’s announcement is that it may be possible to grant additional stock options today which will fall under the grandfathering.  The window of opportunity may be short-lived as no one can predict when the rules will be outlined, which will mark the effective date of the change (there could be an announcement in December, or the matter could be raised for the first time in a Federal Budget which might possibly be scheduled for February 2016).  There may be a window of opportunity, but it may not be a large one.  In any event, granting of a stock option is not itself normally a taxable event.  Thus, there would appear to be little downside to accelerating the granting of stock options in suitable circumstances.

For an individual consultation concerning stock options, please contact us.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Stock Options

“A small change to timing can have a big tax impact”

Generally, when stock options are granted, no tax benefit is recognized for Canadian tax purposes until the employee exercises the option. The benefit is begins as fully taxable employment income. If the exercise price of the options is at least equal to the value of the shares when the options were granted (or, for options of a Canadian-controlled private corporation (“CCPC”), if the shares acquired under the option are held for 24 months or more before they are sold), the full income inclusion is reduced by half. Where the employer is a CCPC and the employee deals at arm’s length with the employer, this benefit can be deferred until the shares are disposed of.

 What do we mean by “disposed of”?  It’s not only a sale to a third party.  Transfers to a holding company, or even an exchange of shares for another class of the same company, are examples of “non-sale” events that are treated as dispositions for tax purposes.  Fortunately the tax rules allow for a transfer or exchange of the shares to be ignored when certain “internal” transfers or exchanges occur. Where the exceptions are met, the income inclusion is deferred until the year in which the employee disposes of or exchanges the securities of the new company (or the securities issued to replace the original shares).

 Let’s use an example.  Assume Opco, a CCPC, is being sold to a new controlling group of Canadian shareholders. Often, the new controlling group will acquire its shares through a holding company (Holdco), also a CCPC. In many cases, the founding shareholders of Opco will transfer their shares of Opco to Holdco as part of the transaction. To the extent the shares the founding shareholders transfer were acquired via stock options, this transfer may trigger unintended tax.  Why? The shares of Opco are technically being disposed of when they are transferred to Holdco so the employment benefit from the original stock options will become taxable unless certain deferral conditions are apply. 

 In particular, the benefit will be deferred until there is a sale of the new Holdco shares if Opco does not deal at arm’s length with Holdco immediately after the transaction. If the new shareholders control Holdco before the founding shareholders transfer their option shares, Holdco may not be arm’s length with Opco immediately after the transfer. This conclusion would trigger the realization of the taxable benefit by the original shareholders on their stock option shares. 

 In order to avoid this problem, the Opco shareholders should sell their option shares to Holdco before the new shareholders take control of Holdco. This ordering ensures that Holdco will be owned only by the previous Opco shareholders immediately after the transfer of the stock option shares. As such, Holdco and Opco would not deal at arm’s length with each other immediately after the transfer and the stock option benefit will be deferred. The new shareholders can then subscribe for their new shares of Holdco. 

 A small change to timing can have a big tax impact.


TAX TIP is provided as a free service to clients and friends of Cadesky Tax. 

The material provided in Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.

Early Exercise of Stock Options

“it is desirable to minimize the employment benefit and increase the potential capital gain.”

Generally, there is no immediate tax implication when a stock option is granted to an employee. The timing and amount of any eventual taxable benefit will be based on the nature of the issuing corporation and the relationship between the exercise price (“strike price”) and the fair market value (“FMV”) of the shares when the stock option is exercised. 

An employment benefit is calculated as the difference between the FMV of the shares at the time the option is exercised and the strike price. However, the time at which the employment benefit becomes taxable differs based on the status of the corporation issuing the stock options.  If the corporation that grants the stock option is a Canadian-controlled private corporation (“CCPC”), the recognition of the employment benefit is deferred until the shares acquired under the stock option are sold.   If the granting corporation is not a CCPC, the benefit is generally taxable in the year that the options are exercised. 

A capital gain will be realized if the shares are sold for proceeds greater than the FMV of the shares when the option was exercised.  If the proceeds are lower than the FMV when the option was exercised, the employee will have a capital loss that cannot be used to offset the employment benefit.

Subject to our comments below, the entire amount of the employment benefit is taxed at the employee’s marginal tax rate, whereas only one-half of a capital gain is taxed at the marginal rate.

The rest of this tax tip will deal with stock options issued by a CCPC.

In most CCPC scenarios, the strike price is nominal even if the shares have a high FMV. Where the employee deals at arm’s length with the CCPC and the employee holds the shares for at least two (2) years after exercise, one-half (1/2) of the employment benefit may be deducted from the employee’s income.  This 50% deduction effectively allows the employment benefit to be taxed at capital gains tax rates even though the amount is employment income (not eligible for the capital gains exemption). 

Even though the employment benefit can be taxed at the same effective tax rate as a capital gain any capital loss from the sale of the shares cannot be deducted against the employment benefit.  Accordingly, it is desirable to minimize the employment benefit and increase the potential capital gain.

In order to:

  1. minimize the employment benefit;
  2. start the two (2) year hold period required for the 50% deduction; and
  3. allow more of the growth in FMV to be treated as a capital gain

employees should consider exercising their stock options early.   If the strike price is nominal, there is little downside to this strategy and potentially large tax savings.  Where the strike price is more than nominal the decision as to when to exercise the stock options is more complicated.

You should consult with your TSG representative if you have any questions relating to the taxation of stock options.  


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

New Rules Regarding Stock Options

“Most employers will not want to elect out of the deduction.”

In most cases, when an employee exercises a stock option, the difference between the price the employee pays for the shares and their market value is treated as a taxable benefit and a deduction equal to one-half of the taxable benefit is allowed. In effect the employee is taxed at the same rate as a capital gain.

Some stock option plans allow the employee to elect to receive a cash payment equal to the value of the option benefit instead of exercising the option and purchasing shares. In essence, the employee can “cash out” the options.

Prior to the March 4, 2010 Federal Budget, the tax consequences to the employee cashing out were the same as if the option had been exercised – the employee was taxed at the same rate as a capital gain. In addition, in certain circumstances, the stock option plans were structured so the employer was able to claim a deduction for the full amount of the cash payment. This result was beneficial since the employer was able to deduct an amount paid to an employee who was subject to tax at the capital gain rate.

The 2010 federal budget eliminated this beneficial treatment for “cash outs” occurring after March 3, 2010. The budget provides that employees cashing out a stock option can claim the deduction of one-half of the employment benefit only if the employer elects to forgo the deduction for the cash payment. If the employer does not make this election, it will be entitled to a corporate tax deduction for the payment but the employees must pay tax on the full value of the employment benefit.

Assuming an individual marginal tax rate of 46%, the cost to the employee of receiving the cash out will be additional tax of 23% unless the employer elects to forego the deduction of the payment. Most employers will not want to elect out of the deduction because they will lose the corporate tax savings.

If possible, it may be preferable for the employee to exercise the option and sell the shares (to generate the cash) rather than receive the payment from the employer. The employee would maintain favourable tax treatment and the employer would avoid the cash outlay.

Since the Department of Finance has not provided any grandfathering relief for stock option cash-out arrangements that were in place before March 4, 2010, employers and employees will need to reconsider the implications of any cash-out arrangements before proceeding.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Stock Option Tax Deferral Election

“The 2010 Federal Budget proposes to repeal the employee stock option tax deferral election.”

Employee stock options can provide a tax-effective way to compensate key employees. There is no tax cost to an employee when a stock option is issued. Once the employee exercises an option to acquire shares of their employer, the difference between the fair market value of the shares at that time and the price the employee pays for the shares is treated as a taxable employment benefit. An employee of a publicly-traded company is required to include this benefit in income for the year during which the option is exercised unless certain conditions are met, in which case the employee can elect to defer the inclusion of up to $100,000 of benefits vesting in a particular year until the year in which the employee disposes of the shares. This “tax deferral election” is not of any practical use if the employee sells the shares immediately after exercising the stock option.

The 2010 Federal Budget proposes to repeal the tax deferral election for stock options exercised after 4:00 p.m. Eastern Standard Time on March 4, 2010. Tax deferral elections made before March 4 will continue to be effective until the shares are sold. However, the ability to make such elections in the future will be eliminated. As a result, the taxable employment benefits for employees of publicly-traded companies will be included in income for the year in which the option is exercised. This change can create a tax liability before the stock option shares are sold.

Furthermore, the Budget clarifies the payroll withholding requirement for the tax on the employment benefit at the time the shares are issued (i.e., when the option is exercised). Tax must be withheld from the employee’s pay and remitted for the pay period that includes the date on which the shares are issued. With certain limited exceptions, this rule will apply for shares issued after 2010 to provide time for employers to put procedures in place to provide for these withholding requirements.

The stock option proposals were not included in Bill C-9, the Budget bill, which is currently before Parliament and is expected to be enacted this spring. The Department of Finance is drafting the amendments to the Income Tax Act for these changes, and it is expected to introduce draft legislation that will include the stock option changes in the summer or fall. Retroactive enactment will likely be late this year or in 2011. It is wise, therefore to assume that these provisions are in force.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Fifth Protocol – Canada-U.S. Tax Treaty – Stock Options

“The revised Protocol provides a mechanism for allocating stock option income between the countries.”

In annex B of the fifth Protocol (the “Protocol”) to the Canada-U.S. Treaty, there is an agreement between Canada and U.S. on how to tax employment income from stock options. In the past, there was an inconsistency between the two countries which sometimes resulted in double taxation. In order to alleviate this issue, the two countries have agreed to tax the employment income on an agreed upon ratio. The ratio is based on the number of days in which an individual was employed at the place of employment to the number of days employed between the date of grant and the date of exercise. Assume the following facts:

  1. An individual was granted a stock option on the first day of his employment in Canada.
  2. The individual worked for 300 days in Canada before moving to the United States.
  3. The individual exercised the options 400 days after moving to the United States. 

In a case like that, 300 over 700 of the employment income will be allocated to Canada and the remainder allocated to the United States.

Notwithstanding the above, the competent authorities of both countries can agree to attribute the income in a different manner if both countries agree that the terms of the option were such that the grant was essentially a transfer of ownership. For example, if the options were granted “in the money” or not subject to a substantial vesting period, then the competent authority can reallocate the employment income.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Stock Option Deductions

“Payments to an employment consultant are not permissible deductions from stock options.”

The case of Morin (2006FCA 25) is a very interesting case recently decided by the Federal Court of Appeal. In computing his tax liability, Mr. Morin had deducted payments to a consulting firm (“Bobsan”), as a deduction under the stock option rules in section 7 of the Income Tax Act. Bobsan had agreed to help Mr. Morin find employment in exchange for a fee based on the value of any employee stock options that Mr. Morin received. When Mr. Morin found a job, he was issued stock options by his new employer, to which the normal stock option rules applied. The issue to be adjudicated was whether amounts paid to Bobsan by Mr. Morin were deductible from his stock option benefits under section 7. Bobsan’s only involvement was providing a list of possible career opportunities to Mr. Morin.

The Tax Court had decided that the amounts paid to Bobsan were deductible under subparagraph 7(1)(a)(iii), as a cost of acquisition of the stock options.

The Federal Court of Appeal reviewed the word “acquire” in some detail and determined that payments made to Bobsan, totalling over $133,000, were not made to acquire the stock options. Bobsan did not transfer title, nor the incidence of title, to Mr. Morin in exchange for the payment, nor did Mr. Morin purchase stock options from Bobsan. Moreover, Mr. Morin would have received the options even if he had failed to pay Bobsan. Based on these facts, the Federal Court of Appeal determined that the payments to Bobsan were not made to acquire the stock options and therefore were not deductible.

The Federal Court of Appeal buttressed their conclusion by adding that “Expenses incurred in the course of searching for employment, including amounts paid to a consultant, are not deductible from employment income under section 8 of the Act.”

The Federal Court of Appeal had great sympathy for the taxpayer, as he was exposed to tax liability on his entire employment income despite using a large portion of the stock option benefit to pay Bobsan for consulting services.

The Federal Court of Appeal’s decision clarifies that amounts paid to a consultant are not deductible expenses, even if the payments are pursuant to an agreement.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

SR&ED/Stock Option #2

“Proposed Amendments to deny stock option benefit in ITC calculation.”

In a previous Tax Tip (05-22), it was discussed that the CRA had issued a bulletin accepting the position in Alcatel (2005 TCC 149), that a corporation will be entitled to an investment tax credit (ITC) in respect of the “stock option benefit” that arises when an employee exercises stock options.

In response to Alcatel, the Minister of Finance tabled a Notice of Ways and Means Motion on November 17, 2005 proposing amendments to the Income Tax Act to deny an ITC on the value of the benefit realized by an employee on the exercise of stock options. More specifically, the amount of expenditure allowable to a corporate taxpayer, and upon which a tax credit or deduction may be claimed, is limited to the amount actually dispersed by the corporate taxpayer. This proposal applies to options granted and shares issued on or after November 17, 2005.

The Minister’s position is that the stock option benefit does not represent an outlay of a corporation. Instead, it represents a dilution of the value of the share equity of the other shareholders of the corporation. Such excesses were not intended to be considered to be expenditures under the SR&ED tax incentive program.

When making an SR&ED tax credit claim, the prescribed form is due to be filed with the Minister no later than 12 months after the filing due date for the tax return in respect of the taxation year in which the expenditures were made (i.e., 18 months after year end). Currently, the Minister has the ability to waive the 12-month filing requirement. The Minister has proposed that it will no longer grant a waiver of the 12-month filing requirement. Therefore, no SR&ED deduction or ITC can be claimed if the taxpayer takes more than the additional 12 months allowed.

Given the short time period between the CRA’s acceptance of the position in Alcatel and the issuance of the proposed amendments denying the benefits realized in Alcatel, it is evident that the Minister intends to act swiftly to amend the Income Tax Act in response to unfavourable positions rendered by the Courts. If this trend continues and is widespread, apparent taxpayer victories will be short lived, as the government tries to close any perceived loopholes in the Income Tax Act.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Stock Option Deferral – Cost Base Calculations

“Detailed records are necessary to calculate the cost base of stock option deferral shares.”

A few years ago, the Department of Finance issued new rules with regard to the deferral of stock option benefits on stock options of public company shares. Before these new rules, the only way that a stock option benefit could be deferred until the sale of the shares was if the stock option was in respect of private company shares. The Department of Finance issued new rules, allowing for a deferral of the stock option benefit where the value of the shares at the time that the stock option was granted did not exceed $100,000. If the taxpayer received stock options where the value of the shares exceeded $100,000, the taxpayer could still defer a portion of the stock option benefit until the shares were actually sold.

One of the complicated areas in these new rules is the calculation of the cost base of the shares that were received when the stock option was exercised. This becomes more complicated when there are shares purchased on the open market mixed with shares received through the exercise of a stock option.

Where there are two groups of shares, the stock option shares are kept in a separate “bundle” in calculating the adjusted cost base of the stock option shares. Moreover, there is a rule that states that the shares that have no stock option deferral on them are deemed to have been sold before the shares for which there is a stock option deferral. These rules are of benefit to taxpayers in that they do not have to bring the stock option benefit into income until the deferred shares are sold. Even within the stock option deferral shares, there can be a further separation of the shares. If options are exercised and sold within 30 days, a taxpayer can elect to have the cost base of those shares specifically isolated and not grouped with the other deferred shares.

Advisors must be careful to separate the various kinds of shares acquired, both through stock options and in the open market and keep track of the timing of when the options were exercised and when the shares are sold.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

SR&ED Claim for Stock Option Benefit

“Stock option benefit can be used for ITC calculation.”

The CRA has recently issued a bulletin accepting the position in Alcatel (2005 TCC 149).The CRA accepts that, where stock options are exercised by an employee, the resulting benefit will be allowed as”salary or wages” and the corporation will be entitled to an investment tax credit in respect of the value of the resulting benefit. As always, however, there are a number of conditions in order for this to occur:

  1. The stock options must be granted to the employee in a fiscal year during which the employee was involved in the SR&ED activities of the claimant;
  2. The options must be received by reason of the employee’s employment, not because the individual is a shareholder;
  3. All, or a portion of, the employee’s salary was an allowable SR&ED expenditure in the year that the options were granted;
  4. The employee has exercised or disposed of the option; and
  5. The claimant files within the 18-month reporting deadline all of the prescribed forms and prescribed information for the year during which the stock option benefits were earned.

The CRA bulletin explains that the stock option benefit is an eligible expenditure for investment tax credit purposes in the same proportion that the employee’s salary was allowed as an SR&ED expenditure in the year that the options were issued. For example, if the employee’s salary in the year that the stock options were issued was 80% eligible as an SR&ED expenditure, then 80% of the stock option benefit would qualify as an SR&ED expenditure. The value of the stock option benefit will not be an allowable SR&ED expenditure for purposes of subsection 37(1) (SR&ED deduction). The stock option benefits are only to be considered in calculating the investment tax credit.

One of the difficult issues with this bulletin is that the stock option benefit calculation is based on matters relating to the year in which the options were issued. This could be a difficult tracking exercise if the options were exercised five years after they were granted. The corporation would have to determine how much of the employee’s salary was allowed as an SR&ED expenditure five years ago in order to determine how much of the stock option benefit is allowable for the investment tax credit calculation.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.