In many publicly-traded companies, employers often grant security options to their employees as part of their benefits. The options provide the employees the opportunity to purchase the shares of the company at a given price (“Exercise Price”). The option agreement can cover shares of a publicly-traded company in/outside of Canada or shares of mutual funds.
If an employee exercises their option and purchases the security at less than their fair market value (FMV), the individual will incur a taxable benefit through employment. For example, if you received an option for 1,000 shares of a corporation and exercised your option at $50 per share, where the fair market value at the Toronto Stock Exchange was $100, you will incur $50,000 in taxable benefits.
Fair market value (FMV) is the price a product would sell for on the open market assuming that both buyer and seller are reasonably knowledgeable about the asset, are behaving in their own best interests, are free of undue pressure, and are given a reasonable time period for completing the transaction (source: Investopedia.com)
First thing first, lets discuss the criteria for an individual to be considered as an eligible employee if they meet the following criteria:
Amounts paid to acquire the eligible security including all amounts paid to acquire the option, can not be less than the Fair Market Value (FMV) of the security at the time option was granted. Let’s look at an example: Assume you work for a company that grants you the option to buy 5,000 shares of the company at $10 per share in 2023. FMV of the stock at the time was also $10 per share. In 2024, the FMV of the share rises to $15 and you decide to exercise your option (5,000 x $10). Option purchase price in this case is not less than the FMV of the share at the time of purchase (both $10). The option would be disqualified if for example, the option was exercisable at $8 per share where the FMV was $10 at the time option was granted.
If an employee purchases shares of a Canadian-Controlled Private Corporation (CCPC) under an employee security option dealing with the client at “Arm’s Length”, the income will only be reported in the year the shares are sold and there is no need to report the taxable benefits in the year the option was granted.
The eligible employee must be a resident of Canada at the time the option is exercised in order to qualify for deferral from the taxable benefit.
When it comes to exercising your employee option agreements, you need to remember one critical date: March 4, 2010. For eligible securities which were not granted by a CCPC, exercised up to and including 4 p.m., Eastern time (EST), on March 4, 2010, an income deferral of taxable benefits up to an annual limit of $100,000 on the FMV of the securities. In this event, the income can be deferred if any of the following occurs first:
If the option for eligible securities which were not granted by a CCPC, was exercised after 4 p.m., Eastern time (EST), on March 4, 2010, the deferral of taxable benefits is no longer available.
If an eligible employee acquired securities under a security option agreement, the individual may be entitled to a deduction equal to one-half of the security option benefit (security option deduction), only if the employer has not claimed a deduction for the issuance of the shares (Box 39 of T4). For example, if the eligible employee exercised stock options from his/her employer and received a taxable benefit of $8,000, the individual can claim a deduction of $4,000 on line 24900 of their tax return. You should enter the amount shown in box 39 of your T4 slip on line 24900. This deduction reduces the taxable income.
If the eligible employee exercises their security options, the employer will be required to withhold and remit an amount in respect of the taxable security option benefit (less any security option deduction) in the same way as if the amount of the benefit had been paid to you as an employee bonus (source: Canada.ca).
In the event the eligible employee donates their shares or mutual fund units under an employee option agreement to a qualified donee such as the Salvation Army, the individual will be required to complete Form T1170 - Capital Gains on Gifts of Certain Capital Property. The donation may qualify for an additional security option deduction equal to half of the taxable benefit.
For further information or if you need to prepare a will, please visit the nearest Softron office or contact Softron at:
Telephone: 1-877-SOFTRON, Website: www.softrontax.com
Posted on 27 July 2023