2- Stock options

An employee who acquires shares in the employer’s corporation¹² under a stock option plan is deemed to have received a taxable benefit in the year equal to the amount by which the FMV of the shares when they are acquired exceeds the price paid for them.

However, the employee is generally entitled to a deduction of the benefit if the amount paid to acquire a share is at least equal to its FMV at the time the option was granted. Any increase (decrease) in value subsequent to the date of acquisition will be taxed as a capital gain (loss) in the year of disposal.

This deduction is equal to 50% of the value of the taxable benefit for stock options exercised prior to June 25, 2024 and 33.33% (1/3 of the taxable benefit) for stock options exercised since June 25, 2024. However, this deduction may be increased to 50% up to an overall annual limit of $250,000 to be shared among employee stock options benefits and capital gains. When the total employee stock option benefits and capital gains exceeds this limit, allocation of the preferential treatment is at the discretion of the individual.

Example: Lindsay realizes a capital gain of $125,000 and has employee stock option benefits of $200,000 in the last six months of 2024. Lindsay can elect to receive a one-half deduction on the full amount of the employee stock options benefits of $200,000 (i.e., $100,000) when calculating her taxable income.

As a result of this election, $50,000 of the capital gain would be included at a one-half inclusion rate and the remaining $75,000 would be included at a two-thirds inclusion rate for a total taxable capital gain of $75,000 ($50,000 x ½ + $75,000 × ⅔).

Alternatively, Lindsay can elect to have the one-half inclusion rate apply to the full amount of her capital gain, resulting in a taxable capital gain of $62,500 ($125,000 x ½). She can receive a one-half deduction on $125,000 of her stock option benefit and one-third on the remaining $75,000, for a total deduction from taxable income of $87,500 ($125,000 x ½ + $75,000 x ⅓).

Deduction in Quebec

In Quebec, the stock option deduction rate is 25% of the value of the taxable benefit.

The deduction is increased to 50% of the value of the benefit for stock options exercised prior to June 25, 2024, or to 33.33% for stock options exercised since June 25, 2024, where the stock option is granted:

• By an “innovative SME” for the calendar year during which the employee acquired the option, i.e. in general a corporation whose total assets are less than $50M and that has been entitled to certain SR&ED tax credits over the past few years.
• After February 21, 2017, by a listed large corporation with a significant presence in Quebec, that is, a corporation with a base payroll attributable to its establishment in Quebec of at least $10M.

Shares of Canadian-Controlled Private Corporations

If a stock option plan pertains to shares of a Canadian-controlled private corporation (CCPC), the amount of the benefit is normally taxable as employment income in the year of disposal of the shares. In such a situation, the employee is entitled to the above-mentioned deductions provided the shares are kept for at least two years, even if the price paid for the shares is less than their FMV at the date the stock option is granted.

Example: On December 20, 2017, ABC Ltd. (a CCPC) grants John, its employee, the right to purchase 1,000 shares for $10 per share, i.e. their FMV at that time. In June 2018, John exercises his option. The FMV of the shares at that time was $15 per share. On May 1, 2024, John sells all of his shares for $12,000.

Tax consequences: There are no tax consequences in 2017 when the option is granted. There is no taxable benefit for John in 2018 because ABC is a CCPC and the gain on the shares qualifies for the deferral. In 2024, when the shares are sold, John has to include a taxable employment benefit of $5,000 ($15,000 – $10,000) in his income. He can also claim a deduction of $2,500 ($5,000 × 50%) for federal purposes and $1,250 ($5,000 × 25%) for Quebec purposes, and a deductible capital loss of $1,500 (($12,000 – [$10,000 + $5,000]) × 50%). Unfortunately, the loss on the disposition of the shares cannot be applied to reduce the taxable benefit.

Maximum deduction for shares of a large corporation

The preferential tax treatment applicable to stock options granted after June 30, 2021, is subject to a limit. This limit does not apply to options granted by a CCPC or an employer whose gross annual income (on a consolidated basis) is $500M or less.

Under these rules, the stock option deduction can only be claimed with respect to an annual vested amount of $200,000 per employee, determined on the basis of the value of the underlying shares at the time the options are granted. Any stock option benefit from exercising an option in excess of this limit is fully taxable for the employee, with no possibility of claiming the deduction in this respect.

Example: On August 31, 2024, John’s employer, a large public corporation, grants him options to purchase 25,000 shares with a FMV of $10 per share on the grant date. Options on 20,000 shares are considered to be eligible for the preferential tax treatment, since they do not exceed the annual vesting limit of $100,000 (20,000 X $10 = $200,000). Accordingly, John can therefore claim the stock option deduction with respect to the benefit from these options, if all other conditions are otherwise satisfied. Options for the additional 5,000 shares will not give entitlement to the stock option deduction. These rules will apply regardless of when the options are exercised.

If, instead, John’s employer grants him 20,000 options in August 2024 and 5,000 options in January 2025, all of the options would be considered as qualified securities and give entitlement to the stock option deduction in accordance with the usual rules.

¹² Or a company not at arm’s length with the employer. The same tax treatment applies to options granted by mutual fund trusts.