Welcome to our blog, where we explore the tax implications of issuing share options to Canadian contractors.

What Are Share Options?

What Are Share Options? Share options (or stock options) give individuals the right to purchase company shares at a fixed price at a future date. While common for employees, businesses may also offer share options to independent contractors as part of their compensation package. However, the tax treatment for contractors is different than it is for employees, and it’s critical to understand these distinctions.

Tax Treatment for Contractors in Canada

In Canada, when a contractor receives stock options as compensation for services rendered, the Canada Revenue Agency (CRA) generally treats the transaction as a barter arrangement. The contractor is considered to have received business income equal to the fair market value (FMV) of the options when they become exercisable or vested—not necessarily when the options are granted.

The CRA often references the grant date as the point of income inclusion of the options. They have not commented on vesting considerations. However, treatment and approach in this area, generally does consider that the options have to be fully vested and exercisable at that time of the income inclusion for a transaction to have been recognized. Professional advice should be considered to determine the proper timing for your particular situation.

The taxable benefit is calculated as the difference between the FMV of the shares at the time the options vest (or become exercisable) and the exercise price. This amount is included in the contractor’s business income for the tax year in which vesting occurs.

Stock Option Example

A contractor receives 1,000 stock options with an exercise price of $10 per share. At the grant date, the shares have an FMV of $20. However, the shares do not fully vest unless the contractor stays with the company for one year.

After a year, the options are fully granted and vested. The contractor is considered to have received a taxable benefit of $10,000 (20−10)×1,000(20 – 10) × 1,000, which is included in their income for that year. They must pay income tax on this amount.

If the contractor operates as a sole proprietor, they must report this income on the T2125 Business Schedule when filing their personal tax return. If registered for GST/HST, or if the amount exceeds the small supplier threshold, they may also need to remit GST/HST.

Tax Implications When Exercising Options

When the contractor exercises the options and buys shares, further tax consequences may arise. Whether the gain is business income or a capital gain depends on the circumstances. Seeking professional tax advice is essential.

The adjusted cost base (ACB) of the shares includes the amount paid plus any taxable income inclusion. When selling shares later, contractors use this ACB to calculate capital gains or losses.

Key Concerns for Contractors

  • The timing of taxation occurs when options vest or become exercisable.
  • There may be a cash tax obligation before any actual cash is received.
  • GST/HST obligations may apply to the FMV of the options received.
  • Proper documentation and valuation are essential to support tax reporting.
  • Seek professional advice to navigate these complex rules.

Summary and Conclusion

Stock options can be a valuable but complex form of compensation for contractors. Before accepting options, contractors must consider the immediate tax cost and potential future gains or losses.

At Virtual Heights Accounting, we specialize in virtual accounting, tax, Virtual CFO, and Controller services for growing businesses. For expert guidance, visit www.vhaccounting.ca/contactus or follow our blog on social media.

This blog provides general information and does not replace professional advice. Always consult a tax professional for your specific situation.