Welcome to our blog, where we explore the tax implications of issuing share options to Canadian contractors.
What Are Share Options?
Share options, also called stock options, allow employees or contractors to buy company shares at a fixed price in the future. These options can be an attractive form of compensation, but tax treatment differs for contractors and employees. If you’re considering accepting share options, you must understand their tax impact.
Tax Treatment for Contractors in Canada
In Canada, contractors receiving stock options treat them as barter transactions for completed work. The Canada Revenue Agency (CRA) considers the value of these options as business income, making them taxable. Unlike employees, who are taxed upon exercising options, contractors must report income at the grant date, not the exercise date.
When a company grants stock options, the contractor receives a taxable benefit. This benefit equals the difference between the fair market value (FMV) of the share and the exercise price at the time of grant. The contractor must include this amount in income for that tax year.
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. The contractor receives 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
One major concern with stock options is the timing mismatch between the grant date and exercise date. Contractors must include the taxable benefit in income at grant, creating a cash tax burden before any financial gain.
If the options become worthless or expire unexercised, contractors can deduct the previously included income from business income in that year. This deduction helps offset the initial tax burden.
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.
