Welcome to our accounting firm’s blog, where we will be discussing the tax implications of issuing share options for Canadian contractors.
What Are Share Options
Share options, also known as stock options, are a form of compensation that allows employees or contractors to purchase shares in the company at a predetermined price at some point in the future. While these options can be an attractive form of compensation for employees and contractors, there are very important differences to the tax treatment and implications if you are a contractor and not an employee of the corporation. If you are considering accepting share options, it is important to understand the tax implications of this decision.
In Canada, stock options received as a contractor are deemed to be received as a barter transaction for work completed. The value of the options are then treated as business income and are subject to income taxes. In the case of contractors in Canada, the income inclusion occurs at the grant date of the options, not the exercise date.
When a company grants a stock option to a contractor, the contractor is considered to have received a taxable benefit equal to the difference between the fair market value of the share and the exercise price of the option at the time of grant. This amount is included in the contractor’s income for the year in which the option is granted.
Example of a Stock Option
For example, let’s say a contractor is granted 1,000 stock options with an exercise price of $10 and a fair market value of $20 at the time of grant. The contractor would be considered to have received a taxable benefit of $10,000 ($20 – $10 x 1,000) at the time of grant, which would be included in their income for the year. They would then owe any income taxes on this related income.
If they are an unincorporated sole proprietor and receive these options personally, this income would then be recorded on their T2125 Business Schedule and filed with their personal tax return. The business owner may also have to remit the related HST/GST applicable on the income if they are a registrant or if the amount is over the small supplier threshold.
When the contractor exercises the stock option and purchases shares in the company, they may be subject to further tax implications. Whether that is considered business income or a capital gain will depend on the situation and specific guidance and professional advice should be sought.
The adjusted cost base of the shares becomes the amount actually paid plus any taxable inclusion of income. This is what is used for shares that are held and sold at a later date to calculate the capital gain or loss.
A few common concerns with accepting share options in Canada is the discrepancy of the grant date from the exercise date. An income inclusion is deemed at grant date which is a cash cost to the contractor in the year they are granted. This can be a considerable cash burden on the contractor now for a future “exit” event. If the contractor’s options are not “in the money” meaning they have not increased in value and the contractor decides to let them expire. The previously included income can be deducted against business income in the year in which the options expired.
Summary and Conclusions
In summary, issuing share options for Canadian contractors can be a complex process with significant tax implications. In general, contractors will want to consider the tax implications and immediate tax cost of accepting such a form of compensation.
Virtual Heights Accounting is a CPA firm that operates in the virtual world. We provide virtual accounting, tax, Virtual CFO and Controller services for your growing Company. Contact us at www.vhaccounting.ca/contactus or follow our blog on your chosen social media source. This blog is intended for general use and understanding and does not replace direct professional advice.