What is a security (stock) options taxable benefit?

Many employers grant options to their employees as a form of compensation. These options give the employee of the employer or of a qualifying person with which the employer does not deal at arm's length, the right to acquire a security of the employer or a security of another qualifying person with which the employer does not deal at arm's length.

A security is a share of the capital stock of a corporation or a unit of a mutual fund trust that is a qualifying person.

Stock options agreements granted to employees are intended to encourage their greater involvement in the corporation.

• What is the taxable benefit?
• Example of a taxable benefit
• Types of options issued to employees
• When will the exercise or disposal of an option not result in a taxable benefit from employment?

What is the taxable benefit?

An option is an opportunity for an employee to acquire securities. When a qualifying employer grants an option to an employee, the employee's tax situation is not affected until he or she exercises or disposes of the option.

If an employee decides to exercise an option and acquire securities at less than their fair market value (FMV), the employee will receive a taxable benefit. The taxable benefit is the difference between the fair market value of the shares or units when the employee acquires them and the amount paid or to be paid for them, including any amount paid for the rights to acquire the shares or units. In addition, a benefit can accrue to the employee if his or her rights under the agreement become vested in another person, or if they transfer or sell the rights.

The shares or trust units are considered to be acquired when legal ownership of the shares has been transferred and the vendor has entitlement to receive payment. In general, this would occur where the shares have been transferred to the employee/broker and paid for.

Include this benefit in box 14, "Employment income," and in the "Other information" area under code 38 at the bottom of the employee's T4 slip. Also, show the deductions the employee is entitled to in the "Other information" area of the T4 slip, as explained in the rest of this section.

For more information, see Interpretation Bulletin IT113, Benefits to Employees - Stock Options.

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Types of options issued to employees

Generally, options issued to employees will be provided under one of the following three types of plans:

Employee stock purchase plan (ESPP): This plan allows the employee to acquire shares at a discounted price, (i.e., for an amount that is less than the value of the stock at the time of the acquisition of the shares). Many ESPPs provide for a delay in the acquisition of the shares: an employee contributes a certain amount over a period of time and at pre-specified periods, the employee can purchase shares at a discount using the accumulated contributions. The benefit is equal to the value of the shares, minus the amount paid.

Stock bonus plan: Under this plan, an employer agrees to give the shares to the employee free of charge. In effect, the employer agrees to sell or issue shares to the employee for no cost.

Stock option plan: This plan allows the employee to purchase shares of the employer's company or of a non-arm's length company at a predetermined price.

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When will the exercise or disposal of an option not result in a taxable benefit from employment?

The exercise or disposal of an option will not result in a taxable benefit when:

• The benefit conferred by the option agreement was not received by reason of the employee's employment.
  • If the employee is also a shareholder or unit-holder, it is a question of fact whether he or she received the shares or units as a shareholder, a unit-holder or an employee.
• There was no intention to issue securities under the terms of the agreement, but there was an intention to issue a cash payment to the employee as a means of compensation (that is, under a phantom stock plan).