Taxation of Employee Stock Options in Canada: Key Rules and Recent Changes

Exercise of Options: When an employee exercises stock options taxation in Canada (i.e., buys the shares under the option), a taxable employment benefit is realized if the shares were acquired at a discount. 

For public company (or other non-CCPC) stock options, the taxable benefit is generally equal to the difference between the fair market value of the shares at the time of exercise and the price the employee paid (the exercise price) for those shares.

In formula terms, the benefit = FMV at exercise minus the exercise price (minus any amount the employee paid to acquire the option itself, if applicable). This benefit is considered employment income in the year of exercise and must be reported as such.

No Capital Gains at Exercise

It’s important to note that this income from exercising options is taxed as ordinary employment income, not as a capital gain. The CRA explicitly notes that the employment benefit from exercising an option is not eligible for the capital gains deduction (i.e., it doesn’t get the 50% inclusion rate at that stage).

However, as discussed below, there is a special deduction that can effectively halve the taxable amount if conditions are met.

Tax Deferral for CCPC Stock Options

Stock options from a Canadian-controlled private Corporation (CCPC) have a significant tax advantage: the taxation of the employment benefit can be deferred until the shares are sold. 

If you exercise options granted by a CCPC (and you deal at arm’s length with that company), you do not include the stock option benefit in your income in the year you acquire the shares. 

Instead, you wait to report that income in the year you eventually sell the shares. In practical terms, this means an employee of a CCPC doesn’t pay tax at the time of exercise – the tax on the “spread” (FMV minus exercise price) is deferred, often for years, until the liquidity event of selling the stock. (This deferral is a key incentive for employees of startups and other private companies.) 

By contrast, for non-CCPC employers (e.g. public companies), the taxable benefit can’t be deferred – it is taxed in the year of exercise.

Selling the Shares: Capital Gains Treatment

After exercising options and acquiring shares, any further gain or loss when you eventually sell those shares is treated as a capital gain or loss. In other words, once you’ve included any applicable employment benefit at exercise, the clock restarts on the cost basis of your shares. If the share price rises after you’ve acquired them and you later sell at a profit, that profit is a capital gain

Conversely, a loss on sale would be a capital loss. Canada’s tax system currently taxes only half of capital gains – meaning 50% of the gain is taxable (at your capital gains inclusion rate). This favorable capital gains inclusion rate is one reason the stock option rules provide a special deduction (discussed next) to mirror that treatment on the initial stock option benefit.

Stock Option Deductions and Limits

Below are the key stock option deduction rules and recent changes:

• 50% Stock Option Deduction (Standard Rule): If certain conditions are met, an employee can claim a deduction equal to 50% of the stock option benefit included in income. This effectively means only half of the option benefit is taxed. 

The conditions for this deduction include criteria such as the shares being ordinary common shares, the employee dealing at arm’s length with the employer, and the exercise price being no lower than the share’s FMV at the grant date. 

When these conditions are satisfied, the tax outcome for the employee’s stock option benefit mirrors the capital gains inclusion rate (50% taxable).

• $200,000 Annual Vesting Limit: In 2021, Canada introduced an annual cap on the amount of stock options that can qualify for the 50% deduction for employees of larger companies. For stock options granted after June 30, 2021, a $200,000 annual vesting limit applies. 

This means that, each year, only stock options up to a value of $200,000 (based on the shares’ FMV at grant) can vest and still be eligible for the 50% deduction. Any stock option benefits from grants exceeding that limit would not qualify for the deduction (thus becoming fully taxable as employment income). 

Importantly, this vesting limit does NOT apply to CCPCs or smaller employers with gross revenues of $500 million or less – it is aimed at employees of large public companies.

• New $250,000 Threshold & 33⅓% Deduction (Proposed Changes): Recent federal proposals will further tighten stock option deductions for high-income gains. Under proposed legislation (originally to take effect mid-2024, now postponed to January 1, 2026), individuals would have a $250,000 combined annual limit on employee stock option benefits + capital gains in terms of preferential tax treatment of stock options in Canada.

Up to $250,000 of such income in a year would continue to be taxed at the 50% inclusion rate (if eligible for the stock option deduction, or as capital gains). Beyond the $250,000 threshold, the employee’s stock option deduction would be reduced to 33.3% of the benefit, meaning 66.7% of the stock option benefit becomes taxable. 

(The $250,000 cap is a combined limit – for example, if an individual has already realized large capital gains in a year, it could limit how much of their option benefit still gets the 50% deduction). This change is designed to ensure very large stock option payouts are taxed more like regular income. 

Conclusion

Understanding how stock options are taxed in Canada is essential for maximizing benefits and ensuring compliance. With the evolving taxation of employee stock options in Canada, staying informed and seeking professional advice is more important than ever.

MyBooks is committed to providing the guidance and support you need to navigate the complexities of stock option tax Canada. Contact us today to learn how we can assist you in optimizing your stock option strategies.