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BackgroundMany companies offer stock options as part of compensation packages to employees. This benefit, once only offered to executives, is now offered to all employees for several reasons which include:

• They want to attract and keep good workers;• They want their employees to feel like owners or partners in the business; and• They want to hire skilled workers by offering compensation that goes beyond a salary.

This is especially true in start-up companies that want to minimize cash payments to employeesin order to fund operations.

A stock option can be described as the right to buy a specific number of shares of his employer’s

Income Inclusion

o The purchaser must be a Canadian resident;o If the security is a share, it must be traded on a Canadian or prescribed foreign stock exchange;o The purchaser cannot be a specified shareholder (i.e. an owner of greater than 10% of the shares); this includes the situation where the purchaser would become a specified shareholder upon exercising the option;o The total deferral of all stock options exercised by a taxpayer in a particular year cannot exceed $100,000 (the $100,000 limit is based on FMV of the shares determined at their respective times at which the options were granted) ; ando The purchaser must be entitled to claim the deduction as defined in Section 110.1(d) of the Income Tax Act (see below).

In order to claim the deferral described in 2) above, the purchaser must make an election by writing to his employer before January 16 of the year following the year in which the options are exercised. The election may take the format of a letter, stating simply “I, the taxpayer, elect totake the stock option benefit deferral under Income Tax Act Subsection 7(1.1).” The purchaser must also file form T1212 with his personal tax return. This form must be filed each year there is a deferred balance outstanding.

The deferral described in 1) above applies by operation of law.

Section 110(1)(d) DeductionTaxpayers who have earned income with respect to stock options are allowed to claim a deduction in the same year, provided certain conditions are met. The purpose of the deduction is to bring the effective tax rate on stock option income to the same rate as that charged on capital gains.However, as this is not a true capital gain, it does not qualify for the Qualified Small Business Corporation share exemption, nor can available capital losses be used to offset the resulting tax.gt the resulting tax.If the shares are those of a CCPC, there are only two requirements to qualify for the deduction:lify for the dedhe deduction:to qualify

• The purchaser must be at arms length from the entity that is granting the options; andtity that is grgrantinthe ent• The shares must be held for a minimum of two years.wo years.m of tw

There is an exception to the above condition: if the purchaser does not hold the shares for the if th pur hasetionminimum period but still meets all of the conditions set for a public company, the employee is ond ons et ff thestill entitled to claim the deduction.

If the shares are of a public company, the requirements to qualify are as follows:y, th equ memp

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Stock Options