Tax Laws Could Affect Stock Option Benefits

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    Depending on how an employee stock option plan is structured, it may be possible for an employee having exercised in-the-money stock options to reduce by half the resulting employment benefit, says a McCarthy Tétrault newsletter. The employment benefit is equal to the difference between the exercise price of the option and the fair market value of the shares acquired as a result of the exercise. It is generated at different times depending on whether the issuer of the optioned shares is a Canadian-controlled private corporation (a CCPC) or an issuer which is not a CCPC. Where the issuer is a CCPC, the employment benefit is generated on the sale of the optioned shares. Where the issuer is not a CCPC, the employment benefit is generated on the exercise of the options. The reduction of the employment benefit is a result of a deduction provided either under paragraph 110(1)(d) or paragraph 110(1)(d.1) of the Income Tax Act (Canada). Under the first paragraph, the optionee can deduct 50 per cent of the employment benefit where the shares were issued by a CCPC and the optionee held the shares for two years before disposing of them. Under the second paragraph, the optionee can deduct 50 per cent of the employment benefit where the exercise price of the options is no less than the fair market value of the shares at the time the options were granted and the shares qualify as ‘prescribed shares’ when the options are exercised and the shares are issued. The rules governing what qualifies as a ‘prescribed share’ are found in section 6204 of the Income Tax Regulations. Until the Tax Court of Canada’s decision in Montminy et al. v. The Queen, the interaction between paragraphs 6204(1)(b) and 6204(2)(c) had not been considered by a court. The decision offers welcome guidance in applying these rules, although, at the same time, the decision confirms just how stringent (and some might argue overly technical) these requirements are.