An employee stock option buyout is generally a taxable employment benefit, but the precise rule depends on how the buyout is structured.
Under subsection 7(1) of the Canadian Income Tax Act, where a qualifying person agrees to sell or issue securities to an employee, the Tax Act taxes either:
- the acquisition of the securities, or
- the disposition of the employee’s rights under the agreement.
If the employee does not receive shares and instead gives up the option rights for value, the buyout is generally taxed under paragraph 7(1)(b) or 7(1)(b.1), not as a capital gain. The benefit is employment income.
- Paragraph 7(1)(b) applies if the employee disposes of the rights to an arm’s length person. The taxable benefit is the excess of the consideration received over any amount paid by the employee to acquire the rights.
- Paragraph 7(1)(b.1) applies if the employee disposes of the rights to the employer or a non-arm’s length qualifying person. The same basic computation applies.
Exchange of employee stock options
Under External T.I. 2004-0065251E5 – Exchange of employee stock options, the CRA clarified that for a buyout of option rights, the benefit is generally:
- value of the consideration received
- minus any amount paid by the employee to acquire the option rights.
CRA states the same formula for a cash-out, transfer, or other disposition of rights.
If the employee paid nothing for the option grant, the full buyout amount is generally the taxable employment benefit.
The Stock Option Deduction
Subsection 110(1) of the Income Tax Act permits eligible employees to include only one-half of the taxable benefit arising from the exercise of employee stock options but only for employees of a Canadian -controlled private corporation.
Under paragraph 110(1)(d), employees of a Canadian-controlled private corporation (CCPC) may deduct 50% of the employee stock option benefit in computing taxable income where the following conditions are met: (1) common shares are acquired upon the exercise of the stock option; (2) the employee deals with the CCPC at arm’s length; and (3) the total option price (including any amount paid to acquire the option) is not less than the fair market value of the shares at the time the option was granted.
Further, paragraph 110(1)(d.1) provides a similar 50% deduction in respect of CCPC shares where the employee has held the shares for at least two years and has not claimed any other stock option deduction in relation to the same benefit.
This deduction is not available to employees of other corporations.
Tax treatment of option cash-out
CRA’s current administrative guidance describes an employee who “chooses to cash out” rights under a security option agreement as having a taxable benefit under paragraphs 7(1)(b) or 7(1)(b.1) of the Income Tax Act, included in income in the year of the cash-out.
For a buyout of option rights, the benefit is generally:
- value of the consideration received
- minus any amount paid by the employee to acquire the option rights.
CRA states the same formula for a cash-out, transfer, or other disposition of rights.
If the employee paid nothing for the option grant, the full buyout amount is generally the taxable employment benefit.
Pro Tax Tips: Employees may still claim 50% deduction on an option cash buyout
A separate issue is whether the employee can claim the stock option deduction under paragraph 110(1)(d) on a cash buyout.
CRA’s current guidance says that for a cash-out after March 4, 2010, the security option deduction can only be claimed in one of the following situations:
- You exercise your options by acquiring shares of your employer, or
- Your employer has elected (as indicated by completing box 86, Security option election, of your T4 slip) for all security options issued or to be issued after 4 pm ET on March 4, 2010, under the agreement and has filed such election with the Minister of National Revenue, that neither the employer nor any person not dealing at arm’s length with the employer will claim a deduction for the cash payment in respect of your disposition of rights under the agreement
Overall, the buyout is still taxable as employment income, but there may be a 50% deduction if the statutory conditions are met and, for a cash-out, the employer makes the required election.
Frequently Asked Questions About Stock Option Buyouts
Is an employee stock option buyout taxable?
An employee stock option buyout is generally taxable as employment income rather than a capital gain. Under subsection 7(1) of the Income Tax Act, the taxable event arises either when securities are acquired or when the employee disposes of their option rights for value.
When can I claim the 50% stock option deduction?
Subsection 110(1) of the Income Tax Act allows eligible employees of a Canadian-controlled private corporation (CCPC) to include only one-half of the taxable benefit arising from the exercise of employee stock options in income. Under paragraph 110(1)(d), this 50% deduction applies where common shares are acquired on exercise of the option, the employee deals at arm’s length with the CCPC, and the total option price is at least equal to the fair market value of the shares at the time the option was granted. Paragraph 110(1)(d.1) provides a similar 50% deduction where CCPC shares are held for at least two years and no other stock option deduction has been claimed for the same benefit. This preferential tax treatment is limited to CCPC employees and is not available to employees of other corporations.
Can I still claim the 50% stock option deduction if I receive a buyout instead of shares?
It may be possible, but it depends on specific conditions. Generally, the subsection 110(1) deduction is intended for situations where shares are acquired, but CRA administrative policy allows limited access to the deduction in certain cash-out scenarios if statutory requirements are met.Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.