A recent technical interpretation (TI) issued by the Canada Revenue Agency (CRA) illustrates the issues faced by employees who hold stock options and who move to or from Canada.
The general rule under subsection 7(1) of the Income Tax Act (Canada) (the ITA) is that an employee who exercises an option to acquire shares of a corporate employer (or related person) is deemed to have received a benefit from employment in the year the option is exercised. This rule typically applies to employees who are Canadian tax residents but, in the era of greater employment mobility, can impact non-residents of Canada as well.
The TI dealt with an employee who had been a tax resident of, and had been working in, China and held stock options granted by a Chinese corporation. The employee then immigrated to Canada to take up employment with a Canadian affiliate of his previous employer. At the time of immigration, the stock underlying the stock options had significantly increased in value. The employee argued that he should only be subject to Canadian tax on the increase in value of the underlying stock from the time he became a Canadian tax resident. However, the TI confirmed that because the employee exercised the stock option at a time when the employee was a resident of Canada, the entire stock option benefit was subject to Canadian tax, including the portion that had accrued during the period when the employee was neither a resident of nor employed in Canada. It is unclear from the TI what level of Chinese tax the employee may also have been subject to in respect of the stock option benefit.
The TI highlights the breadth of the employee stock option rules. Not only will a stock option benefit arise when an option is exercised by a Canadian resident, but will also arise where the option is exercised by a non-resident employee who exercised employment duties in Canada in the year the stock option was granted. Further, where a Canadian-resident employee exercises an option after emigrating from Canada, the stock option benefit remains subject to Canadian tax.
In certain cases, a bilateral income tax treaty may provide relief from Canadian income tax. For example, under the Canada-United States Income Tax Convention a stock option benefit may be entirely exempt from tax in one country or the taxing rights may be allocated between the two countries based on the employee’s principal place of employment during the period from the date of grant of the option to the date of exercise of the option.
Employees who experience a change in tax residence or who engage in cross-border employment should consider the impact this may have on the taxation of their stock options. Employers should also consider the relevant factors, as this may impact an employer’s withholding and reporting obligations.