Stock Option Deduction
T he grant to an executive of a stock option generally does not give rise to a taxable event to the executive. This assumes the stock option was granted with an exercise price at least equal to the fair market value (FMV) of the share underlying the grant. This is consistent with the requirements of the Toronto Stock Exchange applicable to listed issuers.2
Assuming the stock option was granted by a public company with an exercise price at least equal to the FMV of the underlying share, the executive would generally be taxed when exercising the stock option to acquire the underlying share. The amount by which the share price at the time of exercise exceeds the exercise price of the stock option is the amount that is taxable and, commonly, is referred to as the “in-themoney” amount.
The Income Tax Act (Canada) (ITA) generally provides for an income deduction of 50 per cent (only 25 per cent in Quebec) of the in-the-money amount, referred to as the “stock option deduction”, provided certain conditions are met.3 The impact of the stock option deduction is that the stock option is eectively taxed at capital gains rates. This eectively puts the executive in the same position as though the executive had acquired stock at the time of the grant of the stock option and sold it upon exercising the stock option.
Share Appreciation Rights
A share appreciation right (SAR) is a right to receive the in-the-money amount on exercising the SAR, in the form of cash or shares, depending on the terms of the SAR. Exercising SARs, unlike stock options, does not require the holder to use his or her money to buy the share and then sell it in order to receive the in-the-money amount, in addition to paying transaction fees.
SARS can be granted on a stand-alone basis or in tandem with a stock option, which affects their tax treatment. Cashsettled stand-alone SARs do not receive any beneficial tax treatment. On exercise, the in-the-money amount is fully taxable as employment income without any deduction.
Cash-settled SARs granted in tandem with stock options under the pre-Budget tax regime received the same beneficial tax treatment as stock options – namely, the benefit of the stock option deduction. As such, a cash-settled tandem SAR achieved the best of both worlds: the executive received cash compensation that was effectively taxed at capital gains rates; and, the organization was able to deduct the expense. As described below, the Budget proposes to change this tax structure.