Private company stock options canada

How to Understand Private Company Stock Options.

Employees are the primary beneficiaries of private company stock options.

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Related Articles.

1 Employee Stock Purchase Options 2 Understanding Employee Stock Options 3 What Are the Benefits of Employee Stock Options for the Company? 4 Fair Value Method Stock Options.

Small companies often do not have the financial size to offer potential or high performing employees salaries that are commensurate with their large, publicly traded corporate peers. They attract and keep employees through other means, including by giving them greater responsibility, flexibility and visibility. An additional way is through the offering of stock options. Private companies may also use stock options to pay vendors and consultants.

Stock Options.

A stock option is a contract that gives its owner the right, but not the obligation, to buy or sell shares of a corporation’s stock at a predetermined price by a specified date. Private company stock options are call options, giving the holder the right to purchase shares of the company’s stock at a specified price. This right to purchase -- or “exercise” -- stock options is often subject to a vesting schedule that defines when the options can be exercised.

Employee Stock Options.

Employee stock options typically fall into two categories: outright award and performance-based award. The latter is also referred to as an incentive award. Companies either grant outright awards of stock options upfront or on a vesting schedule. They grant incentive stock options on the achievement of specific targets. The taxation of the two differ. Employees who exercise their outright award options are taxed at their ordinary income tax rate. Incentive stock options are generally not taxed when exercised. Employees who then hold the stock for more than a year will pay capital gains tax on subsequent gains.

Payment for Goods and Services.

A startup or rapidly growing small business needs to conserve cash. A company can negotiate to pay its consultants and vendors in stock options to conserve cash. Not all vendors and consultants are receptive to payment in options, but those who are can save a company a significant amount of cash in the short term. Stock options used to pay for goods and services generally have no vesting requirements.

How It Works: Grants.

A Better Day Inc. authorizes 1 million shares of stock but only issues 900,000 to its shareholders. It reserves the other 100,000 shares to support the options it has provided to its employees and vendors. A Better Day’s current valuation is $1.8 million, so each of the 900,000 issued shares has a book value of $2. The company grants a group of newly hired employees 50,000 options to buy stock at $2.50. These options vest equally over a four-year period, meaning the employees can exercise 12,500 options at the end of each year for years one through four.

How It Works: Exercise.

Two years later A Better Day has grown significantly. It now has a valuation of $5 million. It also has issued another 50,000 shares to support the options that were exercised. The price per share is now the $5 million valuation divided by the 950,000 currently outstanding shares or $5.26 per share. The employees who exercised their stock would have an immediate pre-tax profit of $2.76 per share.

References (4)

About the Author.

Tiffany C. Wright has been writing since 2007. She is a business owner, interim CEO and author of "Solving the Capital Equation: Financing Solutions for Small Businesses." Wright has helped companies obtain more than $31 million in financing. She holds a master's degree in finance and entrepreneurial management from the Wharton School of the University of Pennsylvania.

Photo Credits.

Jules Frazier/Photodisc/Getty Images.

More Articles.

How Do I Provide Stock Options?

Incentive Stock Options & the IRS.

The Advantages of Owning Minority Shares of a Privately Held Company.

The taxation of stock options.

The taxation of stock options.

As an incentive strategy, you may provide your employees with the right to acquire shares in your company at a fixed price for a limited period. Normally, the shares will be worth more than the purchase price at the time the employee exercises the option.

For example, you provide one of your key employees with the option to buy 1,000 shares in the company at $5 each. This is the estimated fair market value (FMV) per share at the time the option is granted. When the stock price increases to $10, your employee exercises his option to buy the shares for $5,000. Since their current value is $10,000, he has a profit of $5,000.

How is the benefit taxed?

The income tax consequences of exercising the option depend on whether the company granting the option is a Canadian-controlled private corporation (CCPC), the period of time the employee holds the shares before eventually selling them and whether the employee deals at arm’s - length with the corporation.

If the company is a CCPC, there won’t be any income tax consequences until the employee disposes of the shares, provided the employee is not related to the controlling shareholders of the company. In general, the difference between the FMV of the shares at the time the option was exercised and the option price (i. e., $5 per share in our example) will be taxed as employment income in the year the shares are sold. The employee can claim a deduction from taxable income equal to half this amount, if certain conditions are met. Half of the difference between the ultimate sale price and the FMV of the shares at the date the option was exercised will be reported as a taxable capital gain or allowable capital loss.

Example: In 2013, your company, a CCPC, offered several of its senior employees the option to buy 1,000 shares in the company for $10 each. In 2015, it’s estimated that the value of the stock has doubled. Several of the employees decide to exercise their options. By 2016, the value of the stock has doubled again to $40 per share, and some of the employees decide to sell their shares. Since the company was a CCPC at the time the option was granted, there’s no taxable benefit until the shares are sold in 2016. It’s assumed that the conditions for the 50% deduction are satisfied. The benefit is calculated as follows:

What if the stock declines in value?

In the above numerical example, the value of the stock increased between the time the stock was acquired and the time it was sold. But what would happen if the share value declined to $10 at the time of sale in 2016? In this case, the employee would report a net income inclusion of $5,000 and a $10,000 capital loss ($5,000 allowable capital loss). Unfortunately, while the income inclusion is afforded the same tax treatment as a capital gain, it isn’t actually a capital gain. It’s taxed as employment income. As a result, the capital loss realized in 2016 cannot be used to offset the income inclusion resulting from the taxable benefit.

Anyone in difficult financial circumstances as a result of these rules should contact their local CRA Tax Services office to determine whether special payment arrangements can be made.

Public company stock options.

The rules are different where the company granting the option is a public company. The general rule is that the employee has to report a taxable employment benefit in the year the option is exercised. This benefit is equal to the amount by which the FMV of the shares (at the time the option is exercised) exceeds the option price paid for the shares. When certain conditions are met, a deduction equal to half the taxable benefit is allowed.

For options exercised prior to 4:00 p. m. EST on March 4, 2010, eligible employees of public companies could elect to defer taxation on the resulting taxable employment benefit (subject to an annual vesting limit of $100,000). However, public company options exercised after 4:00 p. m. EST on March 4, 2010 are no longer eligible for the deferral.

Some employees who took advantage of the tax deferral election experienced financial difficulties as a result of a decline in the value of the optioned securities to the point that the value of the securities was less than the deferred tax liability on the underlying stock option benefit. A special election was available so that the tax liability on the deferred stock option benefit would not exceed the proceeds of disposition for the optioned securities (two-thirds of such proceeds for residents of Quebec), provided that the securities were disposed after 2010 and before 2015, and that the election was filed by the due date of your income tax return for the year of the disposition.

» Stock Options.

Quebec Tax Table 2017 Non-Refundable Tax Credits 2017 Marginal Rates 2017 Tax Brackets 2017 Ontario Tax Table 2017 Non-Refundable Tax Credits 2017 Marginal Rates 2017 Tax Brackets 2017 New Brunswick Tax Table 2017 Non-Refundable Tax Credits 2017 Marginal Rates 2017 Tax Brackets 2017 Corporate Taxation and U. S. Federal Tax Rates Business Income Eligible for SBD¹ - 2017 Business Income Not Eligible for SBD - 2017 Investment Income¹ - 2017 Sales Tax - 2017 SR&ED Tax Credits¹ - 2017 Capital Cost Allowance Rates - 2017 U. S. Federal Tax – Individuals (2017) U. S. Federal Tax – Corporations (2017)¹

Stock Options.

An employee who acquires shares in the employer’s corporation 8 under a stock option plan is deemed to have received a taxable benefit in the year equal to the amount by which the FMV of the shares when they are acquired exceeds the price paid for them.

However, the employee is generally entitled to a 50% deduction for federal purposes (25% for Quebec purposes) 9 10 of the benefit if the amount paid to acquire a share is at least equal to its FMV at the time the option was granted. Any increase (decrease) in value subsequent to the date of acquisition will be taxed as a capital gain (loss) in the year of disposal.

8 Or a company not at arm’s length with the employer. The same tax treatment applies to options granted by mutual fund trusts.

9 50% if the option is granted after March 14, 2008 by an “innovative SME”, i. e. in general a corporation whose total assets are less than $50M and that has been entitled to certain SR&ED tax credits over the past few years.

10 50% for options for listed shares granted after February 21, 2017 by a large corporation with a significant presence in Quebec, that is, a corporation with a base payroll attributable to its establishment in Quebec of at least $10M.

Shares of Canadian-Controlled Private Corporations.

If a stock option plan pertains to shares of a CCPC, the amount of the benefit is normally taxable as employment income in the year of disposal of the shares. In such a situation, the employee is entitled to the above-mentioned deductions provided the shares are kept for at least two years, even if the price paid for the shares is less than their FMV at the date the stock option is granted.

Example : On December 20, 2011, ABC Ltd. (a CCPC) grants John, its employee, the right to purchase 1,000 shares for $10 per share, i. e. their FMV at that time. In June 2012, John exercises his option. The FMV of the shares at that time was $15 per share. On May 1, 2017, John sells all of his shares for $12,000.

Tax consequences : There are no tax consequences in 2011 when the option is granted. There is no taxable benefit for John in 2012 because ABC is a CCPC and the gain on the shares qualifies for the deferral. In 2017, when the shares are sold, John has to include a taxable employment benefit of $5,000 ($15,000 – $10,000) in his income. He can also claim a deduction of $2,500 ($5,000 × 50%) for federal purposes and $1,250 ($5,000 × 25%) for Quebec purposes, and a deductible capital loss of $1,500 (($12,000 – [$10,000 + $5,000]) × 50%). Unfortunately, the loss on the disposition of the shares cannot be applied to reduce the taxable benefit.

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How can I sell private company stock?

In some instances, both private and public companies may issue shares to their own employees as part of a compensation program. This action is designed to motivate employees by tying a portion of their earnings to the company's earnings.

In some cases, people may eventually want to sell their shares. For publicly traded shares, this process is simple: an employee can just sell the shares through a broker. Private shares, on the other hand, cannot be sold as easily. Because private shares represent a stake in a company that is not listed on any exchange, finding a buyer may be difficult. The lack of information about most private companies tends to dissuade investors, who are usually very reluctant to buy into a company that they know nothing about.

The simplest solution for selling private stocks is to approach the issuing company and to inquire about what other investors did to liquidate their stakes. Some private companies may have buyback programs, which allow investors to sell their shares back to the issuing company. Private companies may also be able to provide leads about current shareholders or new investors who have expressed interest in buying the company's shares.

After an investor manages to find a buyer for the stocks, it is suggested that he or she visit a securities lawyer in order to finish off the paperwork because although private stocks are not registered with the Securities and Exchange Commission (SEC), all SEC regulations involving selling stocks must still be followed. Failure to comply with all relevant regulations may result in civil, administrative or even criminal penalties.