Employee stock option plan

How BC law treats it

Canada has no equivalent of the US tax-qualified ESOP trust. Canadian private companies use stock option plans, restricted share units or employee share purchase plans. A stock option plan is adopted by directors' resolution, sets a pool of shares reserved for options, and is implemented through individual option agreements stating the exercise price, vesting schedule and expiry. The shares must be authorized by the company's notice of articles and articles under the Business Corporations Act, SBC 2002, c 57 (BCBCA). Granting options is a distribution of securities. Instead of filing a prospectus, private companies rely on the employee, executive officer, director and consultant exemption in National Instrument 45-106, s. 2.24, which requires participation to be voluntary. The Securities Act, RSBC 1996, c 418 has no registration requirement for the plan itself. Tax is governed by section 7 of the federal Income Tax Act, RSC 1985, c 1 (5th Supp). For employees of a Canadian-controlled private corporation (CCPC) dealing at arm's length, the employment benefit (the difference between the share value at exercise and the exercise price) is taxed only when the shares are sold. A deduction of one half of the benefit may be available under s. 110(1)(d) or 110(1)(d.1) if conditions are met. Since July 1, 2021, an annual $200,000 vesting limit on the deduction applies to options from non-CCPC employers with consolidated revenue above $500 million. Generally, the issuing company gets no deduction for the option benefit, except in limited cases for options that exceed the $200,000 limit.

What it means for your business

For BC startups, options are the main tool to recruit and keep talent without paying market salaries. A poorly drafted plan can create tax surprises for employees, securities law breaches, or disputes over vesting when someone leaves. Investors also review the option pool and plan terms in due diligence, so a clean plan with proper board approvals and option agreements makes financing and exit rounds faster. Example: A Vancouver biotech CCPC adopts a plan reserving 10% of its shares, grants options at fair market value to a new engineer with four year vesting, and relies on NI 45-106 s. 2.24. The engineer pays no tax on exercise and is taxed only when she sells the shares on an acquisition.

Risks and common mistakes

Copying a US ESOP or US option plan template that assumes US tax rules. Granting options without a directors' resolution or without enough authorized shares. Setting an exercise price below fair market value, which loses the 110(1)(d) deduction (for CCPC shares, the 110(1)(d.1) deduction then requires holding the shares for at least two years). Leaving vesting and termination rules vague, which leads to disputes when an employee is dismissed. Making participation a condition of employment, which undermines the s. 2.24 exemption.