Shares vs Stock Options

This article discusses the pros and cons of stock options vs shares for employees of Canadian – private and public – companies. The taxation issues are poorly understood and can be very confusing. Current tax regulations can make it difficult for companies to bring new employees and partners in as shareholders.

Stock options are a popular way for companies to attract key employees. They are the next best thing to share ownership. Employees are motivated to add value to their companies in the same way that founder/owners are. Options are also a key part of a compensation package. In larger companies, options contribute substantially – often many times the salary portion – to income. In a recent survey of executive compensation (see, the top 100 BC-based public company executives all earned over $1 million in 2009 income. However, only 5 of them received base salaries over $1 million. Most of the compensation came from stock options – no wonder the CRA (Canada Revenue Agency) wants to tax them!

Unfortunately, tax law can turn stock options into a huge disincentive in attracting key employees. For example, if an employee of a company (private or public) exercises options to buy shares, that employee may have a tax liability even if he sells the shares at a loss. If the company fails, the liability does not disappear. The tax treatment is not the same for Canadian Controlled Private Companies (CCPCs) as it is for public or non-CCPC companies. CCPCs have an advantage over other Canadian companies.

For CCPCs – Canadian Controlled Private Corporations

This discussion is applicable to Canadian Controlled Private Companies (CCPCs). It addresses how a start-up can best get shares into the hands of employees while being aware of possible tax issues.


To give employees an ownership stake (and incentive) in the company, the best solution is to give them founders shares just like the founders took for themselves when the company was formed. Companies should issue founders shares from treasury as early as possible. Some companies issue extra founders shares and hold them in a trust for future employees. Sometimes, the founders will transfer some of their own founders shares to new partners. As a general rule, try to give employees founders shares early in the company’s life. However, make sure that the shares reverse-vest over time (or based on performance), so that quitters and non-performers don’t get a free ride.

By owning shares in a CCPC (Canadian Controlled Private Corporation) for at least 2 years, shareholders get the benefit of the $750,000 life-time capital gains exemption (i.e. pay no tax on the first $750K in capital gains). This is a HUGE benefit. They also get a 50% deduction on additional gains.

If a company is beyond its start up phase, there is a worry that if these shares are simply given (for free or for pennies) to an employee, CRA (Canada Revenue Agency) considers this an “employment benefit” on which income tax is payable. This benefit is the difference between what the employee paid for the shares and their FMV (Fair Market Value).

This benefit is taxed as regular employment income. For CCPCs, this benefit may be deferred until the shares are sold. If held for more than 2 years, there is also a 50% deduction available on the benefit. If held for less than 2 years, another 50% deduction can be used if the shares where purchased at FMV.

However, if the shares are later sold (or deemed to have been sold by virtue of a liquidation) at a lower price than the FMV at the time of acquisition, the tax on the deferred benefit is STILL DUE. And, although this loss (i.e. the difference between FMV and the selling price) is a “capital loss”, it does not offset the tax owing. It may be possible to claim an ABIL (Allowable Business Investment Loss) to offset the tax owing on the deferred benefit, i.e. if you buy shares in a CCPC, you can claim 50% of your investment loss and deduct from other income.

Other than issuing zero-cost founders shares, the next best approach is to sell shares to employees at a “good” price which one could argue is at FMV considering the substantial restrictions on the shares (eg reverse-vesting and risk of forfeiture). This may work well if the company is still quite young and has not raised substantial sums from independent investors.

(In the case of publicly-listed companies, options grants are the norm since FMV can be readily determined – and a benefit assessed – and because regulations often prevent the issuance of zero-cost shares. But for pubcos and non-CCPCs, the tax on these benefits may not be deferred. It is payable in the year in which the option is exercised. This is a real problem for smaller public, venture-listed companies insofar as this tax forces the option to sell some shares just to be the tax! It discourages ownership.)

Some disadvantages of issuing stock are:

  1. Deferred tax liability if shares are bought below FMV (if you can figure out what FMV is – remember, these shares are highly restrictive and are worth less than those purchased by angels and other investors.) A CRA assessment of the deemed benefit is a remote possibility.
  2. May need to defend the FMV. May need independent valuation. (I’ve never heard of this happening.)
  3. Need to make sure that shareholder agreement provisions are in place (eg vesting, voting, etc).
  4. Issuance of shares at very low prices on a cap table may look bad to new investors (whereas option exercises are considered normal)
  5. More shareholders to manage

The benefits of owning shares are:

  1. Can get up to $750,000 in life-time tax-free capital gains
  2. 50% deduction on gains if shares held for more than 2 years OR if shares where issued at FMV
  3. Losses in a CCPC can be used as allowable business losses (if the business fails)
  4. Can participate in ownership of company – voting, dividends, etc
  5. Less dilution than if stock options are issued

Getting cheap shares into the hands of employees is the best way to go for a CCPC. The only downside risk arises if the company fails in less than two years. (See Bottom Line below).

[NOTE: Companies can issue shares (instead of options) to employees at any price and not trigger an immediate taxable event – it’s the same as giving an option grant that is immediately exercised. If shares (instead of options) are given at a very low (e.g. zero) price, fewer shares can be issued than when granting options with a higher exercise price.]


To avoid the risk of having to pay the tax on the deferred benefit if shares are issued to an employee below the FMV, options are often granted. This is only a risk if shares are ultimately sold below the FMV, as may be the case in a bankruptcy. Stock options, if unexercised, avoid this potential problem. An option gives one the right to buy a certain number of shares for a stated price (the exercise price) for a given period of time. The is no liability at the time that options are granted. Only in the year that options are exercised, is there is a tax liability. For CCPCs this liability can be deferred until the shares are actually sold. If the shares are held for more than 2 years, this tax liability is calculated at 50% of the benefit. That is, both a deferral and a deduction of 50% are available to those having exercised options. (If shares are held for less than 2 years, a 50% deduction is available if shares were purchased at FMV.)

Some disadvantages with stock options are:

  1. The tax liability (if options are exercised) is never erased – this is exactly the same scenario as if shares were given.
  2. The lifetime capital gains exemption cannot be used unless the shares – not the options – are held for 2 years after exercising. Capital gains are calculated on the difference between the selling price and the FMV when exercised.
  3. Must hold the shares for 2 years, after exercising the option to get the 50% deduction. (If exercise price of option = FMV at date of option grant, a 50%  deduction is also available).
  4. The benefit is considered “income”, not a capital gain and if shares are subsequently sold at a loss, the income benefit cannot be reduced by this capital loss.
  5. The tax risk increases over time since it is the difference between FMV and exercise price at the time of exercise that sets up the contingent tax liability, so the longer you wait to exercise (assuming steadily increasing FMV), the greater the potential tax liability.
  6. Options do not constitute ownership; optioned shares cannot be voted.
  7. Large option pools are negatively viewed by investors because they may cause substantial future dilution (unlike public companies that are generally limited to 10% in options, private companies can have very large option pools).
  8. Still need to have a defensible FMV; may need independent valuation. It may become a real headache if CRA requires that this be done retroactively when an exit is achieved.
  9. They could expire too soon. May need to have a very long term, say 10 years or more.
  10. Showing lots of stock options on the company’s cap table directly impacts (negatively) the per-share valuation in on-going financings since investors always look at all outstanding options as outstanding shares.

Some benefits with stock options are:

  1. No tax liability when options are received, only when they are exercised.
  2. No cash outlay required until exercised and even then, it may be minimal.
  3. Can exercise options to buy shares immediately at discounted prices without having to pay any tax until shares are sold.  An early exercise avoids a higher FMV, and hence avoids a greater taxable benefit, later.

From the company’s perspective, granting shares (instead of options) at a very low price means that fewer shares need to be issued – which is good for all shareholders. For example, giving shares at a penny instead of granting options exercisable at 50 cents means that more options must be granted which means greater dilution later when an exit is realized. The extra 49 cents doesn’t do much for shareholders as the exercise amount by then is nominal compared to the exit value. That amount will go right back to the new owner of the company meanwhile diluting all shareholders participating in the exit!

Action item for investors: check your company’s cap table for options and get rid of them! Give shares instead that are notionally equal to the Black-Scholes value of the option. Example, Joe Blow holds an option to buy 100K shares at 60 cents. The shares are currently valued at 75 cents (based on recent investments). The value of the options is determined to be 35 cents (i.e. $35K in total value). The 35 cents is based on the value of the option (say 20 cents) plus the in-the-money amount of 15 cents. As a rule of thumb, when an option is issued with an exercise price equal to current share price, an approximate determination of the options value is taken by dividing the price by 3 which in this example is 60/3 = 20 cents. Now, take the total value of $35K and issue 46,666 shares for $1.00 (because 46,666 shares at 75 cents = $35K). This is better than showing 100K shares as options on the cap table!!


  1. Grant stock options, exercisable at a nominal cost, say 1 cent – good for at least 10 years or more.
  2. Suggest that option holders exercise their option and buy shares immediately (just skip step #1 altogether)
  3. Make sure that grantees understand that if they exercise early or immediately, they start the 2-year clock on the deduction and also get the lifetime capital gains exemption. (They should also understand that there may be a possible downside in so doing – i.e. the liability on the “benefit” when options are exercised is still taxable even if the company fails – in which case, they can still claim the ABIL offset. Grantees may elect to trade-off this potential liability by forfeiting the deduction and exemption and not exercising until there is an exit in which case they take no risk but have a much lower – as much as 50% lower – profit).:


An employee is given an option to buy shares for a penny each. Shares are currently being sold to investors for $1.00 each (CRA would argue that the $1.00 price is the FMV). If the employee exercises the option immediately and buys shares, then he is deemed to have received an employment benefit of 99 cents which is fully taxable as income BUT both a DEFERRAL and a DEDUCTION may be available. First, the tax on this income can be deferred until the shares are sold (if the company fails, they are considered to be sold). Companies must file T4 slips with CRA (so you can’t hide this sale). Second, if the Shares (not the Option) are held for at least 2 years, then only 50%, i.e. 49.5 cents is taxed as income.  The difference between the selling price (and the FMV at the time the shares were acquired) is taxed as a capital gain which is also eligible for a $750K life-time exemption!  If the shares are sold for $1.00 or more – no problem! But, if the shares are sold for less than $1.00, the employee is still on the hook for the 99 cent (or .495 cent) benefit and although he would have a capital loss, it cannot be used to offset the liability.  He can mitigate this by claiming an Allowable Business Investment Loss (ABIL).  50% of the ABIL can be reduced to offset employment income. In this example, 49.5 cents would be allowed as a deduction against the 49.5 cents that is taxed as income, leaving the employee in a neutral position with respect to tax liability. Caution – claiming an ABIL may not work if the company has lost its CCPC status along the way.

(Note: I’ve heard of people in this situation claiming that the FMV is exactly what they paid since it was negotiated at arms-length, the shares could not be sold, the company was desperate, etc, etc. Their attitude is let CRA challenge it. That’s OK as long as the Company didn’t file a T4, as it should but likely won’t if it’s bankrupt.)

On the other hand, if the company succeeds, employees can enjoy tax-free gains (up to $750K) without having to put up much capital and taking only a limited risk.

If the employee holds an option until the company is sold (or until the shares become liquid) and then exercises the option and immediately sells the shares, the employee’s entire gain (i.e. the difference between his selling price and the penny he paid for each share) is fully taxed as employment income and there is no 50% deduction available (unless the exercise price of the option = FMV when the option was granted).


The best deal for both the company (if it’s a CCPC) and its employees is to issue shares to employees for a nominal cost, say 1 cent per share. If this grant is to garner an employee’s commitment for future work, reverse-vesting terms should be agreed to before the shares are issued. To determine the number of shares, start by arbitrarily setting the price per share. This could be the most recent price paid by arms-length investors or some other price that you can argue is reasonable under the circumstances. Let’s say that the price per share is $1.00 and you want to give your recently recruited CFO a $250K signing bonus. Therefore, he’d get 250K shares as an incentive (these should vest daily over a 3-year period). He pays $2,500 for these. Tax-wise, he is now liable for the tax on $247.5K in employment income. However, he can defer payment of this tax until the shares are sold.

Here are the possible outcomes and consequences:

a)Shares are sold for $1.00 or more after holding the shares for at least 2 years: he is taxed on income of 50% of $247.5K (i.e. $250K minus the $2,500 paid for the shares), i.e. the deferred benefit, less the 50% deduction PLUS a capital gain on any proceeds above his $1.00 per share “cost”. This gain is taxed at a rate of 50% and, if not previously claimed, his first $750K in gains is completely tax-free.

b)Shares are sold for $1.00 or more but in less than 2 years: he is taxed on income of $247.5K, i.e. the deferred benefit, as there is no deduction available PLUS a capital gain on any proceeds above his $1.00 per share “cost”. He does not benefit from the 50% deduction on the employment benefit nor the 50% capital gains deduction. This is why it makes sense to own shares as soon as possible to start the 2-year clock running.

c)Shares are sold for less than 1.00 after holding the shares for more than 2 years: he is taxed on income of 50% of $247.5K, i.e. the deferred benefit less the 50% deduction. He can offset this tax by claiming an ABIL. He can take 50% of the difference between his selling price and $1.00 and deduct that from his employment income – this is a direct offset to the deferred benefit. If the company fails and the shares are worthless, he is taxed on employment income of  50% of $247,500 MINUS 50% of $250K – i.e. no tax (indeed, a small refund).

d)Shares are sold for less than 1.00 after holding the shares for less than 2 years: he is taxed on income of $247.5K, i.e. the deferred benefit as there is no deduction available. He can offset this tax by claiming an ABIL. He can take 50% of the difference between his selling price and $1.00 and deduct that from his employment income – this is a partial offset to the deferred benefit. If the company fails and the shares are worthless, he is taxed on employment income of  $247,500 MINUS 50% of $250K = $122,500. NOT GOOD! This is the situation that must be avoided. Why pay tax on $122.5K of unrealized income that has never seen the light of day? How? Make sure you let 2 years pass before liquidating if at all possible. You can also argue that the benefit was not $247,500 because there was no market for the shares, they were restricted, you could not sell any, etc. Let CRA challenge you and hope they won’t (I’ve not heard of any cases where they have – in the case of CCPCs).

Why bother with options when the benefits of share ownership are so compelling? And the only possible financial risk to an employee getting shares instead of stock options arises in (d) above if shares are sold at a loss in less than 2 years. If the company fails that quickly, the FMV was likely never very high and besides, you can stretch the liquidation date if you need to.

Contractors and Consultants

The deferral of tax liability in respect of CCPCs is granted only to employees of the CCPC in question (or of a CCPC with which the employer CCPC does not deal at arm’s length). Contractors and consultants are not entitled to the benefit of the deferral. Consequently, contractors and consultants will be liable to pay tax upon exercise of any options.

What can CRA do?

Never underestimate the power of the Canada Revenue Agency. One might expect them to chase after the winners – those with big gains on successful exits but what about the folks that got stock options, deferred the benefit and sold their shares for zip? Will CRA kick the losers when they’re down?

For Publicly Listed Corporations and non-CCPCs

In the case of public companies, stock option rules are different. The main difference is that if an employee exercises an option for shares in a public company, he has an immediate tax liability.

Up until the Federal Budget of March 4th, 2010, it was possible for an employee to defer the tax until he actually sells the shares. But now, when you exercise a stock option and buy shares in the company you work for, CRA wants you to pay tax immediately on any unrealized “paper” profit even if you haven’t sold any shares.

Furthermore, CRA now wants your company to withhold the tax on this artificial profit. This discourages the holding of shares for future gains. If the company is a junior Venture-Exchange listed company, where will it find the cash to pay the tax – especially if it is thinly traded?

This process is not only an accounting nightmare for you and the company – it’s also fundamentally wrong in that CRA is making your buy/sell decisions for you.

It is also wrong in that stock options will no longer be an attractive recruiting inducement. Emerging companies will find it much harder to attract talent.

It will also be a major impediment to private companies that wish to go public. In the going-public process, employees usually exercise their stock options (often to meet regulatory limits on option pools). This could result in a tax bill of millions of dollars to the company. Also, it won’t look good to new investors to see employees selling their shares during an IPO even though they have to.

Before the March 4th budget, you could defer the tax on any paper profit until the year in which you actually sell the shares that you bought and get real cash in hand. This was a big headache for those who bought shares only to see the price of the shares drop.

The stories you may have heard about Nortel or JDS Uniphase employees going broke to pay tax on worthless shares are true. They exercised options when shares were trading north of $100, giving them huge paper profits and substantial tax liabilities. But when the shares tanked, there was never any cash to cover the liability – nor was there any offset to mitigate the pain. The only relief is that the drop in value becomes a capital loss but this can only be applied to offset capital gains. In the meantime, though, the cash amount required to pay CRA can bankrupt you.

CRA argues that the new rule will force you to sell shares right away, thereby avoiding a future loss. (Aren’t you glad that they’re looking after you so well?) But, that’s only because the stupid “deemed benefit” is taxed in the first instance.

Example: You are the CFO of a young tech company that recruited you from Silicon Valley. You have a 5-year option to buy 100,000 shares at $1.00. Near the expiration date, you borrow $100,000 and are now a shareholder. On that date, the shares are worth $11.00. Your tax bill on this is roughly $220,000 (50% inclusion rate X the top marginal tax rate of 44%X $1 million in unrealized profit) which you must pay immediately (and your Company must “withhold” this same amount). Unless you’ve got deep pockets, you’ll have to sell 29,000 shares to cover your costs – 20,000 more than if you did a simple cashless exercise. So much for being an owner! In this example, if the company’s shares drop in price and you later sell the shares for $2.00, you’ll be in the hole $120,000 ($200,000 less $320,000) whereas you should have doubled your money! Sure, you have a capital loss of $9 (i.e. $11 less $2) but when can you ever use that?

As part of the March 4 changes, CRA will let the Nortel-like victims of the past (i.e. those that have used the previously-available deferral election) file a special election that will limit their tax liability to the actual proceeds received, effectively breaking-even but losing any potential upside benefit. I guess this will make people with deferrals pony up sooner. The mechanics of this are still not well defined. (see the paragraph titled “deferrals election” below)

Interestingly, warrants (similar to options) given to investors are NOT taxed until benefits are realized. Options should be the same. Investors get warrants as a bonus for making an equity investment and taking a risk. Employees get options as a bonus for making a sweat-equity investment and taking a risk. Why should they be treated less favorably?

I don’t understand how such punitive measures make their way into our tax system. Surely, no Member of Parliament (MP) woke up one night with a Eureka moment on how the government can screw entrepreneurs and risk takers. Such notions can only come from jealous bureaucrats who can’t identify with Canada’s innovators. What are they thinking?

A common view is that large public corporations, while it creates more accounting work for them, aren’t that upset about this tax. They do see it as a benefit and for them and their employees, it might be better to sell shares, take the profit and run. For smaller emerging companies – especially those listed on the TSX Venture exchange, the situation is different. For one thing, a forced sale into the market can cause a price crash, meaning having to sell even more shares. Managers and Directors of these companies would be seen as insiders bailing out. Not good.

The rules are complex and hard to understand. The differences between CCPCs, non-CCPCs, public companies and companies in transition between being private and non-private give you a headache just trying to understand the various scenarios. Even while writing this article, I talked to various experts who gave me somewhat different interpretations. Does your head hurt yet? What happens if you do this…or if you do that? It’s messy and unnecessary.

The solution: don’t tax artificial stock option “benefits” until shares are sold and profits are realized. For that matter, let’s go all the way and let companies give stock – not stock option – grants to employees.

I wonder how many MPs know about this tax measure? I wonder if any even know about it. It’s a complex matter and not one that affects a large percentage of the population – certainly not something that the press can get too excited about. I’m sure that if they are made aware of it, they’d speak against it. After all, on the innovation front, it’s yet another impediment to economic growth.

For another good article on the subject, please read Jim Fletcher’s piece on the 2010 Budget on BootUp Entrepreneurial Society’s blog.

Also, see this writer’s article on T-Net:

Deferrals Election

For those who exercised an option before March 2010, and deferred the benefit, CRA is making a special concession. On the surface it looks simple: You are allowed to file an election that lets you limit your total tax bill to the cash you actually receive when you sell the shares (which will likely leave you with nothing for your hard work) rather than be subject to taxes on income you never realized (as is the case before March 2010). Indeed, CRA thinks it’s doing everyone a big favor because it’s being kind in helping with a mess that it created in the first place!

There’s a detailed and lengthy discussion in an article by Mark Woltersdorf of Fraser Milner Casgrain in “Tax Notes” by CCH Canadian.  The key point in the article is that you have until 2015 to decide how to handle any previously deferrals. The decision is not straightforward because it depends on an individual’s specific circumstances. For example, if there are other capital gains that could be offset, filing the election would result in not being able to offset these. The article states: “On filing the election, the employee is deemed to have realized a taxable capital gain equal to one-half of the lesser of the employment income or the capital loss arising on the sale of optioned shares. The deemed taxable capital gain will be offset (partially or in full) by the allowable capital loss arising from the disposition of the optioned share. What is the value of the allowable capital loss that is used, and therefore, not available to offset other taxable capital gains?”  The article gives a few good examples to illustrate various scenarios. So, if you’re in this situation – do your analysis. I tried to link to the article, but it’s a pay-for publication, so that’s not available. Your tax accountant might give you a copy.

Thanks to Steve Reed of Manning Elliott in Vancouver for his tax insights and to Jim Fletcher, an active angel investor, for his contributions to this article.

Footnotes (the devil is in the details):

1.”Shares” as referred to herein means “Prescribed Shares” in the Income Tax Act. Generally this means ordinary common shares – BUT – if a Company has a right of first refusal to buy back shares, they may no longer qualify for the same tax treatment.

2.There are really two 50% deductions are available: The regular capital gains deduction which permits a 50% deduction on capital gains made on shares that are acquired at FMV and the 50% deduction available to offset the employment income benefit on shares that are held for more than 2 years. (Of course, only one 50% deduction is available. )

3.CCPC status may unknowingly be forfeited. For example, if a US investor has certain rights whereby he has, or may have, “control”, the company may be deemed to be a non-CCPC.

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43 Responses to “Shares vs Stock Options”

  1. Basil Peters says:

    Mike – thanks for this very valuable contribution to the community. Options are one of the most common mistakes I see in corporate structures. A couple of additional points:

    1. When companies use options, or vesting stock, they are subject to the stock based compensation rules. This makes the preparation of financial statements much more complicated and expensive.

    2. Options are also much more dilutive. Few people actually ‘get this’ but the short description is that everyone I’ve met always counts all of the options into the fully diluted calculation without considering the additional cash from the exercise. That makes the dilution effectively equal between a share or option.

    But employees consider an option as worth much less than a share. So to get the same incentive, in practice, you have to allocate more options than shares.

    3. The additional governance complexity you point out is a consideration. I prefer to make the employee shares a different class with equal economic advantage, but without votes.

    In the US, options have become so much less desirable that many companies, for example Microsoft, have just stopped using them as a way to motivate the team.

    It would be interesting to see comments here from some of our friends in the legal and accounting professions. They are often the ones advising young companies on this.

    Thanks again for the excellent summary.

  2. Mike,

    Your input is excellent but I am curious about the implications of FMV and the Issuance of extra founders shares set aside in Trust. Although we have been ‘doing business as’… for over a year now, we are now preparing to incorporate and issue founders shares. Are you saying that although I can issue additional founders shares without tax implication, in the beginning, in trust to be issued to new staff at a later date, if I transfer them at a later date they may have serious tax implications? Re-worded, do these shares even though they have already been issued and all new shareholders would be aware of the dilution factor of those shares, once a major investor comes on board, does the transfer of those shares now represent a benefit and therefore a differed tax presence? If so what would be the point in issuing them in trust. Why not simply issue them. If I am guessing at the reason, it would be because once you have a tangible investor, you have a distinctive FMV and therefore your later issuance of founders shares represents a very real conflict in the interests to your new higher paying shareholders?


    • admin says:

      Good questions. A trust may be useful in that you would allocate shares in your cap table and all shareholders would regard them as part of the founders block.
      As a CCPC you can issue shares at any time at any price (just make sure you comply with the securities regulations). Suppose that an investor has just paid $1.00 per share. If an employee gets 100,000 shares for free (say $.0001 per share), she has a “deferred employment benefit” of $100K on which she has to pay tax WHEN she sells the shares. You might be thinking that the investor who just paid $1.00 will be annoyed if someone else gets shares for free, right? In this case you have to explain to the investor that a) the employee is getting this break as part of her compensation package (and working for a low salary) and b) it’s a good deal for all shareholders because if you issued options at $1.00, you’d likely have to issue more than 100,000 which means more dilution later to all shareholders. Also, by her holding CCPC shares for 2 years, she gets up to $750K in capital gains tax-free!

  3. Mike,

    I believe that I read in your article that the founders block in a publicly held corporation can be as much as 10% of the shares in a company, or maybe that was the block which was allocated to options in a public company. Anyways, is there a maximum percentage of shares that can be issued into trust or is this simply a common sense issue where if you have way too many shares in trust that you will more than likely make some of your early investors a bit concerned about investing in your company with so many shares outstanding?


    • admin says:

      10% is a kind of a rule of thumb for public and private companies. Public companies are restricted – usually to a max of but more normally 10%. There’s no limit on private companies. If the shares are all issued, it shouldnt make investors nervous – it’s when they get diluted from stock option exercises that they get nervous.

  4. Cyri says:

    Thanks very much for the super helpful post! I have been trying to figure this all out for the past year, reading so many different articles and sources that left me completely confused. Your article was amazing summary of all the scenarios, written in easy to understand style and will really help me with my venture plans… and also help my students I teach as well in an entrepreneurship class.

  5. Tricia says:

    Mike thank you for your input. Do you know if a public Canadian Company can grant its Directors the stock option on the name of the Director’s private company and not in the name of the director him/herself?

    Thank you,

    • admin says:

      I don’t see why not. But, check with a secuties lawyer. Also, check any tax implications either way. Mike

  6. Nancy says:

    Hi there,

    Do these rules apply regardless of the company being public or private? My accountant seems to think so…


    • admin says:

      The rules are quite different for public vs private companies. They are more favorable to private companies because stock option benefits can be deferred whereas there is no deferral for public companies. It means that, in a public company, you are forced to sell some shares immediately so that you can pay the taxes. It discourages ownership which is unfortunate.

  7. Dave [Eagles] says:

    What are the tax implications for purchase, nominal value transfer or gifting of shares in a CCPC between two shareholders of the CCPC? Thx–this article seems to be one of the best around on this topic

    • admin says:

      I think it depends on the nature of the transaction and the current value of the shares.
      If you make a disposition, e.g. as a gift, you might have to pay tax on the appreciated value. The recipient wouldn’t have a tax issue until the shares are sold.
      If you give shares to someone in lieu of pay, then they will have to pay tax on the benefit (diff between fair value and their cost) and you will have to pay tax on the appreciated value.

  8. Freedy Deeb says:


    I have vested share options in a private canadian corporation that I VERY recently exercised at a penny a share. The fair market value is 70 cents a share. In the next month or two we expect the company to be sold to some corporation overseas for at least $1 a share. Am I right in expecting that the 69cents between the fair market value (70cents) and my exercise price (1 cent) will be taxed as income, while the gain between 70cents and the $1+ per share the company is sold at will be taxed as captial gains?

    There is absolutely no 2 year hold period possible, but some people think the quick time period (1-2 months) between exercising options and the sale of the company might somehow be ‘exempt’ from going the capital gains route and instead just be treated as regular income.


  9. Heather says:

    Thanks so much for the article Mike. It is very clear.

    What happens if say you hold the shares of a CCPC for 1.5 years and at that point it becomes public (IPO) and is no longer CCPC? Do you not get the 750K tax exemption or the other goodies? Even if you wait another 0.5 year before selling so it’s 2 years in total?

  10. Patrick says:

    What are the benefits of receiving “no-cost founder shares”?

    Are the shares deemed to have a different FMV, ex. the FMV when the company was established?

    Great article, I’m just a little unsure of the definition for founder shares.



    • admin says:

      The benefit is that they cost you nothing and will someday, hopefully, be very valuable. The FMV (Fair Market Value) is what they are worth on the day you get them. Founders shares are usually issued when the company is founded (started) and at its early stages when partners are brought in to work in the company long before investors are brought in. At this stage, they are usually considered to be of zero value (at least for tax purposes).

  11. Ken Hewitt says:

    Mike…. thank you (again) for your helpful post (May 2011!).

    I am interested in the SHARE issue concept (“founders shares”) – specifically the opportunity for the recipient employee to defer tax for 2 years or more. We have recently awarded two employees with share ownership, but everything I can find on CRA web site indicates that such awards are immediately taxable.

    I can not find any CRA reference to the defef\rrment opportunity. Specifically CRA bulletin IT113R4 provides advice on this – but not about deferrment.

    Can you point me to a CRA reference in this regard?

    • admin says:

      On CRA’s website, there are instruction on completing the tax return Line 101 Security Option Benefits where it says: “If your employer is a Canadian controlled private corporation (CCPC), which you deal with at arm’s length, you only have to report this taxable benefit on your tax return for the year you sell the securities. If your employer is not a CCPC you may have to report taxable benefits you received in (or carried forward to) the year you exercise your stock option.”

      • Ken Hewitt says:

        Thanks Mike.

        BUT… the sentence you quoted: “On CRA’s website, there are instruction on completing the tax return Line 101 Security Option Benefits where it says: “If your employer is a Canadian controlled private corporation (CCPC), which you deal with at arm’s length, you only have to report this taxable benefit on your tax return for the year you sell the securities.” …

        is preceded by “A security option benefit results when you buy securities through your employer at apre-established price which is less than the fair market value of the securities.”

        So … doesn’t that mean this reference is related to stock option plans (i.e. “a pre-established price”)…. not to a general award or gift of shares ?

        • Mike says:

          If you get below-cost shares in a QSB (regardless of whether they are a gift, a discount, bonus, etc) then you have a benefit. This benefit can be defered until you sell the shares.

  12. Diana says:

    For the first time in many years I have exercised options of a public company. I have “Security Options Benefits” and “Security Options Deductions” on my T4, leaving me with 50% of the gain on the option sale within my income.

    I also have a tremendous amount of carryforward capital losses. I was hoping the the option gain could be fully offset by these losses, as they both arise from publicly traded stock.

    But I can find no method of “deducting” my capital losses against the income that has been built into my T4. This income IS the result of a capital gain on the disposition of the share options, so why can’t I find a way to use my loss carryforward against it?

    To add insult to this, last year I had “qualified” gains on the disposition of farm property. Instead of allowing me to deduct the gain from my “lifetime exemption”, the CRA forced me to us my carryforward capital losses. When I do finally have gains on shares, my losses won’t be there to limit the tax.

    Wouldn’t be so awful, except I made those losses on borrowed money, and I need all the gains to pay back the loans. I have loans outstanding after the underlying asset has gone – sold at a loss. It’s simply crazy!

    Now here I am with legitimate gains, but can’t find a way to exercise the losses against them.

    • Mike says:

      I sympathize with you! The only thing I can offer is that you can at least deduct the interest on your loan. Also, let’s hope you have lots of capital gains in the future against whcih you can use your accrued losses.

  13. Rob says:

    Excellent post Mike! Very informative.

    If a corporation was created 17 years ago and some employees worked there for 15 years, can founder shares still be created and assigned to these employees?

    Is there a tax benefit of getting these shares assigned to a corporation the employee owns? Instead of big corporation providing shares to directly to the employee they first go to another corporation that the employee owns?

    Regardless of the above, “the bottom line” section of your post still sounds like an amazing deal. Most taxes deferred. Assuming no change in valuation eventually taxed at normal employment income like figure of gifted shares in the event of a sale. Seems too good to be true!

    Can you recommend further reading materials? I am especially interested in private established corporations gifting shares to their employees.


    • Mike says:

      Rob, you can create “founders” shares any time you like – that is, by founders shares I trust you mean zero-cost shares. I believe that if the shares are issued to a corporation, there’d be taxable benefit although I’m not sure if it can be deferred. I suggest that you check with your own accountant about your particular situation – just to be safe.

  14. boli says:

    Hi Mike,

    a CCPC grants share to employee with an FMV and the employee could defer the tax benefits till selling the shares. If the employee never sells the shares because the later share value is lower than the previous FMV when shares granted, will deferred tax be erased?


    • Mike says:

      I don’t think the benefit ever gets erased. And there’s never a “never sell” because either the company or the shareholder will die someday (and then there’s a deemed disposition).

      • boli says:

        thanks Mike! Oh, yes, the shares could be sold passively. how CRA could determine the FMV of a shared granted by a CCPC 5 years ago?

        • Mike says:

          Yes, that’s the challenge. I’ve never actually heard of CRA determining this for a small CCPC startup. I’d love to hear from anyone that has.

  15. Levi says:

    Hi Mike, Thanks for the very informative article. Can you please refer me to the section of the Income Tax Act that allows for a deferral AND/OR 50% deduction as it relates to the taxable benefit under a SHARE sale. I believe what you are looking at covers Options and not shares. Thanks, Levi

    • Gary says:

      Follow up the questions above from Ken and Levi, has this been resolved re whether these rules only apply to options and not shares? Ken and Levi were looking for confirmation/references to the tax act allowing the deferral relating to shares (not stock options). Thanks for any comments on this.

      • Mike says:

        The rules relate to shares. Options are just a right to buy shares. If you acquire shares below the so-called market value, this could be due to an option that you’ve exercised or simply due to an agreement (eg employment agreement). Regardless of how or why you got “cheap” shares, the tax liability kicks in when you get the “benefit”. This benefit is taxable but it can be deferred (for a private company) until you sell the shares. There is no tax due when you receive stock options – regardless of the terms of the option grant.

  16. Yu says:

    Hi, Mike, excellent article. I’m wondering if Founders Share should be hold by founder or company, if hold by founder, can deferred rules apply?

    • Mike says:

      Companies don’t hold shares in themselves. Founders shares would be held by individual “founders” which could really be anyone you wish to deal in.

  17. Rob Stanley says:

    Hi Mike,

    Great article. Have any of these provisions been updated in the 6 years since the article was originally published? We’re based in Toronto and setting up a new tech startup. We’ve decided to incorporate in Delaware as we want to eventually attract money from the valley. But for founders and key employees it seems that both options and founders shares could be problematic? as a non CCPC, Canadian employees who receive options would be in a situation similar to your CFO with 100,000 options in a Silicon Valley startup – they would have a tax liability on the FMV at time of exercising, due immediately. Is this still the case?

    If we issue shares (founder shares?) as a non-CCPC, even with reverse vesting (or RSU equivalents), it seems there would be an immediate tax liability based on FMV at the time the shares are issued – am I understanding that correctly?

    • Mike says:

      I’m not aware of any changes in the past 6 years since I wrote the post. Yes, the rules are different in the USA. Not as good as in Canada. Many startups I know have no trouble attracting Valley Capital because they are CCPCs. In your case, if the recipients of the founders shares (in the Delaware Corp) are Canadian, I believe that the Canadian rules are applicable and they have no immediate tax liability. BUT – they do not get a shot at the $835K Cap Gains exemption. Then, of course, there’s also the question of what is the FMV. If no capital has been raised, and if the company is brand new, I’d argue that the FMV is zero. Even for later stage issuances, I’ve not heard of CRA setting an FMV.

  18. Armin says:

    Hello Mike,

    Thank you very much for this very useful article.

    Would you please let me know what would happen in case of a founder receiving options and exercising them while the company is still pre-revenue? Would the difference between what investors pay per share and exercise price still be considered a benefit even though that founder most probably won’t find any buyer for his shares?

    • Mike says:

      It would be considered a benefit but the tax owing as a result can be deferred until the shares are sold. I wonder, though, why the founder would want to exercise the option so early? I also wonder why the founder wouldn’t have (or get) founders shares instead of options.

  19. Dave Brown says:


    As others have said – thanks for putting in the work to research write this article.

    It strikes me as I talk with other startup founders in 2019 that there is a pervasive belief that options for anyone other than the early founders is the way to go. Tax complexities and the risk of owing RCA for gains on worthless stock are usually cited as the reason for options.

    I don’t want to create a deterrent to investors who might balk at seeing anything weird on the cap table, or in any of the agreements made to team members, be they initial founders or early-ish employees.

    I hear you making an argument in favour of stock for everyone. And the case you make is quite persuasive. It certainly seems to favour the employee who is very tax-savvy, but risky for those that don’t manage their tax situation closely. It also seems to apply more strongly to those companies that have de-risked the business.

    For an early-stage startup, facing very high risk of failure in the first 2 years, do you still recommend shares for everyone (beyond the initial founders)?

    If you wouldn’t mind adding some more detail, what incentive plan design do you think 2019’s sophisticated angel investors favour? And why?


    • Mike says:

      Yes, Dave, it is very traditional to go with options. But, I don’t think it is the BEST way for all situations. For example, if a company is attracting senior talent and is still very early in its life (and especially if it hasn’t raised a lot of capital), it makes sense to include new recruits as founders. I don’t think 2019’s angels care too much since it doesn’t affect them, although giving shares is less dilutive than giving options. Hope that help!

  20. Elena says:

    Thank you very much for this article.
    I am a founder in a CCPC startup. I have received additional shares (regular shares) in exchange of working for the company. Do I have to declare them as income?
    Thank you

    • Mike says:

      Hi Elena, if you are a founder and if the shares are issued before the CCPC sells shares to others, you don’t need to make any declarations. If you receive shares as compensation there is a taxable benefit but you can defer the tax on that benefit until you sell the shares.

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