Stock Option Taxation in Canada (CCPC vs. Non-CCPC)

Section 7 of the Income Tax Act applies whenever a corporation agrees to sell or issue its shares to an employee. For this purpose an employee includes an officer, and the Act treats a corporate director's position as an office, so directors are covered too. Section 7 does not apply if the benefit was not received in respect of the employment, for example when a founder subscribes for shares as a shareholder at the same price as everyone else.

The employment benefit is the value of the shares when the employee acquires them, minus the exercise price and anything paid for the option itself. The amount is fixed at exercise; what differs is when it is taxed:

Under paragraph 53(1)(j), the benefit is added to the cost base of the shares, so the same value is not taxed twice. The employer generally cannot deduct the benefit; the exception for non-qualified securities is described below. Options granted to independent contractors generally fall outside section 7 and are taxed under other rules.

For a Canadian-controlled private corporation, subsection 7(1.1) moves the benefit from the year of exercise to the year the employee disposes of or exchanges the shares. Two conditions apply, both tested when the option agreement is made:

• CCPC at grant. The corporation that agreed to issue the shares was a CCPC when it granted the option. Options granted while the company was a CCPC generally keep the deferral even if it later loses that status, for example in a Delaware flip; options granted afterwards do not get it.
• Arm's length. The employee dealt at arm's length with the corporation and the employer. Related persons are deemed not to deal at arm's length, and a corporation is related to the person who controls it and to anyone related to that person. A controlling founder, or that founder's spouse or child on the payroll, therefore gets no deferral. For unrelated people, arm's length is a question of fact.

The deferral solves the cash problem of private company options: the employee owes nothing when exercising shares that cannot yet be sold. The CRA's security options guidance confirms that the employer withholds no income tax, CPP or EI on a CCPC share benefit, and that the benefit is included in income in the year the employee disposes of the shares.

The employee deducts one-half of the benefit in computing taxable income if either test is met; both cannot be claimed for the same benefit.

Paragraph 110(1)(d) applies to options from any employer if:

1. The shares are prescribed shares, broadly ordinary common shares without capped dividends or a holder's redemption right.
2. The exercise price, plus anything paid for the option, was not less than the shares' fair market value when the option was granted. Our entry on the employee stock option plan covers how a board sets and records that value.
3. The employee dealt at arm's length with the employer and the issuing corporation immediately after the grant.
4. The shares are not non-qualified securities under the $200,000 rule below.

Paragraph 110(1)(d.1) applies only to a benefit deferred under the CCPC rule, and requires the employee not to dispose of or exchange the shares within two years after acquiring them, other than on death. It rescues CCPC options priced below fair market value at grant, which fail paragraph (d).

If an employer cashes out options instead of issuing shares, only one of them can deduct the payout: generally, the employee keeps the paragraph (d) deduction only if the employer elects under subsection 110(1.1) not to deduct it.

Status as of October 2026. Budget 2024 proposed cutting the deduction to one-third for amounts above a combined $250,000 annual threshold, effective June 25, 2024. On March 21, 2025, the government announced it would not proceed, so the deduction remains one-half. Where an employer reported a one-third deduction for an option exercised between June 25 and December 31, 2024, the employee can claim the additional deduction on their return to reach one-half.

For options granted on or after July 1, 2021, a cap applies where the employer or the issuing corporation is a specified person: a corporation that is not a CCPC and has gross revenue above $500 million, measured on its own financial statements or, for a member of a group, the group's consolidated statements. Options from CCPCs and from smaller non-CCPCs are outside the rule.

For each vesting year, meaning the calendar year in which options first become exercisable under their vesting schedule, only options over shares worth up to $200,000 qualify for the paragraph 110(1)(d) deduction. Value means the shares' fair market value at grant. Options above the limit are non-qualified securities: the employee is taxed on the full benefit at exercise with no deduction. The employer may then deduct the benefit under paragraph 110(1)(e), but only if it notified the employee in writing within 30 days after the grant and notifies the CRA in prescribed form by its filing-due date for the year of the grant. A specified person may also designate options as non-qualified even within the limit, which shifts the deduction from the employee to the employer.

For example, an employee of a large non-CCPC receives 32,000 options over shares worth $50 at grant, vesting 8,000 a year. Each vesting year covers $400,000 of shares, so, if no other options vest that year, 4,000 options a year qualify for the deduction and 4,000 are non-qualified.

• A falling share price after exercise. The benefit is fixed at exercise even when tax is deferred. If the shares later lose value, the employee still reports the full benefit and is left with a capital loss, which generally can offset only capital gains, not employment income.
• Founders holding options. A controlling founder gets neither the deferral nor either deduction. Founder equity is therefore usually issued as shares at a nominal price at incorporation, with reverse vesting, rather than as options.
• Expecting the LCGE to apply. The employment benefit is not a capital gain, so the lifetime capital gains exemption cannot shelter it. Only growth after exercise can qualify, and the 24-month holding period starts at exercise.

Lamba Law's cap table and stock option practice structures plans and grants with these rules in mind, working alongside the company's tax adviser.

Anjali Rao is a data scientist at Brightwell Analytics Inc., a Mississauga CCPC in which she held no shares when hired. In March 2023 the board grants her 20,000 options over common shares at $1.00, the fair market value it determined at grant. In June 2026, after a financing has valued the shares at $4.00, she exercises all of them for $20,000.

Her benefit is fixed at 20,000 × $3.00 = $60,000. Because Brightwell was a CCPC at grant and she deals with it at arm's length, nothing is taxed in 2026 and nothing is withheld. In 2029 a buyer acquires Brightwell and she sells her shares for $10.00 each, or $200,000.

Her adjusted cost base of $80,000 is the $20,000 she paid plus the $60,000 benefit. Of her $180,000 economic gain, $90,000 is taxable at her federal and Ontario rates.

Had Brightwell already been controlled by US investors when it granted the options, it would not have been a CCPC. Anjali would then have reported the $60,000 benefit in 2026, with tax withheld through payroll, even though she could not sell a share until 2029.