Stock Options for Employees in Canada: Tax and Withholding

When are stock options taxed in Canada?

Never at grant. The taxable benefit is the share value when the engineer acquires the shares, minus the price paid (Income Tax Act, s. 7(1)(a)). When that benefit is taxed depends on who granted the option:

The benefit is employment income, even if the engineer has left the company by the time of exercise or sale (s. 7(4)). Half of it is usually deductible (below). Any rise in value after the shares are acquired is a capital gain when they are sold.

It gets harder when the company changed status, flipped under a US parent or granted below share value, or the engineer lives in Quebec or leaves Canada. Gather each grant's agreement, date, price and share value, the cap table history, and exercise and sale records.

Does our startup count as a CCPC for its options?

The statute points to each option's grant date: section 7(1.1) applies where a CCPC "has agreed to sell or issue" its shares, which looks at the grant, not the exercise or sale (s. 7(1.1)). The CRA's payroll page lists the CCPC conditions "at the end of the tax year", the general definition, and does not address options granted before a change of status (CRA). Keep a record of CCPC status on every grant date.

A CCPC is a private Canadian corporation (resident in Canada and, in general, incorporated here) that is not controlled, directly or indirectly, by non-residents or public corporations, alone or together, and no class of whose shares is listed on a designated stock exchange (s. 125(7)). Two consequences for startups:

• A Delaware corporation is not a CCPC, because it is not a Canadian corporation, and its Canadian subsidiary is not one either while a non-resident parent controls it. A startup formed in Delaware with a Toronto subsidiary has no sale-time deferral for anyone.
• A founder who controls the company, or is related to someone who does, is not at arm's length with it (s. 251(1)), and so gets neither the sale-time deferral nor the deduction under paragraph 110(1)(d). For unrelated minority co-founders it is a question of fact.

We raised from US funds or flipped under a Delaware parent: what happens to options already granted?

A round that ends CCPC status does not change options granted before it: those benefits are still taxed when the shares are sold. Only grants made after the company lost status are taxed at exercise. What the round does to the company itself, including a deemed year-end, is in Losing CCPC status to foreign investors.

In a flip, Canadian options may be swapped for options on the Delaware parent. Section 7(1.4) treats the new option as "the same option as, and a continuation of" the old one, and the parent as the same person as the Canadian issuer, so sale-time taxation can carry over if all these conditions are met (s. 7(1.4)):

• The engineer receives nothing for the old option except the new option.
• The new option's in-the-money value (share value minus price) right after the swap is no more than the old option's right before it. The CRA describes this as no "economic gain" from the exchange (CRA, Event 3).
• Right after the swap, the Delaware parent and the Canadian company are not at arm's length, normally because the parent now controls it, so the timing of the option swap within the flip matters.

Cash, a better spread or a different instrument can break this. Shares already acquired from CCPC options and exchanged for parent shares keep the deferral under section 7(1.5) on similar conditions (CRA Event 2). The deduction under paragraph 110(1)(d) also survives a qualifying swap (s. 110(1)(d)(iii)). The founders' side of the flip is in Moving a Canadian startup under a Delaware parent.

Who can deduct half of the stock option benefit?

An engineer may deduct 50% of the benefit under paragraph 110(1)(d) when all of these are true (s. 110(1)(d)):

• The shares are ordinary common shares, a "prescribed share" (Regulation 6204).
• The exercise price is not less than the share value on the grant date.
• The engineer dealt at arm's length with the company and the employer right after the grant.

A startup that grants below share value loses this deduction at a non-CCPC. For a CCPC grant, the engineer still gets 50% under paragraph 110(1)(d.1) if the shares are kept at least two years after they are acquired. For a US-dollar exercise price, exchange-rate moves after the grant are ignored in the price test (s. 110(1.5)(a)).

An annual vesting limit of C$200,000 applies only to employers that are not CCPCs and whose group revenue exceeds C$500 million. Options above the limit are non-qualified (unrelated to US non-qualified stock options): no deduction for the engineer, a written notice within 30 days of the grant, and Form T2SCH59 for the employer (s. 110(1.31) and (1.9)). Most seed to Series B startups are far below it.

Options cancelled for cash, for example in an acquisition, are also a taxable benefit. The engineer gets the deduction only if the employer elects to give up its own deduction for the payment and gives the engineer written evidence (T4 code 86) (s. 110(1.1)).

What must payroll withhold when an employee exercises?

For options taxed at exercise (from a company that is not a CCPC, or a CCPC's grant to an employee not at arm's length), the benefit counts as a bonus for withholding (s. 153(1.01)). Payroll withholds:

• Income tax on the benefit minus the deduction under paragraph 110(1)(d), if the engineer qualifies for it.
• CPP (QPP in Quebec) on the benefit, up to the year's maximum.
• No EI, unless the option was cashed out (CRA).

Nothing is withheld on a CCPC option benefit deferred to sale, at exercise or at sale. The benefit being shares rather than cash is no reason to reduce withholding (s. 153(1.31)): the employer still has to remit, so the cash has to be arranged with the engineer before the remittance date. Convert US-dollar amounts at the exchange rate on the date of each transaction. In a cashless exercise, some or all shares are sold at once: the benefit is still taxed at exercise, and a same-day sale gives little or no capital gain. If the engineer already holds identical shares, naming the newly acquired shares as the ones sold on the return keeps that result, for a sale within 30 days with no other purchase or sale of identical shares in between (s. 7(1.31)).

If payroll fails to withhold, the employer owes a penalty of 10% of the amount not withheld (s. 227(8)), and its directors can be personally liable for amounts not withheld or remitted, unless they took reasonable care, for up to two years after they leave the board (s. 227.1). Remittance dates and other penalties are in Running payroll.

How are stock option benefits reported on the T4?

On the T4 for the year the benefit is taxed: the exercise year, or the sale year for CCPC grants. The benefit is included in box 14 and in box 26 (CPP/QPP pensionable earnings), with the detail in the other information area (CRA):

Slips for 2026 and later use only codes 38, 39 and 41. Some 2024 and 2025 slips show codes 90, 91 and 92 instead, left from a proposed cut of the deduction to one-third that the government cancelled; engineers should not mix the two sets up. Slips are due by the last day of February following the calendar year to which the slips apply.

For a CCPC grant, payroll only knows about the benefit when the engineer reports the sale, even years after leaving; the former employer still issues that T4. In Quebec, the employer also files an RL-1 by the last day of February of the following year.

Our Delaware parent grants the options: who withholds, and can the subsidiary deduct what it pays?

The parent withholds unless the Canadian subsidiary reimburses it; the subsidiary may report the benefit either way, and the benefit itself is not deductible. The CRA says a non-resident parent "is responsible for withholding and reporting" the benefit, unless the Canadian subsidiary reimburses the parent for it. The CRA lets the subsidiary's payroll report on the parent's behalf, but that does not relieve the parent of withholding and remitting (CRA). The CRA also warns that a parent's plan may not meet the conditions for the deduction under paragraph 110(1)(d), so check each one above.

The benefit is not deductible: section 7(3)(b) deems any person's income to be no less than it would have been if the shares had not been issued to the employee (s. 7(3)). Whether a cash recharge the subsidiary pays the parent for the shares is deductible depends on the agreement and the facts. How the subsidiary prices its work for the parent is in Pricing between your Canadian and US companies; transfer pricing documentation is separate work.

Our US plan calls them ISOs or NSOs: does that change the Canadian tax?

No. Incentive stock options (ISOs) and nonstatutory, often called non-qualified, stock options (NSOs) are US categories (IRS Topic 427); Canada taxes every employee option under section 7. For an engineer who lives in Canada, is not a US citizen or green card holder, and never works in the US:

US citizens and green card holders living in Canada also file US returns: see When you need a cross-border accountant.

Are RSUs taxed like options in Canada?

RSUs settled in the company's own shares are generally an agreement to issue shares, so section 7 applies, with no exercise price. With no price, the price test for paragraph 110(1)(d) fails: an RSU from a company that is not a CCPC is generally fully taxed when the shares are delivered, with payroll withholding. A CCPC's RSU is taxed at sale, with 50% deductible under paragraph 110(1)(d.1) if the shares are kept two years. The CRA's payroll page does not set out RSU treatment, so the plan's terms matter.

Units settled in cash are not section 7 agreements. To stay outside the salary deferral rules, a cash bonus generally must be paid within 3 years after the end of the year the work was done (s. 248(1), paragraph (k)).

What goes on my own return in the year I exercise or sell?

• The year the benefit is taxed: the T4 benefit is part of employment income on line 10100, and the deduction from codes 39 or 41 (91 or 92 on some 2024 and 2025 slips) goes on line 24900 (CRA).
• The year you sell: report the gain or loss on Schedule 3. Your cost is the price you paid plus the taxable benefit (T4037), and 50% of the gain is taxable. For a CCPC grant, the benefit and the gain often land in the same year.
• Balance owing: nothing is withheld on CCPC grants, and withholding on other grants may fall short, so a large year can mean a balance owing and instalments.
• Minimum tax: the stock option deductions are not allowed in the alternative minimum tax calculation (s. 127.52(1)(h)), so a large option year can trigger it above C$181,440.
• Quebec: Quebec gives its own deduction of 25% of the benefit, or 50% if certain conditions are met, on line 297 from RL-1 boxes L-9, L-10, L-12 and L-13 (Revenu Québec).

The lifetime capital gains exemption on CCPC shares is in Losing CCPC status to foreign investors.

Example

All figures are illustrative and in Canadian dollars unless marked US$.

A CCPC grant at C$0.50, sold after a Series A

A Toronto GPU cloud startup, a CCPC, grants an engineer 40,000 options at C$0.50, the share value, in 2024. In 2026 a US fund leads its Series A and the startup stops being a CCPC.

• 2027: she exercises when shares are worth C$5.00. The benefit is C$180,000, but because the grant was made while the startup was a CCPC, there is no tax, no withholding and no T4 amount.
• 2029: she sells at C$12.00. The 2029 T4 shows the C$180,000 benefit (code 38) and a C$90,000 deduction (code 39), so C$90,000 is taxable employment income. Her cost is C$200,000 (C$20,000 paid plus C$180,000 benefit); proceeds of C$480,000 give a C$280,000 capital gain, half of it taxable.

A grant at C$5.00 after the round

The same startup grants another engineer, at arm's length, 20,000 options at C$5.00, the share value then, after the round. He exercises in 2029 at C$12.00: a C$140,000 benefit, taxed in 2029. Payroll withholds income tax on C$70,000 (after the deduction) and CPP on the benefit up to the year's maximum, but no EI, and reports code 38 C$140,000 and code 39 C$70,000. His cost is C$12.00 a share. The annual vesting limit does not apply: the group's revenue is far below the threshold.

US$2.00 options labelled ISOs from a Delaware parent

A Bay Area GPU cloud, a Delaware C corporation with a Toronto engineering subsidiary, grants a Toronto engineer, who is not a US citizen or green card holder and never works in the US, 10,000 options labelled ISOs at US$2.00, the share value at grant. She exercises at US$10.00 when US$1 buys C$1.35: a US$80,000 benefit, or C$108,000. Canada taxes it now. The subsidiary's payroll withholds income tax on C$54,000 and CPP, and issues the T4. There is no US tax, no W-2 and no Form 3921. If the subsidiary does not pay the parent for the shares, the parent stays responsible for that withholding even though the subsidiary's payroll runs it; if it pays the parent C$108,000, the CRA's exception for a reimbursed parent applies. Either way the benefit itself stays non-deductible.

Different for you?

• Your startup is losing CCPC status in a round now: the deemed year-end and the lifetime capital gains exemption are in Losing CCPC status to foreign investors. Get help for data center and AI infrastructure companies.
• You are planning a flip: the share exchange and each company's filings are in Moving a Canadian startup under a Delaware parent.
• You have not chosen where to incorporate: see Delaware or Canadian corporation for a startup.
• Founders hold restricted shares, not options: see Founder shares that vest.
• The engineer moved between Canada and the US during vesting: see Stock awards and pay after a move.
• The engineer leaves Canada holding shares from CCPC options: leaving generally counts as selling them (s. 128.1(4)(b)), so the deferred benefit is taxed that year; see Stock awards and pay after a move.
• The engineer works for a US employer, commutes, or spends time at a US site: see Working across the border or Canadian employee working in the US.
• You are setting up Canadian payroll for the first time: see Hiring an employee across the border.
• The company is being sold: the founders' side is in Canadian founder selling US startup shares. Options cashed out in the sale need the employer's election above.
• You exercised or sold this year: get help with your return through individual tax.