Do you want to retain your best people while motivating them to surpass themselves? Consider stock options. Since they can have complex tax consequences for your employees, here’s what you need to know to come out with a “win-win” arrangement.
Propose to your employees to become shareholders of your company? Why not! In a competitive job market, stock options can be a form of employee benefit to win the loyalty of your best employees. Many Canadian companies – such as Canadian Tire or CGI – use this type of incentive compensation to retain their best people while promoting the development of the organization.
How do call options work?
A stock option plan allows you to offer employees the opportunity to acquire a certain number of company shares at a predetermined price and for a defined period. The objective is to retain key resources by enabling them to benefit from the company’s revenue growth, regardless of their position in the organization.
What are the advantages and disadvantages?
In general, this incentive remuneration is negotiated, in the same way as the salary.
For the employer, the costs are lower than an expense in salary: the purchase option does not directly lead to an outflow of money, but the management costs associated with this program must be foreseen.
During the negotiation of the agreement, the employer can not only determine the number of options, but also cut these options into monthly or annual blocks that the employee can buy gradually, starting from a date fixed in advance. . The employer thus protects himself against a premature departure and he ensures that the employee will contribute to the full performance of the company for several years.
For the employee, there are no tax consequences until a purchase option is exercised. Then, it’s a different story, because the taxation related to stock options is complex.
Suppose your employee buys a block of 1,000 shares at $3 each, for a total of $3,000. As long as the latter does not touch it, there is no tax impact. If, after four years, the employee decides to sell his shares when they are worth $5 each, the tax authorities will consider that he has received a taxable benefit of $2,000, which is the difference between the price of the share determined at the start ($3) and its value when sold ($5).
In the case of a publicly traded company, this taxable benefit is added to the employee’s income from the year he exercises a call option and not when he sells them. Its shares are a liquid asset that has a market value. When the employee sells his shares, he may be taxed a second time if the resale price is higher than the adjusted cost base of his shares.
If it’s a private company controlled by Canadian executives, then the employee can’t sell his shares as easily. The tax authorities take this lack of liquidity into account. If the employee keeps his shares for at least two years after the exercise of his options, he can delay the declaration of his taxable benefit until the year of the sale.
The taxable benefit from exercising stock options is employment income, but is taxed as a capital gain rather than salary. In fact, the employee can benefit from a 50% deduction from the federal and provincial governments. In fact, in 2017, Quebec increased this deduction, which was formerly 25%.
In other words, if the options are used to compensate for an unattractive salary, for example, make sure that in the end they will represent a good deal for the employee. In the event, of course, where the title has appreciated.
Other plans to retain your employees
There are other types of stock-based incentive plans, such as the stock purchase plan, under which employees can buy shares at a reduced price, as well as the stock bonus plan, which allows the employer to reward employees in shares when certain performance objectives are achieved.
Regardless of the formula chosen, keep in mind that there is great flexibility in stock option plans: as an employer, you are free to set the terms. Options are generally valid for a period ranging from three to five years.
In some cases, the employer may allow an employee to receive a cash payment – instead of securities – in exchange for his stock options. In other words, the employee will give up the stock options in exchange for a sum of money (or other benefits in kind), without buying the shares of the company.
Who can benefit?
The stock option plan is as advantageous for large organizations as it is for SMEs or even start-ups with high growth potential. In addition to stimulating your troops, this formula gives you some financial flexibility, because the amounts that will not be used to pay salaries or bonuses can be kept in the company.
If turning your employees into shareholders has multiple advantages, make sure that the employee does his homework and fully understands the implications of the compensation you offer him before accepting it.
Stock options are an attractive formula, but employees are not always accustomed to sharing the risk of shareholder return. Therefore, do not hesitate to institute other programs within your company to preserve the mobilization of your most precious resources