Tax Treatment Of Stock Options Granted To Independent Contractors

• Published date: 12 December 2022
• Subject Matter: Tax, Income Tax
• Law Firm: Miller Thomson LLP
• Author: Mr Brendon Ho

The tax treatment of stock options granted to employees has been well established by the Income Tax Act (Canada) (the "ITA") and related commentary. In particular, Section 7 of the ITA contains the taxation rules for stock options granted to employees. However, these rules do not apply in the context of stock options granted to independent contractors.¹ As a result, the unique tax treatment of stock options granted to independent contractors is often overlooked.

Subsection 9(1) of the ITA provides that a taxpayer's income for a taxation year from a business, is the taxpayer's profit from that business for the year. Therefore, in a case where a stock option is granted in respect of services rendered pursuant to an independent contractor relationship, the Canada Revenue Agency's ("CRA") position is that the fair market value ("FMV") of such stock option will be included in a taxpayer's business income under subsection 9(1) in the year of the grant.²

The entire FMV of the stock option granted may not be subject to an immediate income inclusion if all or part of the stock option does not vest on the date of the grant. The CRA has not opined on vesting conditions directly. However, certain jurisprudence has supported the position that vesting or the fulfillment of conditions precedent are pre-conditions to an income inclusion.³ Based upon this, it is the author's view that the business income inclusion should be limited to the number of options that vest in a particular year. Upon vesting, the FMV of such options would then be included in the business income of the independent contractor in such year.

The determination of the FMV of a stock option is a question of fact. However, the CRA's position is that the value of a stock option is the greater of:

• The trading value of the rights received; and
• The amount by which the FMV of the shares subject to the option at the time of the option's distribution exceeds the exercise price provided in the option.⁴

Based upon the above valuation mechanism, the CRA has accepted that where there is no market for the options and the exercise price is equal to or greater than the FMV of the shares at the time of the grant, then there is no benefit.⁵ The CRA seemed to accept that this could be accomplished by ensuring that the stock option plan only granted stock options at times when the exercise price was above the FMV of the shares:

It is possible that no amount would have been included in Corporation's income when the...