Tax on Stock Options Canada: Employee Guide

In Canada, exercising an employee stock option triggers a taxable employment benefit equal to the difference between the shares' fair market value and the exercise price. Non-CCPC employees are taxed at exercise; CCPC employees can defer tax until they sell the shares. A 50% deduction under s. 110(1)(d) often applies if conditions are met.

The tax on stock options in Canada turns on two questions more than any others. Is the employer a Canadian-controlled private corporation (CCPC)? And does the $200,000 annual vesting limit introduced in 2021 apply to the grant? Get those wrong and an employee can face a tax bill in a year with no cash to pay it.

This guide is for both sides of the table. Ontario founders and HR or finance teams administering option plans need it, and so do employees trying to understand what an exercise notice will cost them. For broader context on how business owners structure compensation and corporate income, see our overview of corporate tax planning strategies for Toronto businesses.

How Stock Options Are Taxed in Canada: The Basic Rule

The starting point for stock options tax in Canada is section 7 of the federal Income Tax Act. When an employee acquires shares under an agreement with their employer, the employee is deemed to receive a benefit from employment. The amount of that benefit is:

the fair market value (FMV) of the shares on the date the option is exercised, minus
the exercise price paid for the shares, minus
any amount the employee paid to acquire the option itself.

Three features of this rule surprise many people.

First, nothing happens at grant. Receiving an option is not a taxable event for an employee under the general rule. The tax consequences begin when the option is exercised (or, for CCPC employees, later still).

Second, the benefit is employment income, not a capital gain. It is added to the employee's income for the year and reported on the T4 slip, just like salary. This is the single most common misunderstanding about employee stock options and Canada tax. The growth in value between grant and exercise is compensation for work, so it is taxed as such.

Third, the benefit is locked in on the exercise date. Whatever happens to the share price afterward does not change the amount of the employment benefit. Only growth (or decline) after exercise is treated as a capital gain (or capital loss) when the shares are eventually sold.

For example, suppose an employee holds 1,000 options with an exercise price of $1 per share, and exercises them when the shares are worth $10. The section 7 benefit is $9,000. The employee's adjusted cost base in the shares becomes $10 per share (the $1 paid plus the $9 already taxed as a benefit). So if the shares are later sold at $15, only the additional $5,000 is a capital gain.

The CRA's guidance on employee security options walks through the same calculation.

CCPC Stock Options vs. Non-CCPC Options: The Critical Timing Difference

When the benefit is taxed depends on the type of employer that granted the option.

Non-CCPC employers: taxed in the year of exercise

For public companies, and for private companies that are not CCPCs, the section 7 benefit is included in income in the year the employee exercises the option. This second group includes, for example, a Canadian subsidiary controlled by a foreign parent, or a private company controlled by non-residents.

For employees of a listed company, this is usually manageable, because shares can be sold to fund the tax. The real danger is with private non-CCPCs: an employee may owe tax on a large benefit while holding shares that cannot be sold. This is often called "dry income."

CCPC employers: taxed when the shares are sold

CCPC stock options receive much more favourable timing. Under subsection 7(1.1) of the Income Tax Act, the rule changes if the employer was a CCPC when the option agreement was made and the employee dealt at arm's length with the corporation. In that case, the benefit is not included in income when the option is exercised. Instead, it is deferred to the year the employee disposes of the shares (subject to special rules on death).

An employee of a Canadian-controlled startup can therefore exercise, hold the shares for years, and pay no tax on the benefit until a sale or other disposition. The test looks at CCPC status when the option agreement was made, not later. So options granted while the company was a CCPC generally keep this deferral even if the company later loses CCPC status, for example on going public or after a foreign investment.

Two cautions apply. CCPC status is a fact-specific legal question involving control tests and share rights, so confirm it with counsel rather than assume it. And this deferral is distinct from other tax-deferred tools, such as a section 86 rollover, that founders may use when restructuring share capital.

The Stock Option Deduction in Canada: Section 110(1)(d)

The stock option deduction in Canada is what makes options tax-efficient compared with a cash bonus of the same size. Where the conditions in paragraph 110(1)(d) of the Income Tax Act are met, the employee can deduct 50% of the section 7 benefit when calculating taxable income.

Returning to the example above, the $9,000 benefit is still reported in full as employment income, but a $4,500 deduction reduces taxable income, so only $4,500 is effectively taxed.

The result resembles capital gains treatment, because the capital gains inclusion rate is also 50%. The two regimes are legally distinct, however. The benefit remains employment income, it appears on the T4, and it cannot be offset by capital losses.

To qualify for the section 110(1)(d) deduction, the following conditions must generally be satisfied:

Exercise price at or above FMV at grant. The exercise price must not be less than the fair market value of the shares on the date the option was granted. Options granted "in the money" do not qualify under this paragraph.
Prescribed shares. The shares must be "prescribed shares" under the Income Tax Regulations. In general, this means ordinary common shares without preferential features such as guaranteed redemption or dividend priority.
Arm's length. The employee must deal at arm's length with the employer (and with the corporation issuing the shares, if different). Founders and their family members often fail this test.
Not a non-qualified security. For options granted after June 30, 2021, the shares must not be "non-qualified securities" under the $200,000 regime discussed below.

Non-CCPC employees claim the deduction in the year of exercise; CCPC employees claim it in the year of disposition, alongside the deferred benefit.

The $200,000 Annual Vesting Limit (Options Granted After June 30, 2021)

In 2021, the federal government limited the section 110(1)(d) deduction for employees of larger companies. The rules, now found in subsections 110(1.1) to (1.9) and related provisions of the Income Tax Act, apply to options granted after June 30, 2021.

Who the limit applies to

The limit does not apply to CCPCs. It also does not apply to non-CCPC employers whose annual gross revenue is $500 million or less. For corporate groups preparing consolidated financial statements, this is measured using consolidated group revenue. In practice, this means the vast majority of Ontario startups and private companies are unaffected. The CRA's guidance on employee security options and the underlying Income Tax Act provisions set out the full mechanics.

How the limit works

For employers that are subject to the rules, each employee can receive up to $200,000 worth of options vesting in a single calendar year. Those options remain eligible for the 50% deduction. The $200,000 figure is measured using the fair market value of the underlying shares at the grant date, not at exercise.

Options that vest above the limit become "non-qualified securities." When exercised, the full benefit is still taxed as employment income, but the employee cannot claim the 50% deduction on that portion. In exchange, the employer may be able to claim a corporate deduction for the benefit on non-qualified securities. That deduction is not available for ordinary qualifying options. Employers subject to the regime can also choose to designate options as non-qualified, even within the $200,000 limit, to preserve their own deduction.

Employer notification duties

An employer granting non-qualified securities must notify the affected employee in writing. This notice must generally go out within 30 days after the grant and state that the options are non-qualified securities. The employer must also notify the CRA by the filing due date for its tax return for the year in which the options were granted.

Employees of large private technology companies or Canadian subsidiaries of multinationals should ask HR whether their employer exceeds the $500 million threshold. Most others can set this rule aside.

CCPC Stock Options: The Section 110(1)(d.1) Two-Year Holding Deduction

CCPC employees have a second path to the 50% deduction that is not available to anyone else. Under paragraph 110(1)(d.1), an employee who acquired shares of a CCPC under an option agreement, while dealing at arm's length with the employer, gets that second path. They may deduct 50% of the benefit if they hold the shares for at least two years before disposing of them.

Paragraph 110(1)(d.1) differs from 110(1)(d) in one key way. The two-year deduction does not require the exercise price to have been at or above fair market value at the grant date. This matters for early-stage companies where valuations are uncertain and options may have been priced below value. The employee cannot claim both deductions on the same benefit. If the section 110(1)(d) conditions are met, that deduction applies, and the (d.1) route becomes relevant only where it is not available.

Put together, CCPC stock options can offer two advantages at once:

Deferral: no tax on the benefit until the shares are sold, under subsection 7(1.1).
Reduced rate: a 50% deduction on the benefit, either under paragraph 110(1)(d) or, after two years of holding, under paragraph 110(1)(d.1).

This combination is a major reason founders of Canadian-controlled companies use options to attract talent. Founders who also hold shares and sit on the board should keep their different roles in view when approving grants to themselves or related parties. Our article on the difference between a director and a shareholder explains how those roles interact.

Employer Withholding and T4 Reporting Obligations

Employers carry real compliance duties for stock options, and errors tend to surface on T4 slips and payroll audits.

Withholding at source

Non-CCPC employers must generally withhold and remit income tax on the section 7 benefit in the pay period in which the option is exercised. This applies even though the benefit is non-cash. Where the section 110(1)(d) deduction is available, withholding is calculated on the benefit net of that deduction. Canada Pension Plan contributions generally also apply to the benefit.

For CCPC employers, the CRA's security options guidance indicates that income tax withholding is generally not required on a benefit deferred under subsection 7(1.1). Withholding relief depends on specific conditions, so employers should confirm their position with a tax professional before each exercise window. They should also consider how option plans fit their broader corporate tax planning.

T4 codes

The CRA's page on reporting the benefit on the T4 slip sets out how the benefit and deductions are reported:

Code 38: security option benefits, which are also included in Box 14 employment income.
Code 39: the section 110(1)(d) deduction.
Code 41: the section 110(1)(d.1) deduction for CCPC shares.
Code 86: security option cash-out payments for which the employer has made the election discussed below.

Cash-outs and the section 110(1.1) election

Some plans allow the employer to cancel options in exchange for a cash payment rather than issuing shares. In that case, the employee can claim the 50% deduction only if the employer files an election under subsection 110(1.1) to forgo its own deduction for the payment. Without the election, the full cash-out is taxed as ordinary employment income with no deduction.

Common Pitfalls for Ontario Employers and Employees

The rules on tax on stock options in Canada are technical, but most expensive mistakes fall into a handful of recurring patterns.

Granting options to contractors

Section 7 applies only to employees. An independent contractor, consultant, or advisor who receives options does not get the section 7 regime at all. Under subsection 9(1) of the Income Tax Act, the value of the options is generally treated as business income. It can be taxable at grant, with no CCPC deferral and no 50% deduction. There may also be HST exposure if the contractor is registered.

Early-stage Ontario companies often grant advisors options under a plan drafted only for employees; those arrangements usually need a different structure. Worker classification also has employment-law consequences separate from tax; our Toronto employment lawyers page covers that side of the analysis.

Underwater options after exercise

The section 7 benefit is fixed on the exercise date. So a non-CCPC employee who exercises and holds still owes tax on the original benefit even if the share price later collapses. The loss on sale is a capital loss, usable generally only against capital gains, not against the employment income that created the tax bill.

Leaving Canada with unexercised options

On ceasing Canadian residency, an individual is generally deemed to dispose of most property at fair market value under section 128.1 of the Income Tax Act (departure tax). Employee stock options are an "excluded right or interest" and are not subject to that deemed disposition. However, the section 7 benefit remains taxable as Canadian-source employment income to the extent it relates to work performed in Canada. Exercising after moving abroad may therefore require a Canadian non-resident tax filing. The new country may tax the benefit too, so get cross-border advice before leaving.

Assuming a cash-out qualifies for the deduction

The 50% deduction does not apply automatically to a cash-out on a sale or reorganization. Confirm in writing that the employer will make the subsection 110(1.1) election; otherwise, the full payment is taxed as ordinary compensation.

Frequently Asked Questions

Is the capital gains inclusion rate increase in effect in Canada in 2026?

No. The federal government proposed in 2024 to raise the capital gains inclusion rate from one-half to two-thirds on gains above $250,000, as described in the Department of Finance backgrounder. That change was deferred in January 2025 and formally cancelled on March 21, 2025, as confirmed in the Government of Canada's announcement cancelling the proposed increase. The 50% rate still applies to gains on option shares sold after exercise, and remains current as of this article's publication date.

What happens to my options if my CCPC employer goes public?

Subsection 7(1.1) looks at the employer's CCPC status when the option agreement was made, not later. Options granted while the company was a CCPC generally keep the deferral to the year of sale. Options granted afterward follow the general rule and are taxed at exercise, and the $200,000 limit may then apply if the company exceeds the $500 million revenue threshold.

Can I claim both the section 110(1)(d) and (d.1) deductions?

No. The two deductions are alternatives for the same benefit. Section 110(1)(d) is claimed where its conditions are met. Section 110(1)(d.1) is available to CCPC employees where the (d) conditions are not met but the shares have been held for at least two years.

Should I exercise my options early to reduce tax?

It depends heavily on the employer's status. For CCPC employees, early exercise at a low valuation can shrink the eventual benefit and start the two-year clock for the (d.1) deduction, often at no immediate tax cost. For non-CCPC employees, early exercise triggers tax immediately and carries the underwater risk described above. Model the decision with an advisor before acting.

Sources & Official Resources

Federal Statutes Cited

Government Guidance

This article provides general information and is not legal or tax advice. CCPC status, prescribed share conditions, and eligibility for the stock option deductions are fact-specific. Individual option grants and plans should be reviewed by a lawyer or accountant before you rely on any particular tax treatment.

Contact Hadri Law

Whether you are a founder designing an option plan for a CCPC or an employee who has just received an exercise notice, the details matter. Getting CCPC status, the 50% deduction conditions, and the $200,000 limit right can mean a materially different result on your tax on stock options in Canada. Martina Caunedo, our tax lawyer, brings more than 12 years of tax experience, including CRA audits, objections, and Tax Court appeals. She works alongside our corporate and M&A team, led by Nassira El Hadri and Nicholas Dempsey. Together they review option plans, grant agreements, and the tax consequences of exercises, cash-outs, and exits.

Call (437) 974-2374 or book a free consultation. We serve clients in English, French, Spanish, and Catalan.

Tax on Stock Options in Canada: A Guide for Employees and Employers

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