Question

Lennox Lowes was granted, in year one, an option to purchase 50,000 common shares at $1 per share from her employer, Michael Ltd., a Canadian-controlled private corporation. The shares had an estimated fair market value at this date of $1.50. However, according to the agreement, Lennox could not exercise her option until her fourth employment year. Lennox did exercise her entire option in year five; the fair market value of the shares at that time was $3. Lennox sold all the shares in year six, at $6 per share.

Required:

Discuss the tax implications of the above transactions.

Lennox Lowes was granted, in year one, an option to purchase 50,000 common shares at $1 per share from her employer, Michael Ltd., a Canadian-controlled private corporation. The shares had an estimated fair market value at this date of $1.50. However, according to the agreement, Lennox could not exercise her option until her fourth employment year. Lennox did exercise her entire option in year five; the fair market value of the shares at that time was $3. Lennox sold all the shares in year six, at $6 per share.

Required:

Discuss the tax implications of the above transactions.

Answer 1

At the time of exercise – as a perquisite. When the employee has exercised the option, the difference between the FMV (on exercise date) and exercise price is taxed as perquisite. The employer deducts TDS on this perquisite.

At the time of sale by employee – as a capital gain. The employee may choose to sell the shares once these are bought by him. If the employee sells these shares, another tax event happens. The difference between sale price and FMV on the exercise date is taxed as capital gains.