What should an Ontario corporation know before setting up a stock option plan?

Stock option plans allow employees and service providers to purchase shares in a corporation at a fixed price (the exercise price) set at the time the options are granted. If the business grows and the share value increases, the option holder benefits from the appreciation. Options typically vest over time to encourage retention.

From a corporate standpoint, an Ontario corporation setting up a stock option plan needs to consider: the corporation's share structure and whether the plan requires shareholder approval, how options are priced (using a fair market value exercise price avoids certain tax complications), vesting schedules and cliff provisions, what happens to unvested options on termination, and whether the plan is intended to be a qualifying plan under the Income Tax Act for favourable employee tax treatment.

For private companies, the tax treatment of stock options is complex. The benefit to the employee is generally recognized when they exercise the option (the difference between exercise price and fair market value). Public company rules differ. Recent federal budget changes have modified the stock option deduction for some employees — confirming the current tax rules with a tax advisor is important.

A well-drafted option plan and individual grant agreements protect both the company and the recipients. Employment lawyers and tax advisors typically need to collaborate on this.