Shawnee Love   •  
March 8, 2010

Canadian companies with stock options take heed. You have come under scrutiny from a government that is trying to reduce the deficit without raising taxes, and one of the ways they are doing that is by going after cash settled stock options.

Cash settled stock options allow employees to choose to be paid out in cash rather than receive shares of the company. If exercised, these options were great for employers because they didn’t dilute the stock and the employer could claim the payout as a compensation expense. Employees liked them because they could claim capital gains deductions on the profit.

The new budget says from now on either the employer or the employee gets to claim the deduction but not both.

Stock options are pretty much not worth the paper they are written on if the stock price written on them is above the current market price, but in situations when the stock option price is below the market price, employees may choose to exercise their options to realize the gains or hold on to the stock for awhile in anticipation of further growth.

If you are an employer that isn’t making a profit, then you might not need the extra compensation expense on your books, so you can pass on the savings to your employees. But when you are making a profit, you will have to carefully consider the costs and benefits of deducting the compensation expense yourself vs. passing on the capital gains deduction to your employees. You will have to weigh the value of tax savings against employee goodwill, particularly when the typical employee with cash settled stock options holds a leadership position and plays a key role in the business.

Stock options are still a great way to add compensation to employees and build employee motivation, but with this change to the rules, I suspect the cash settled version is now out of fashion.