Stock-Based Compensation Accounting for Private Companies in Canada

Stock-based compensation has become an increasingly popular tool for private companies in Mississauga, the GTA, and across Ontario to attract and retain top talent without depleting cash reserves. However, the accounting and tax treatment of stock options, restricted share units (RSUs), phantom shares, and other equity-based compensation arrangements can be complex and requires specialized expertise.

By Bader A. Chowdry, CPA, CA, LPA | Insight Accounting CPA

At Insight Accounting CPA Professional Corporation in Mississauga, we help private companies design, implement, and account for stock-based compensation plans that align with ASPE (Accounting Standards for Private Enterprises) requirements while optimizing tax efficiency for both the company and employees.

Understanding Stock-Based Compensation for Private Companies

Stock-based compensation refers to any arrangement where a company provides employees, directors, or consultants with equity instruments (shares or stock options) or cash payments based on the company’s share price as part of their remuneration package.

For private companies in Ontario and across Canada, these arrangements serve multiple strategic purposes:

• Cash conservation: Reward employees without immediate cash outflow
• Talent attraction: Compete with larger firms for skilled professionals
• Alignment of interests: Create ownership mentality among key employees
• Retention: Vesting periods encourage long-term commitment
• Tax efficiency: Potential tax advantages compared to cash compensation

However, private companies face unique challenges compared to public companies:

• No market price: Share valuation requires professional assessment
• Limited liquidity: Employees may have difficulty realizing value
• Control considerations: Dilution must be carefully managed
• Complex accounting: ASPE Section 3870 requires specific treatment

Types of Stock-Based Compensation for Private Companies

1. Stock Options

Stock options give employees the right to purchase company shares at a predetermined price (the exercise price or strike price) within a specified period.

Key characteristics:

• Graded or cliff vesting: Options vest over time (e.g., 25% annually over 4 years)
• Exercise price: Typically set at fair market value at grant date
• Exercise period: Often 5-10 years from grant date
• Tax treatment: Potential for stock option deduction under subsection 110(1)(d) of the Income Tax Act if conditions are met

Example scenario:

ABC Tech Inc., a private software company in Mississauga, grants an employee 10,000 stock options at $10 per share (current fair market value). The options vest 25% annually over four years and are exercisable for 10 years. If the company is later sold for $50 per share, the employee can exercise all vested options, purchasing shares for $10 and realizing a $40 per share gain.

2. Restricted Share Units (RSUs)

RSUs represent a promise to deliver shares (or cash equivalent) at a future date, typically upon vesting.

Key characteristics:

• No purchase required: Unlike options, employees don’t pay to receive shares
• Vest over time: Subject to service conditions (and sometimes performance conditions)
• Settlement: Can be settled in shares or cash equivalent
• Tax treatment: Taxed as employment income when shares are delivered or cash is paid

RSUs are particularly attractive for private companies because they:

• Provide certainty of value to employees (no risk of being “underwater” like options)
• Avoid the liquidity issue of employees needing cash to exercise options
• Are simpler to communicate and understand

3. Phantom Share Plans

Phantom shares are synthetic equity that mirrors the value of actual shares but doesn’t involve issuing real equity.

Key characteristics:

• Cash-settled: Employees receive cash payments based on share value appreciation
• No dilution: Doesn’t affect actual share ownership
• Flexible design: Can be tied to overall company performance or specific metrics
• Tax treatment: Payments taxed as employment income when received

Phantom share plans work well for:

• Companies with complex shareholder agreements
• Situations where actual equity issuance is restricted
• Privately held family businesses wishing to avoid dilution
• Professional corporations with ownership restrictions

4. Stock Appreciation Rights (SARs)

Similar to phantom shares, SARs provide cash payments equal to the appreciation in share value from the grant date to exercise date.

Key characteristics:

• Appreciate-only: Only pay out if share value increases
• No shares issued: Cash-settled like phantom shares
• Employee choice: Employees typically decide when to exercise (within exercise period)
• Tax treatment: Taxed as employment income when exercised

ASPE Section 3870: Accounting for Stock-Based Compensation

For Canadian private companies reporting under ASPE, Section 3870 “Stock-based Compensation and Other Stock-based Payments” provides the accounting framework.

Recognition and Measurement Principles

#### Equity-Settled Awards

For stock options and other equity-settled awards:

1. Measure the fair value of the equity instruments granted at the grant date
2. Recognize compensation expense over the vesting period
3. Record a corresponding increase in contributed surplus (part of shareholders’ equity)
4. Reclassify from contributed surplus to share capital when options are exercised

Journal entries example:

At grant date (Year 1 of 4-year vesting):

“`

Dr. Compensation Expense $25,000

Cr. Contributed Surplus $25,000

(To record 1/4 of $100,000 fair value of options granted)

“`

When options are exercised:

“`

Dr. Cash $50,000

Dr. Contributed Surplus $100,000

Cr. Share Capital $150,000

(To record exercise of options at $5 per share for 10,000 options)

“`

#### Cash-Settled Awards

For phantom shares, SARs, and cash-settled RSUs:

1. Measure fair value at each reporting date (liability remeasured)
2. Recognize compensation expense over vesting period
3. Record as a liability (not equity)
4. Remeasure at each reporting period until settlement

Journal entries example:

Year 1 (grant date, 1,000 phantom shares, $10 FMV):

“`

Dr. Compensation Expense $2,500

Cr. Liability – Phantom Shares $2,500

(To record 1/4 of $10,000 fair value, first year of 4-year vesting)

“`

Year 2 (share value increases to $15):

“`

Dr. Compensation Expense $7,500

Cr. Liability – Phantom Shares $7,500

(Year 2 vesting: $15,000 2/4 = $7,500 cumulative, less $2,500 previously recorded)

“`

This remeasurement continues until settlement, creating volatility in compensation expense.

Fair Value Measurement for Private Companies

One of the biggest challenges for private companies in Ontario is determining the fair value of equity instruments when there’s no active market.

Valuation approaches:

1. Option pricing models: Black-Scholes or binomial models adapted for private company characteristics
2. Business valuation: Professional valuation of the company’s shares
3. Simplified methods: ASPE allows certain simplified approaches for private companies

Key valuation inputs:

• Current share fair value
• Exercise price
• Expected term (considering vesting and exercise periods)
• Expected volatility (often based on comparable public companies)
• Risk-free interest rate
• Expected dividend yield

At Insight Accounting CPA, we work with qualified business valuators in the GTA to obtain defensible valuations that satisfy both accounting standards and CRA requirements for tax purposes.

Graded Vesting vs. Straight-Line Method

ASPE provides flexibility in how companies recognize compensation expense for awards with graded vesting.

Example: 1,000 options vest 25% annually over 4 years.
Option 1 – Graded vesting (treating each tranche separately):

| Year | Vesting | Expense Recognition |

|——|———|———————|

| 1 | 250 options | 250 options FV |

| 2 | 250 options | (250 FV) + (250 FV 1/2) |

| 3 | 250 options | (250 FV) + (250 FV 1/2) + (250 FV 1/3) |

| 4 | 250 options | Remaining balance |

Option 2 – Straight-line (treating entire grant as one unit):

Total fair value recognized evenly over 4-year vesting period: 1,000 options FV 4 years

The choice affects the pattern of expense recognition but results in the same total expense over the full vesting period.

Tax Implications of Stock-Based Compensation in Canada

Employee Tax Treatment

#### Stock Options – Qualified for Deduction

If stock options meet specific conditions under subsection 110(1)(d) of the Income Tax Act, employees can claim a 50% deduction on the employment benefit:

Conditions for CCPC shares:

1. Shares are prescribed shares (common shares)
2. Employee deals at arm’s length with the corporation
3. Employee holds shares for at least 2 years after exercise
4. Exercise price equals or exceeds FMV at grant date (for options granted after June 2021, subject to $200,000 annual vesting cap)

Conditions for non-CCPC shares:

1. Shares are prescribed shares
2. Employee deals at arm’s length
3. Exercise price equals or exceeds FMV at grant date
4. Subject to $200,000 annual vesting cap for options granted after June 2021

Tax calculation example:

• Option exercise price: $10 (FMV at grant)
• FMV at exercise: $50
• Shares: 1,000
• Employment benefit: 1,000 ($50 – $10) = $40,000
• Stock option deduction (if qualified): $40,000 50% = $20,000
• Net taxable income: $20,000

This effectively provides capital gains-like treatment (50% inclusion rate) on stock option benefits.

#### Stock Options – Not Qualified for Deduction

If conditions aren’t met (e.g., $200,000 annual vesting cap exceeded, options not at FMV):

• Full employment benefit is taxable
• No 50% deduction available
• Taxed as regular employment income at full marginal rate

#### RSUs and Phantom Shares

• Fully taxable as employment income when received
• No preferential treatment
• Subject to withholding tax obligations by employer

Employer Tax Treatment

Stock options:

• No tax deduction when options granted
• No tax deduction when options exercised (if employee receives deduction under 110(1)(d))
• Tax deduction available when options exercised IF employee does NOT receive 110(1)(d) deduction (conditions not met)

Cash-settled awards (phantom shares, SARs):

• Tax deduction when cash payment is made
• Deductible as employment expense

This creates a trade-off: equity-settled options that qualify for employee tax benefits don’t provide employer tax deductions, while cash-settled arrangements provide employer deductions but less favourable employee treatment.

Withholding Requirements

Employers in Ontario must withhold:

• Income tax on employment benefits from stock-based compensation
• CPP contributions (up to annual maximum)
• EI premiums (up to annual maximum)

Challenge for private companies: Withholding cash when no cash changes hands (e.g., option exercises where employee receives shares).
Solutions:

1. Cashless exercise: Employee sells enough shares to cover withholding
2. Net settlement: Company withholds shares equivalent to tax owing
3. Employee pays: Employee provides cash for withholding obligations

Insight Accounting CPA helps Mississauga and GTA companies establish compliant withholding procedures that balance employee experience with regulatory requirements.

Designing Effective Stock-Based Compensation Plans

Key Design Considerations

#### 1. Plan Objectives

Define what you want to achieve:

• Attract new talent vs. retain existing employees?
• Broad-based (all employees) vs. targeted (executives only)?
• Long-term incentive vs. annual performance reward?
• Minimize cash compensation vs. supplement competitive packages?

#### 2. Eligibility and Allocation

Determine:

• Which employee categories are eligible
• How many options/units each level receives
• Whether allocation is formula-based or discretionary
• How new hires are incorporated

#### 3. Vesting Schedule

Common approaches:

• Cliff vesting: All options vest at once after a period (e.g., 100% after 3 years)
• Graded vesting: Options vest incrementally (e.g., 25% annually over 4 years)
• Performance vesting: Vesting contingent on achieving specific goals
• Hybrid: Combination of time and performance conditions

Longer vesting periods improve retention but may be less attractive to candidates.

#### 4. Exercise Price

For stock options:

• At-the-money: Exercise price = FMV at grant (qualifies for tax deduction)
• In-the-money: Exercise price < FMV at grant (doesn't qualify; creates immediate taxable benefit)
• Out-of-the-money: Exercise price > FMV at grant (rarely used)

For private companies in Ontario, obtaining a credible FMV at grant date is critical for both accounting and tax purposes.

#### 5. Exercise Period and Expiry

Typical provisions:

• Options exercisable for 5-10 years from grant
• Termination provisions (e.g., 90 days to exercise after resignation)
• Change of control acceleration (all options vest immediately upon sale)
• Death/disability provisions (extended exercise periods)

#### 6. Dilution Limits

Shareholders typically approve:

• Maximum percentage of shares reserved for options (e.g., 10% of outstanding)
• Annual grant limits
• Individual participant maximums

For private companies in Mississauga and the GTA, managing dilution is especially important when planning for future financing rounds or potential sale.

Common Plan Structures for Private Companies

#### Startup/High-Growth Tech

• Heavy use of stock options to conserve cash
• Broad-based eligibility (all employees receive some equity)
• 4-year vesting with 1-year cliff (industry standard)
• Exercise price at FMV to qualify for tax deduction
• Generous dilution pool (15-20% of equity)

#### Mature Private Company

• Mix of options and cash bonuses
• Targeted eligibility (executives, key technical staff)
• Performance-based vesting tied to revenue/profit targets
• Moderate dilution pool (5-10% of equity)
• May use phantom shares to avoid dilution

#### Family Business

• Phantom shares or SARs to avoid issuing equity to non-family members
• Restricted eligibility (senior management only)
• Long vesting periods (5+ years) to ensure commitment
• No actual dilution of family ownership

#### Professional Corporation

• Cash-settled plans only (due to ownership restrictions)
• Phantom shares tied to practice profitability
• Annual or semi-annual payouts rather than long-term vesting
• Designed to supplement base salary based on firm performance

Implementing a Stock-Based Compensation Plan

Step-by-Step Process

#### 1. Board and Shareholder Approval

• Draft plan document outlining all terms
• Board resolution approving the plan and initial grants
• Shareholder approval (may be required by articles/unanimous shareholder agreement)
• Document approval in corporate minute book

#### 2. Fair Market Valuation

For private companies in Ontario:

• Engage qualified business valuator
• Obtain formal valuation report
• Document valuation methodology and assumptions
• Update periodically (annually or at each grant date)

This valuation serves dual purposes:

• ASPE Section 3870 accounting requirements
• CRA compliance for employee stock option deduction eligibility

#### 3. Grant Documentation

For each participant:

• Individual stock option agreement or RSU grant agreement
• Clear statement of number of options/units, vesting schedule, exercise price
• Provisions for termination, change of control, transferability
• Employee acknowledgment and signature

#### 4. Accounting Setup

• Establish contributed surplus account (for equity-settled awards)
• Create liability accounts (for cash-settled awards)
• Calculate initial compensation expense based on fair value
• Set up schedule to track vesting and expense recognition over time

At Insight Accounting CPA, we implement robust tracking systems for our GTA clients that automate expense recognition and provide real-time reporting on outstanding equity awards.

#### 5. Payroll and Tax Compliance

• Establish procedures for withholding when options exercised or awards settled
• Prepare T4 slips reporting employment benefits
• File stock option benefits with CRA on prescribed forms
• Maintain detailed records of all grants, exercises, and settlements

#### 6. Ongoing Administration

• Track vesting schedules for all participants
• Process exercises and settlements
• Issue shares or make cash payments
• Update valuation periodically
• Amend plan as needed (with board/shareholder approval)

Many of our Mississauga clients outsource this administration to us, ensuring accurate accounting, tax compliance, and timely reporting.

Common Challenges and Pitfalls

Challenge 1: Valuation Uncertainty

Issue: Private company shares have no market price, making valuation subjective and potentially contentious.
Solution:

• Obtain independent professional valuations at regular intervals
• Use consistent methodology over time
• Document key assumptions clearly
• Consider formula-based valuation approaches in shareholder agreements

Challenge 2: Liquidity Constraints

Issue: Employees hold illiquid shares with no ready market to sell.
Solution:

• Establish company buyback programs to provide liquidity at specific intervals
• Include drag-along provisions so employees can participate in sale transactions
• Consider cash-settled alternatives (phantom shares) instead of actual equity
• Communicate realistic expectations about liquidity timeline

Challenge 3: Dilution Concerns

Issue: Existing shareholders resist dilution from employee equity awards.
Solution:

• Set clear dilution limits in advance (approved by shareholders)
• Use phantom shares or cash-settled RSUs to avoid actual dilution
• Reserve option pool as part of capitalization table from early stages
• Communicate value creation from employee equity incentives

Challenge 4: Changing Tax Rules

Issue: Federal budget 2021 introduced $200,000 annual vesting cap on qualifying stock options.
Impact:

For options granted after June 2021, only $200,000 worth of options (based on FMV of underlying shares at grant date) that vest in any calendar year qualify for the 50% stock option deduction. Options exceeding this cap are taxed as regular employment income.

Solution:

• Spread vesting over multiple years to stay within annual cap
• Identify qualifying vs. non-qualifying options at grant date
• Communicate tax implications clearly to employees
• Consider cash bonuses or other compensation for executive-level employees who exceed cap

Challenge 5: Accounting Volatility (Cash-Settled Awards)

Issue: Phantom shares and SARs require remeasurement at each reporting date, creating earnings volatility.
Solution:

• Consider equity-settled alternatives if volatility is problematic
• Use longer-term strategic planning to smooth impact over multiple periods
• Communicate nature of volatility to stakeholders (lenders, investors)
• Hedge exposure if awards are significant (rare for private companies)

Challenge 6: Termination Provisions

Issue: Employees who leave (voluntarily or involuntarily) create complex exercise scenarios.
Solution:

• Draft clear termination provisions in option agreements:
• Resignation: typically 90 days to exercise vested options
• Termination for cause: forfeiture of all options (vested and unvested)
• Termination without cause: retention of vested options with exercise period
• Death/disability: extended exercise period (e.g., 12 months)
• Consistently apply provisions to avoid discrimination claims
• Document circumstances of each termination

Best Practices for Ontario Private Companies

1. Obtain Professional Valuation Regularly

Work with qualified business valuators in the GTA to:

• Establish defensible fair market value for accounting and tax purposes
• Support stock option deduction eligibility for employees
• Provide credibility with CRA in case of audit
• Update valuation at least annually or when significant events occur

2. Integrate with Overall Compensation Strategy

Stock-based compensation should complement, not replace, competitive base salary and benefits:

• Benchmark total compensation (cash + equity) against market
• Consider life stage of employees (early career vs. established professionals)
• Communicate value of equity awards clearly (many employees undervalue illiquid equity)
• Provide choice where possible (e.g., higher salary vs. more equity)

3. Plan for Exit Scenarios

Address what happens to unvested and vested equity in common scenarios:

• Sale of company (accelerated vesting? buyer assumption of options?)
• Recapitalization (adjustment of exercise price?)
• Bankruptcy/wind-up (subordination of equity claims)
• IPO (conversion to public company options?)

Well-drafted plan documents and option agreements anticipate these scenarios.

4. Maintain Detailed Records

Essential documentation includes:

• Board resolutions approving plan and each grant
• Individual option/RSU agreements signed by participants
• Valuation reports at each grant date
• Vesting schedules and tracking spreadsheets
• Exercise/settlement records
• T4 slips and payroll records
• Minute book entries for share issuances

This documentation is critical for:

• Audit support (financial statement audits)
• CRA tax audits
• Due diligence in M&A transactions
• Legal disputes with former employees

5. Communicate Clearly and Often

Employees often don’t fully understand their equity awards:

• Provide educational materials explaining how options/RSUs work
• Hold annual updates on company valuation and vesting status
• Offer one-on-one sessions for significant grants
• Explain tax implications at grant, vesting, and exercise
• Set realistic expectations about liquidity and valuation growth

At Insight Accounting CPA, we help our Mississauga clients prepare employee-friendly summaries and conduct education sessions.

Insight Accounting CPA: Your Partner for Stock-Based Compensation

At Insight Accounting CPA Professional Corporation in Mississauga, we provide comprehensive support for private companies implementing and managing stock-based compensation plans across Ontario and the GTA:

Our Services Include:

Plan Design and Documentation:

• Collaborate with legal counsel to draft plan documents and agreements
• Model financial impact of different plan structures
• Recommend optimal mix of equity-settled vs. cash-settled awards
• Ensure compliance with corporate law, tax law, and accounting standards

Valuation Coordination:

• Engage qualified business valuators
• Review valuation reports for reasonableness and compliance
• Coordinate regular valuation updates
• Support valuation documentation for CRA purposes

Accounting Implementation:

• Calculate fair value of equity instruments under ASPE 3870
• Set up contributed surplus and liability accounts
• Establish tracking systems for vesting and expense recognition
• Prepare journal entries and financial statement disclosures

Tax Compliance and Planning:

• Determine whether stock options qualify for employee tax deduction
• Calculate employment benefits and withholding requirements
• Prepare T4 slips and required CRA forms
• Optimize plan design for tax efficiency
• Represent clients in CRA audits related to stock-based compensation

Ongoing Administration:

• Track vesting schedules for all participants
• Calculate periodic compensation expense (quarterly or annually)
• Process option exercises and RSU settlements
• Maintain participant records and reporting
• Provide annual statements to employees showing vested/unvested awards

Strategic Advisory:

• Benchmark equity compensation against industry standards
• Advise on dilution management and cap table planning
• Plan for exit scenarios (sale, IPO, recapitalization)
• Support due diligence in M&A transactions
• Integrate equity compensation with overall talent strategy

Why Mississauga and GTA Companies Choose Insight Accounting CPA

Specialized ASPE Expertise: Deep knowledge of Section 3870 and related standards for private companies.
Tax Optimization: Maximize tax benefits for both company and employees within CRA rules.
Integrated Service: Coordinate valuation, accounting, tax, and payroll aspects seamlessly.
Technology-Enabled: Robust tracking systems and automated reporting reduce administrative burden.
Practical Approach: Recommend solutions that work in the real world, balancing compliance with business objectives.
Ongoing Support: Available for questions, plan amendments, and troubleshooting as your business evolves.
Proven Track Record: Successfully implemented stock-based compensation plans for technology companies, professional services firms, healthcare practices, and family businesses across the GTA.

Industry-Specific Considerations

Technology Startups in Mississauga and GTA

Tech companies typically grant broad-based stock options:

• Accounting: Options vest over 4 years with 1-year cliff; fair value calculated using Black-Scholes model adapted for private company volatility
• Tax: Ensure exercise price equals FMV to qualify for employee deduction; monitor $200,000 annual vesting cap for senior employees
• Strategy: Reserve 15-20% dilution pool to remain competitive; offer cash bonuses to offset employees who can’t wait for liquidity

Healthcare Professionals (Physicians, Dentists)

Professional corporations face ownership restrictions:

• Accounting: Use phantom shares (cash-settled) instead of actual equity; remeasure liability quarterly based on practice valuation
• Tax: Phantom share payments fully deductible for corporation; taxed as employment income for recipient
• Strategy: Tie phantom shares to practice profitability metrics; shorter vesting periods (2-3 years) given stable business model

Manufacturing and Construction

Capital-intensive businesses with stable cash flows:

• Accounting: Mix of stock options (senior management) and cash bonuses (production staff); options vest over 3-5 years tied to revenue milestones
• Tax: Use CCPC stock option rules to maximize 50% employee deduction; coordinate with estate planning for owner succession
• Strategy: Moderate dilution (5-10%); phantom shares for non-family employees in family-owned businesses

Professional Services (Consulting, Legal, Accounting)

Partnership or professional corporation structures:

• Accounting: Often use “points” or “units” rather than shares; profit-sharing rather than equity appreciation
• Tax: If structured as partnership, different tax rules apply (partnership allocations); if professional corporation, phantom shares preferred
• Strategy: Focus on annual or semi-annual performance payouts rather than long-term capital appreciation

Emerging Trends in Private Company Equity Compensation

1. Performance-Based Vesting

Increasingly, private companies in Ontario are moving beyond time-based vesting to include performance conditions:

• Revenue targets (e.g., options vest only if company achieves $10M ARR)
• Profitability milestones (e.g., EBITDA > $2M for two consecutive years)
• Individual performance metrics (tied to MBOs or KPIs)
• Relative performance (company growth vs. industry benchmarks)

Accounting impact: Performance conditions affect vesting probability assumptions and may require remeasurement if performance metrics are market-based.

2. Restricted Stock Awards (RSAs)

Some private companies grant actual shares upfront (subject to forfeiture if employee leaves):

• Employee owns shares immediately (with voting rights)
• Shares subject to vesting (forfeited if employment terminates before vesting)
• Section 83(b) election (US concept; no direct equivalent in Canada)
• Tax: immediate employment benefit unless shares have no value; forfeiture doesn’t generate loss

RSAs are less common in Canada due to tax complications.

3. Secondary Market Opportunities

To address liquidity challenges, some high-growth private companies facilitate secondary transactions:

• Annual tender offers allowing employees to sell vested shares to investors
• Company buyback programs at formula-based valuations
• Employee pools that participate when investors exit

Accounting impact: May affect share valuation if secondary transactions establish market price.

4. Hybrid Structures

Combining elements:

• Options that convert to RSUs if not exercised within a period
• Performance RSUs that convert to options if targets exceeded
• Cash-settled awards with option to take shares instead

These structures add complexity but can better align incentives.

Frequently Asked Questions

1. How do I determine the fair value of stock options for a private company?

Fair value is typically calculated using option pricing models (Black-Scholes or binomial) that consider:

• Current share fair value (from business valuation)
• Exercise price
• Expected term (time until exercise, typically shorter than contractual term)
• Expected volatility (often based on comparable public companies)
• Risk-free interest rate (Government of Canada bond yields)
• Expected dividend yield

Private companies should engage qualified valuators in the GTA to determine these inputs and calculate fair value in compliance with ASPE 3870.

2. Can employees exercise stock options if they don’t have cash?

Yes, several alternatives exist:

• Cashless exercise: Employee simultaneously sells shares to cover exercise cost and withholding taxes
• Net settlement: Company withholds shares equivalent to exercise cost and taxes, issues net shares to employee
• Employer loan: Company loans funds to employee to exercise (creates employee loan on balance sheet)
• Wait for liquidity event: Employee exercises upon sale or financing when cash proceeds available

Each alternative has different accounting, tax, and legal implications.

3. What happens to stock options when an employee leaves?

It depends on termination provisions in the option agreement:

• Resignation: Typically 90 days to exercise vested options; unvested options forfeited
• Termination for cause: All options (vested and unvested) forfeited immediately
• Termination without cause: Vested options retained with exercise period; unvested forfeited (sometimes with partial credit)
• Retirement: Extended exercise period (e.g., 12-24 months)
• Death/disability: Extended period (12-24 months) and sometimes accelerated vesting

Clear termination provisions are essential to avoid disputes and ensure consistent treatment.

4. Do phantom shares dilute existing shareholders?

No. Phantom shares are synthetic equity that creates economic exposure without issuing actual shares. They are cash-settled liabilities, not equity.

However, the cash drain from settling phantom shares can impact company value, which indirectly affects shareholders (reduced cash reduces enterprise value).

5. How does the $200,000 annual vesting cap work?

For employee stock options granted after June 2021:

• Calculate FMV of underlying shares at grant date
• Multiply by number of options vesting in each calendar year
• If annual vesting exceeds $200,000, only the first $200,000 qualifies for the 50% employee deduction
• Excess is taxed as regular employment income (no deduction)

Example: Employee granted 100,000 options when shares are worth $10. Options vest 25% annually (25,000 options per year).

Annual vesting value: 25,000 $10 = $250,000

Only $200,000 qualifies for deduction; remaining $50,000 is non-qualifying.

6. What financial statement disclosures are required under ASPE?

ASPE Section 3870 requires disclosure of:

• Description of stock-based compensation plans
• Number and weighted-average exercise price of options (outstanding, granted, exercised, forfeited)
• Weighted-average remaining contractual life
• Range of exercise prices for outstanding options
• Method of fair value determination and key assumptions
• Total compensation expense recognized in the period
• For cash-settled awards, total liability and intrinsic value

Insight Accounting CPA prepares comprehensive note disclosures for our Mississauga and GTA clients.

7. Should we use equity-settled or cash-settled awards?

The choice depends on several factors:

Equity-settled (stock options, RSUs settled in shares):

• No cash outflow (conserves cash)
• Aligns employee interests with shareholder value
• May qualify for 50% employee tax deduction
• Dilutes existing shareholders
• Creates illiquid shares for employees
• No corporate tax deduction (if employee gets deduction)

Cash-settled (phantom shares, SARs):

• No dilution of shareholders
• Corporate tax deduction when paid
• Employees receive cash (liquidity)
• Cash drain when settled
• Taxed fully as employment income (no preferential treatment)
• Accounting volatility (liability remeasured each period)

Many of our Ontario clients use a hybrid approach: equity-settled for senior management (aligned with exit value), cash-settled for broader employee base (liquidity and simplicity).

Take Action: Implement Stock-Based Compensation That Works

Stock-based compensation is a powerful tool for private companies in Mississauga, the GTA, and across Ontario to attract, motivate, and retain talent. However, the accounting complexity under ASPE 3870 and the tax implications for both employers and employees require specialized expertise.

At Insight Accounting CPA Professional Corporation, we guide private companies through every stage:

Plan design that aligns with business objectives

Compliance with ASPE 3870 accounting requirements

Tax optimization for both company and employees

Valuation coordination with qualified business valuators

Ongoing administration and reporting

Whether you’re implementing your first stock option plan or managing a mature equity compensation program, our team in Mississauga has the expertise to ensure your plan is compliant, tax-efficient, and aligned with your talent strategy.

Contact Insight Accounting CPA today:

(905) 270-1873

info@insightscpa.ca

www.insightscpa.ca

Serving Mississauga, Toronto, Brampton, Oakville, and the Greater Toronto Area

---

Frequently Asked Questions About Stock-Based Compensation

Q1: How do I determine the fair value of stock options for a private company?

Fair value is typically calculated using option pricing models (Black-Scholes or binomial) that consider current share value, exercise price, expected term, volatility, risk-free rate, and dividend yield. Private companies should engage qualified valuators to determine these inputs in compliance with ASPE 3870.

Q2: Can employees exercise stock options if they don’t have cash?

Yes. Options include cashless exercise (simultaneous sale of shares), net settlement (company withholds shares for taxes), employer loans, or waiting for liquidity events. Each has different accounting and tax implications.

Q3: What happens to stock options when an employee leaves?

It depends on the option agreement. Typically: resignation (90 days to exercise vested options), termination for cause (all options forfeited), termination without cause (vested retained), death/disability (extended exercise period). Clear provisions prevent disputes.

Q4: Do phantom shares dilute existing shareholders?

No. Phantom shares are cash-settled liabilities that don’t involve issuing actual equity. However, cash payouts can reduce company value, indirectly affecting shareholders.

Q5: How does the $200,000 annual vesting cap work?

For options granted after June 2021, only $200,000 worth of options (based on FMV at grant) vesting per calendar year qualify for the 50% employee tax deduction. Excess is taxed as regular employment income.

Q6: What disclosures are required under ASPE Section 3870?

Disclosures include plan descriptions, option activity (granted, exercised, forfeited), weighted-average exercise prices, contractual life, valuation methods and assumptions, compensation expense, and liability balances for cash-settled awards.

Q7: Should we use equity-settled or cash-settled awards?

Equity-settled (stock options, RSUs): no cash outflow, potential employee tax deduction, but dilutes shareholders and creates illiquid shares.

Cash-settled (phantom shares, SARs): no dilution, corporate tax deduction, liquidity for employees, but requires cash and creates accounting volatility.

Many companies use hybrid approaches based on employee level and business objectives.

---

About the Author

Bader A. Chowdry, CPA, CA, LPA is the founder of Insight Accounting CPA Professional Corporation in Mississauga. With extensive experience serving private companies across Ontario, Bader specializes in complex accounting standards (ASPE/IFRS), tax planning, and strategic financial advisory. His patent-pending AI governance framework for accounting firms has been featured in Yahoo Finance and positions Insight Accounting as a leader in technology-enabled professional services.

Insight Accounting CPA serves businesses across Mississauga, Toronto, Brampton, Oakville, Vaughan, and the Greater Toronto Area, providing accounting, tax, audit, fractional CFO, and AI advisory services to companies ranging from startups to established enterprises.

Ready to implement a stock-based compensation plan that attracts talent and drives growth? Call (905) 270-1873 for a consultation with our team.