Just to clarify for those who may be less familiar with Canadian tax rules: Canadian-controlled private corporation is exactly what it sounds like and has special tax rules (including lower tax rates) in Canada.

I interpret the parent as referring to options in a corporation that is not a CCPC rather than options in a private corporation controlled by non-Canadians.

Correct. Options exercised in a CCPC don't result in a tax hit until the shares are liquidated.

Options exercised in a non-CCPC are subject to income tax on the difference between strike price and FMV of the shares at the time of exercise.

Fun!

Got any good sources on what exactly the rules are in Canada?

Taxes on income (share value - option strike price) become owing on option exercise.

If the company is not a CCPC and the value of the options at grant-time were less than the share value, you may qualify for a 50% deduction (bringing it in line with capital gains), subject to some conditions (arms-length dealing, etc).

If the company is a CCPC, you can defer the taxes until the shares are sold. If sold within 2 years, you pay full income tax. If sold after 2 years of holding, a 50% deduction applies bringing it in line with capital gains. CCPC status of options are grandfathered in so if the company loses CCPC status, your options continue to qualify.

Keep in mind that going bankrupt/company sale are forced sales of your shares, which could hit you with a big tax bill and since that tax bill is income (not cap gains), the capital losses of the sale cannot be used to offset it!

CCPC employees should also look at the lifetime capital gains exemption (LCGE) of $750000 to reduce taxes on the capital gains following exercise, and the allowable business investment loss (ABIL) which can be used to halve the tax owing in the downside case. In theory, the 50% deductions mentioned above and the ABIL stack to reduce the tax owed to 0.

The problem with all of this stuff is that when you exercise, there is no way to know what deductions you will qualify for under various hypothetical scenarios.

It feels like tax laws just aren't set up to deal with the notion of illiquid shares and fairy tale valuations.

This is actually a pretty good summary:

http://www.taxplanningguide.ca/tax-planning-guide/section-1-...

Not, the 50% income deduction also applies to non-CCPC shares if the circumstances are right, which brings the income tax down to approximately capital gains... which at least softens the blow a bit.