A Canadian Share Option Agreement is a legal contract between a corporation and an individual (typically an employee, director, officer, or consultant) that grants the individual the right, but not the obligation, to purchase a specified number of the corporation's shares at a predetermined price (the exercise price) within a defined time period. Share option agreements are a key component of equity compensation in Canada and are subject to a complex intersection of corporate law, securities law, tax law, and employment law.

The corporate law framework for share options is established by the applicable Business Corporations Act, whether the Canada Business Corporations Act (R.S.C. 1985, c. C-44) for federally incorporated companies or the applicable provincial Act (such as the Ontario Business Corporations Act, R.S.O. 1990, c. B.16, or the Business Corporations Act of British Columbia, S.B.C. 2002, c. 57). These statutes set out the requirements for the authorization and issuance of shares, including the need for proper board and shareholder approval.

The tax treatment of stock options in Canada is governed primarily by section 7 of the Income Tax Act (R.S.C. 1985, c. 1 (5th Supp.)), which provides that the benefit arising from the exercise of an employee stock option is generally included in the employee's income for the taxation year in which the shares are acquired. A special rule for Canadian-controlled private corporations (CCPCs) defers the inclusion of the benefit until the shares are actually disposed of, making CCPC stock options particularly attractive for startup companies and their employees.

A Canadian Share Option Agreement is needed whenever a corporation wishes to grant stock options to employees, directors, officers, consultants, or advisors as part of an equity compensation or incentive plan. Stock options are widely used by Canadian companies of all sizes, from early-stage startups to publicly traded corporations, as a tool for attracting and retaining talent, aligning the interests of key personnel with those of shareholders, and conserving cash by offering equity-based compensation.

Startup companies and emerging growth companies frequently use share option agreements to compensate founders, early employees, and advisors when the company cannot afford competitive cash salaries. The CCPC stock option deferral under the Income Tax Act makes options issued by qualifying private corporations particularly attractive. Publicly traded companies use stock options as part of broader executive compensation packages, subject to the rules of the applicable stock exchange and securities commission.

A share option agreement is also needed when a corporation implements a formal stock option plan that has been approved by the board of directors and, where required, by the shareholders. The individual option agreement documents the specific terms applicable to each grant, including the number of shares, exercise price, vesting schedule, and expiration date.

An effective Canadian Share Option Agreement must include several essential elements that address corporate, tax, and securities law requirements. The agreement must identify the corporation and the optionee, specify the jurisdiction of incorporation, and reference any stock option plan under which the options are granted.

The grant section must specify the number of shares, the class of shares (e.g., common shares, Class A shares), the exercise price per share in Canadian dollars, and the grant date. The exercise price should be set at no less than the fair market value of the shares at the time of grant to qualify for the stock option deduction under paragraph 110(1)(d) of the Income Tax Act.

The vesting schedule defines when the optionee becomes entitled to exercise the options, and may include a cliff period (typically 12 months) after which a portion of the options vest, with the remainder vesting monthly or quarterly over a total vesting period (commonly four years). The exercise mechanism should specify whether exercise is by cash payment, cashless exercise, or the optionee's election.

The agreement must address what happens to options upon termination of the optionee's relationship with the company, including the post-termination exercise period for vested options and the treatment of unvested options. A non-transferability clause should restrict the transfer of options to by will or laws of succession only. The tax implications section should reference subsection 7(1) of the Income Tax Act and the CCPC deferral if applicable. Securities law compliance should reference National Instrument 45-106 and applicable resale restrictions. The governing law clause should specify the applicable province and federal law.