Who withholds tax when employee stock options are cashed out in a sale?

When a company is sold, employees who hold stock options are often paid out in cash at closing. Because that payment is employment-related, tax generally has to be withheld before the employee receives it, and someone must remit it to the CRA. In a deal with several parties it is easy to assume another party is handling this, so it helps to see what the Income Tax Act actually says.

The rule in the Income Tax Act

Section 153 requires every person paying salary, wages or other remuneration to deduct or withhold the amount set by prescribed rules and to remit it to the Receiver General. For stock options, subsection 153(1.01) treats an amount deemed received as a stock option benefit as remuneration paid as a bonus, which brings it into that rule. The Act excepts the portion deductible under paragraph 110(1)(d), the portion deemed received because of a disposition of securities to which subsection 7(1.1) applies, and the portion deductible under paragraph 110(1)(d.01), so the amount withheld can be less than the full benefit.

Who the payer is in a sale

The rule attaches to the person who pays, so the answer depends on how the money moves. If the company that employs the option holder runs the payment through its payroll, that company withholds. If a buyer or an escrow agent pays holders directly, the agreement should say who withholds and who remits. The CRA publishes how and when payroll deductions are remitted, including a final remittance when a business is changing.

Closing the payroll account

If a payroll account is closing, the CRA says that before closing it you must remit all payroll source deductions, file final payroll information returns and give T4 slips to former employees. A cash-out paid around closing should therefore be captured in those remittances and slips.

What the sale agreement should settle

• Which entity treats the payment as payroll, and who funds the tax withheld.
• Whether an accountant has confirmed how each holder’s benefit is treated under the plan’s terms.
• When the remittance to the CRA is made and when T4 slips are issued.
• Whether any provincial or territorial withholding applies where the employee works.