Stock Options and The Independent Consultant
Over the last few years there has been a lot written on the value of employees receiving stock options as an employee benefit and the favourable tax treatment this form of compensation receives from the Canada Revenue Agency. However there has been very little discussion on the benefits of using stock options as a way that skilled independent IT consultants can be paid in lieu of money. Independent IT consultants may want to explore this alternative during lean economic times.
It was not that long ago when we heard daily news about Gen Xers who had just graduated college and had begun working for start-up companies that suddenly went public on some stock exchange. Overnight these twenty-something-year-olds would find themselves with more than enough money in the bank to retire comfortably for life. This was, and still is, the lure of company stock option programs. It seems like a lifetime ago since Jan. 14, 2000, when the Dow Jones peaked at 11,722.98 points and March 10, 2000, when the Nasdaq reached its all-time high of 5048.
The lessons that history has taught us over the last century about the movement of stock prices can be summed up in eight words: the downs are temporary; the ups are permanent. Stock options might be out of favour as today’s preferred form of compensation, but those with vision and faith in our economy know that experience has proven that what most people describe as a bear market is actually a really a big sale.
Further, those IT professionals who embrace stock options as a portion of their employment financial compensation have deep down within them an intrinsic belief that their stock options will be very valuable in the future because the companies they are working with will be successful. They want to share in that financial success. In the end true optimism is realism. Fear of the future is counterintuitive to the nature of human progress. The microprocessor, to date, is humanity’s greatest invention and it is only 30 years old; just imagine what innovation the next 30 years will bring.
When the job market was tight in the late ’90s for hitech professionals, paying in stock options allowed companies to get access to top talent at below-market prices. This same logic applies when the Canadian economy is soft.
Companies that trade their potential future stock value in options are able to barter for the skills of highly paid consultants today. Including stock options as compensation will, from the employers’ point of view, solidify their relationship with their contractors. Also, if structured properly, stock options have no financial risk. There are no tax consequences to either the employer or the independent computer consultant as long as the options are not exercised. And when the stock options are exercised, the consultant will receive favourable tax treatment on the proceeds of the sale.
If independent computer consultants are considering receiving stock options as part of the payment, they should be particularly cautious that their relationship is structured contractually so the CRA will view them as independent, not as employees. The CRA tests individuals on four criteria to determine their status as independent consultants:
- Test 1. To what extent does the independent consultant control how the work is done?
- Test 2. Does the independent consultant own the tools?
- Test 3. Does the independent consultant pass the integration test?
- Test 4. What are the chances of profit and loss for the independent consultant?
To help create safeguards from having an employer/ employee relationship deemed by the CRA, stock options issued to independent computer consultants should be in the name of their incorporated companies, not to them personally. All stock option documentation specific to the independent consultant should be excluded from stock option plans and documents for the company’s full-time employees.
Over the last few years the legislation regulating stock options as compensation for employment in Canada have been in constant flux. It would be highly recommended before considering receiving this type of compensation to seek the advice of a labour and employment lawyer and to seek counsel from chartered accountants and certified financial planners to make sure all bases are covered.