10 March 2000 External T.I. 2000-0006935 - STOCK OPTIONS-EMPLOYEES AND CONTRACTORS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

What are the tax consequences in respect of the issue and exercise of stock options issued as part of an arrangement designed to establish a new corporation and implement a consulting agreement with an individual?

Position:

Explanations and references to publications were provided with respect to the possible tax consequences of receiving and exercising options held by employees, independent contractors and shareholders.

Reasons:

The tax consequences and their timing will depend on whether the option holder receives the options as an employee or as an independent contractor.

XXXXXXXXXX 		2000-000693
W. C. Harding
March 10, 2000

Dear Sir:

Re: Proposed Share Swap Arrangement

This is in reply to your letters of July 20,1999 and January 27, 2000 to the Calgary Tax Services Office in respect to the above-noted arrangement which was referred to us for reply.

In your letter you outlined an arrangement under which you and a public corporation ("Pubco") propose to establish a new corporation ("Newco") for the purpose of operating a new business venture. You also propose to enter into an agreement for consulting services with Newco, and to establish a stock purchase agreement (the "Option") with Pubco. The Option will provide you with a right to acquire shares of the Newco over the life of the consulting agreement and a right to swap such shares for shares of Pubco. The Option will also provide Pubco with a right to acquire any of your shares of Newco acquired under the Option over a specified period of time. You ask what the tax consequences would be to you if the option is issued and exercised and if Pubco elects to exercise its option.

Since your inquiry relates to a specific proposal to establish an actual arrangement, written confirmation of the tax implications may only be provided by us where the proposal is the subject matter of an advance income tax ruling request submitted in the manner set out in the Canada Customs & Revenue Agency's (the "Agency") Information Circular IC70-6R3 Advance Income Tax Rulings which may be obtained from your local tax services office or on the Internet at http://www.ccra-adrc.gc.ca/menu-e.html. Accordingly we can only provide you with the following general comments and conclusions based on the information provided. These may or may not be applicable to your actual situation and are not binding on the Agency.

In general, an option to acquire shares of a corporation is taxable in a manner described in the Agency's Interpretation Bulletin IT-96R6 entitled Options Granted by Corporations to Acquire Shares, Bonds, or Debentures and by Trusts to Acquire Trust Units. This bulletin is available from any tax services office or on the internet at the above-noted address. However, if an option is received by an employee as part of the employee's remuneration, or by an individual as a result of the operation of a business these general provisions may not apply.

Where an option is acquired by an employee, a number of provisions of the Income Tax Act (the "Act") may apply to establish the amount and the timing of any benefits that must be included in the employee's income. These provisions are described in detail in the Agency's Interpretation Bulletin IT-113R4, Benefits to Employees - Stock Options which is also available on the Internet at the same address noted above. Basically, the Act provides that a taxable benefit equal to the value of the shares at the time the option is exercised minus any cost incurred to acquire the option or the shares must be included in the employee's income either at the time of its exercise or, in certain circumstances as discussed in the bulletin when the shares so acquired are sold. Also note the announcement in the Budget Speech of February 28, 2000, concerning the deferral of tax on employee options granted with respect to listed securities.

Where an option is acquired by an individual by virtue of the operation of a business, the Act generally requires the holder to include the value of the option as income from business at the time the option is acquired. Additional income or losses may also result from a subsequent exercise or non-exercise of the option. However the effect of these will depend on whether the option is held in the business as a capital property, to which the comments in IT-96R6 referred to above will apply, or is held as non-capital property used in a business.

When a person enters into a consulting contract it will generally be necessary to determine whether the agreement will establish an employer/employee relationship or a business relationship before it can be determined which of the above provisions will apply. In this respect the Agency relies on several basic tests developed by the courts in deciding whether a particular contract is a contract of services (employer/employee relationship) or a contract for services (client and independent contractor relationship). These tests are generally referred to as the control test, the integration test, the economic reality test and the specified results test. (See Weibe Door Services Ltd. 87 DTC 5025). We are also of the view that a contract which sets out the rights and obligations of the parties and the actual circumstances surrounding the performance of services (and whether such findings of facts agree with what is stated in the contracts) are important to determining whether or not an employer/employee relationship exists at any particular time. The Revenue Collections Division of your tax services office can assist you in understanding the above-noted tests and in determining if an employer/employee relationship exists in your situation. A form CPT1(99) which is also available on the internet at http://www.ccra-adrc.gc.ca/E/pbg/tf/cpt1bq/README.html) may also be submitted to the Revenue Collections Division to request a determination of the relationship once an actual contract is entered into.

An option provided to Pubco to acquire shares of Newco would itself be an option subject to the same comments noted above. However if the option is exercised, the individual would be the vendor of the shares and would be required to report an gains or losses from their disposition either on account of capital (as explained in IT-96R6) or on income account as part of the determination of profits from a business.

We trust this explanation will be of assistance to you.

Yours truly,

P. Spice
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch