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.
Principal Issues: What is the effect on the calculation of the benefit under section 7 of a restriction placed on the sale of shares acquired under an ESPP
Position: Provided information
Reasons: routine explanation of topic.
XXXXXXXXXX 2005-011290
W. C. Harding
April 25, 2005
Dear XXXXXXXXXX:
Re: XXXXXXXXXX Employee Stock Purchase Plan (ESPP)
This is in reply to your letter of January 24, 2005, in which you asked how benefits under section 7 of the Income Tax Act (the "Act") should be calculated when an employee must hold shares acquired under your ESPP for 3 months before being able to sell them. You also asked if an employee would qualify for a deduction under paragraph 110(1)(d) of the Act.
As discussed in our telephone conversation of April 13, 2005 (XXXXXXXXXX/Harding), we cannot provide rulings on, or confirmation of, the tax implications of the ESPP as the plan is already in existence. However, we can provide the general comments that follow below that are not binding on the Department but may be of assistance. As also discussed during our telephone conversation, your local tax services office may be able to assist you with this matter and, in particular, may be able to provide guidance with respect to the valuation of the shares issued under the plan.
It is our understanding that employees may elect to participate in the ESPP by agreeing to have a specified amount withheld from their pay over a quarter. The amount withheld is kept in an account in the employee's name and, at the end of the quarter, is used to acquire shares of XXXXXXXXXX. The price paid by the employees for the shares acquired under the plan is the lesser of:
? 85% of the closing price per share of the shares on the New York Stock Exchange on the first trading date of a quarter; and
? 85% of the closing price per share of the shares on the New York Stock Exchange on the last trading date of a quarter.
We also understand that:
? shares are acquired at the end of each quarter through the services of a broker but that the shares are acquired from the parent corporation and not through the purchase of shares on the open market;
? the shares cannot be sold by an employee for a period of three months following their acquisition; and
? employees automatically continue to participate under the ESPP for subsequent quarters until such time as the employees elect to suspend or terminate their participation.
Interpretation Bulletin IT-113R4 Benefits to Employees - Stock Options provides a detailed explanation of the taxation of employee share purchase plans. In general, subsection 7(1) of the Act applies when a particular corporation, or a trustee acting under its direction, agrees to sell or issue shares of that corporation, or shares of another corporation with which it does not deal at arm's length to an employee of the particular corporation or of any corporation with which it does not deal at arm's length.
Subject to some exceptions, an employee who acquires shares under such an agreement is, in general, required under paragraph 7(1)(a) of the Act to include in employment income, in the taxation year in which the shares are acquired, a benefit equal to:
? the fair market value of the shares at the time the shares are acquired by the employee
minus
? any amount paid or payable by the employee to the corporation for the shares, plus
? any amount paid by the employee to acquire the right to acquire the shares.
The fair market value of a share at the time of its acquisition is a question of fact. If an employee acquires a share pursuant to a share purchase plan, the provisions of which prohibit transfer of the share for a period of time, the employee is considered to have "acquired" the share within the meaning of section 7. However, the value of the share will, in general, be considered to be the fair market value of an identical share at the time of acquisition that has no trading restriction, less an appropriate discount in respect of the restriction.
As discussed in paragraph 18 of Interpretation Bulletin IT-113R4, provided certain conditions are met, a taxpayer may, pursuant to paragraph 110(1)(d) of the Act, deduct in computing taxable income for a taxation year, one-half of the amount of the benefit included in income for the year under subsection 7(1) of the Act as a result of the exercise or disposal of a right under a share purchase agreement. One of the conditions that must be satisfied is that the amount paid by the taxpayer to acquire a share under such an agreement cannot be less than:
? the fair market value of the share at the time the agreement was made
minus
? any amount paid or payable by the employee to the corporation for the share, and
? any amount paid by the employee to acquire the right to acquire the share.
In our view, the time at which the agreement is made is the effective date at which the corporation is committed to selling the share specified in the agreement. If it is established that the agreement is granted to an employee at the beginning of a period (i.e., at the beginning of a quarter), a deduction under paragraph 110(1)(d) will only be available to an employee if the actual price paid for the share is not less than the fair market value of the share at the beginning of the period and the transaction otherwise qualifies under paragraph 110(1)(d) of the Act.
In our view, the above condition can not be satisfied when the amount payable by an employee to acquire a share pursuant to a plan is 85% of the closing price of the share on a stock exchange on the first or last trading date of a quarter (whichever is lower) if the closing price on the first day of the quarter represents the fair market value of the share. However, as noted above, if an employee is prohibited from selling a share acquired pursuant to an agreement for a period of time, the fair market value of the share is, in general, considered to be the fair market value of an identical share at the time of acquisition that has no trading restriction, less an appropriate discount in respect of the restriction. Accordingly, in some situations, it may be possible that the discounted value of a share at the beginning of a period may be less than the price paid for the share.
The following example may help to clarify the situation.
An employee elects to participate in an ESPP similar to the one described above, for the period beginning July 1, 2005 and ending September 30, 2005. The closing price for a share on the exchange on July 1, 2005 is $100 and the employer's valuations experts determine that this price reflects the fair market value of a share on the open market. However, the valuators also determine that an identical share that cannot be sold for three months after it is acquired should be discounted to $98 to reflect the restriction.
On September 30, the closing price of share on the exchange is $110. Accordingly, as provided in the plan the employer issues a share of the employer for $85, this being 85% of the lower closing price at the commencement of the period. The appraisers also determine that on September 30, the day the share is acquired, the fair market value of the share should be discounted to $108 to reflect the trading restriction.
The taxable benefit to the employee under subsection 7(1)(a) of the Act is $23. This is the amount by which the value of the share at the time it is acquired, $108, exceeds the $85 paid for the share by the employee. The employee will not get a deduction under subsection 110(1)(d) of the Act, as the fair market value of the share at the time the agreement was entered into on July 1, 2005 was $98 and this exceeds the $85 that the employee paid for the share on September 30.
We trust our comments will be of assistance to you.
Yours truly,
Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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