1999 Ministerial Correspondence 991354A - STOCK OPTION EXCHANGE, TAKEOVER

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 qutexact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Will the receipt of "in the money stock options" by employee/shareholders, as part of a series of transactions :involving the sale of the company, be considered stock options for the purposes of section 7 of the Act or proceeds of disposition?

Position: Stock options subject to section 7 of the Act.

Reasons: Based on the facts in this particular situation, we concluded that the ”in the money stock options" represented incentives provided by the Purchaser to retain the key employees and not proceeds of disposition. This is supported by the fact that the non-employee shareholders only receive cash for their shares.

xxxxxxxxxx
xxxxxxxxxx 991354
xxxxXxxxxx

Attention: xxxxxxxxxx

xxxxxxxxxx, 1999

Dear Sirs:

Re: Advance Income Tax Ruling
xxxxxxxxxx

This is in reply to your letters dated xxxXxxxXXx, wherein you requested an advance income tax ruling on behalf of the above noted taxpayer. We also acknowledge the information provided during our various telephone conversations (xxxxxxxxxx).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

Facts

1. xxxxxxxxxx (the "Company") is a xxxxxxxxxx Canadian-controlled private corporation. The expression "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7) of the Income Tax Act (the "Act").

The Company's address is xxxxxxxxxx. The Company files its tax returns with the xxxxxxxxxx Taxation Centre and is serviced by the XXxxxxXXxx Tax Services Office.

2. The Company's authorized share capital includes an unlimited number of common shares. Currently, the Company's issued share capital consists of xxxxxxxxxx common shares (the "Shares")with a paid-up capital of $XXXXXXXXXX. The expression "paid-up capital" has the meaning assigned by subsection 89(1) of the Act.

The Shares are owned by xxxxxxxxxx individuals and xXXxxxXxxx of the individuals are resident in Canada for purposes of the Act. The shareholder that owns the largest number of Shares holds xxxxxxxxxx common shares (xxxxxxxxxx%) and the shareholders that own the least number of Shares hold XXXXxxxxxx common shares (xxxxxxxxxx%). The non-resident shareholder holds xxxxxxxxxx Shares (xxxxxxxxxx%). xxxxxxxxxx of the shareholders are employees of the Company and these employee/shareholders own xxxxxxxxxx Shares of the Company (XXXXXXXXXX%).

3. A U.S. public corporation (the "Purchaser") offered to purchase, through one of its Canadian subsidiary corporations, all of the issued Shares of the Company for approximately $XXXXXXXXXX U.S. (approximately $XXXXXXXXXX U.S. per share). As part of the negotiations, the Purchaser requested the implementation of a stock option plan in order to retain the services of the Company's key employees which includes the employee/shareholders. The Purchaser is involved in XXXXXXXXXX.

4. On xxxxxxxxxx, the Company established "XXxxxxXXXX" (the "Plan") for the benefit of its key employees (the "Participants"). The principle terms of the Plan are as follows:

(a) The principle purpose of the Plan is to provide incentives to retain and motivate eligible persons whose present and potential contributions are important to the success of the Company.

(b) The total number of Shares reserved and available for grant and issuance pursuant to the Plan is xxxxxxxxxx. A committee established by the Company's Board of Directors will administer the Plan and will grant the options to eligible persons, as defined in the Plan.

(c) Each option granted under the Plan will be evidenced by a stock option agreement (the "Agreement") . The Agreement will set out the exercise price to be paid to acquire Shares of the Company, the option exercise period (including the expiration date) and the vesting requirements.

(d) Where a Participant's employment with the Company has terminated, the Plan provides restrictions in respect of any unvested options held by the Participant at that time. Vesting will be different depending on termination being with or without cause. In addition, the Plan provides time limits for the exercise of any vested options that may be held by a Participant who ceases to be employed by the Company.

(e) A Participant is required to pay the exercise price for the Shares acquired under the options, in any of the acceptable manners described in the Plan, before the Company will issue its Shares to the Participant.

(f) Where there is an acquisition of control of the Company, the Plan allows the purchaser or its parent corporation to assume the obligations under the options under the Plan. In that case, the Participant's rights to acquire Shares of the Company will be converted into rights to acquire shares of the acquiring legal entity or its parent corporation, subject to the same terms that exist under the options granted under the Plan. However, the number of shares and the exercise price for such shares may be adjusted, as required under the terms of the agreement for the acquisition of control of the Company. The Company will try to ensure that any conversion of options will meet the requirements of subsection 7(1.4) of the Act.

(g) The Plan will terminate xxxxxxxxxx years from the date that it is adopted by the Company's Board of Directors.

5. On xxxxxxxxxx, the Company granted options (the "Options") to acquire xxxxxxxxxx common shares of the Company under the Plan to xxxxxxxxxx employees (the "Employees"). The xxxxxxxxxx employee/shareholders are included in the group of Employees that were granted Options and they received, in aggregate, Options to acquire xxxxxxxxxx common shares of the Company or xxxxxxxxxx% of the total number of Options granted. The terms of the Options are as follows:

(a) The exercise price is set at $xxxxxxxxxx Canadian (approximately $xxxxxxxxxx U.S.).

(b) So long as the Employee is employed by the Company or any of its subsidiary corporations, xxxxxxxxxx% of the Options will vest on xxxxxxxxxx (the "First Vesting Date") and xxxxxxxxxx% of the Options will vest on each monthly anniversary of the First Vesting Date. On termination of an Employee's employment, the vesting will be in accordance with the terms of the Plan.

(c) For a period of xxxxxxxxxx days from the date that the Options are granted to the Employees, the Company may cancel the Options, for any reason, without any compensation being paid to the Employee.

6. On xxxxxxxxxx, each of the shareholders of the Company, the Company and the Purchaser entered into "xxxxxxxxxx" (the "Sales Agreement"). The terms of the Sales Agreement include the following:

(a) Each of the shareholders agrees to sell all of his or her shares of the Company to the Canadian subsidiary of the Purchaser and the Canadian subsidiary of the Purchaser agrees to buy all of the shares of the Company held by each of the shareholders for the aggregate price set out in the Sales Agreement (the "Purchase Price"). Provided all of the conditions in the Sales Agreement are satisfied, the closing date for the sale will be xxxxxxxxxx or any earlier date on which all of the conditions contained in the Sales Agreement have been satisfied (the "Closing Date").

(b) Each Option issued by the Company under the Plan will be converted into an option to acquire shares of the Purchaser (the "New Options"). The terms and conditions of the New Options will be identical to the terms and conditions of the Options issued by the Company under the Plan. Each New Option shall provide for the same total value and total amount payable per share by the Employee immediately prior to and at the Closing Date, subject to any rounding.

(c) The number of common shares of the Purchaser that an Employee will be entitled to acquire under the New Option will be equal to the product of (A) the number of common shares of the Company that could be acquired under the Option immediately prior to the Closing Date multiplied by (B) the quotient of the Purchase Price (see (a) above) divided by the issued and outstanding common shares of the Company immediately prior to the Closing Date and the mean of the closing prices for common shares of the Purchaser as reported on the XXXxxXXXXX for the ten (10) trading days immediately preceding the Closing Date (or such lower number of trading days as the parties may agree to). In the event the foregoing calculation results in a fractional share, the number of shares subject to such New Option shall be rounded down to the nearest whole share number.

(d) The exercise price to be paid by the Employee to acquire a common share of the Purchaser under the New Option will be equal to the quotient of (A) the exercise price per share under the Option (exchanged by the Employee) immediately prior to the Closing Date and (B) the quotient of the Purchase Price divided by the issued and outstanding common shares of the Company immediately prior to the Closing Date and the mean of the closing prices for common shares of the Purchaser as reported on the XXXXxXXXxx for the ten (10) trading days immediately preceding the closing date (or such lower number of trading days as the parties may agree to).

Proposed Transactions

7. The Purchaser will acquire the common shares of the Company under the terms of the Sales Agreement described in paragraph 6 above.

8. The Options held by the Employees will be converted into New Options in accordance with the Sales Agreement described in paragraph 6 above.

Purpose of the Proposed Transactions

9. The purpose of the proposed transaction is to allow the Purchaser to acquire the Company and to provide long term motivation and incentive for the key employees thereby maximizing the Purchaser's return on its investment in the Company.

Additional Information

10. To the best of your knowledge and the knowledge of the Company, none of the issues involved in this request for an advance income tax ruling:

(a) is in an earlier return of the Company or of a person related to the Company;

(b) is being considered by a tax services office or taxation centre in connection with a previously filed return of the Company or of a person related to the Company;

(c) is under objection by the Company or by a person related to the Company;

(d) is before the courts; or

(e) is the subject of a ruling previously issued by the Income Tax Rulings and Interpretations Directorate.

Ruling Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described herein, we rule as follows:

A. An Employee who obtains a New Option in exchange for an Option in accordance with paragraph 6 above will be considered to have satisfied the conditions in paragraphs 7(1.4)(a) and 7(1.4)(b) of the Act. Provided paragraph 7(1.4)(c) of the Act is satisfied, the rules in paragraphs 7(1.4)(d) through (f) of the Act will apply.

The above ruling, which is based on the Act in its present form and does not take into account any proposed amendments thereto, is given subject to the general limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996, and is binding on Revenue Canada provided that the proposed transactions are completed within six months of the date of this letter.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate