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:

Can a Section 7 employee stock option plan be implemented in substitution for an existing SAR plan without any immediate tax consequences.

Position:

Yes.

Reasons:
Paragraph 7(3)(a) has broad application to limit taxation that results from the implementation of an employee stock option plan.  The employer is issuing an option in substitution for future rights under the SAR so 7(3)(a) should apply.  Furthermore if the employee is merely substituting one expectation for another, it may be said that the employee does not receive any economic gain at the time of the conversion.
			February 16, 2001

	Toronto West Tax Services Office	HEADQUARTERS
Mr. John Jackson	W.C. Harding
	Director	(613) 957-8953

	Attention:  Ray Lazzara
	                  Large File Case Manager
			2000-005365

Exchange or Conversion of Stock Appreciation Rights ("SAR") Plan
To an Employee Stock Option Plan

This is in reply to your e-mail of January 24, 2001, in which you asked us to provide you with a response to the submission made by XXXXXXXXXX with respect to the tax consequences that may arise as a result of a replacement of a SAR Plan with an employee stock option plan.

Background and Proposal

There are several types of arrangements that are referred to as "SAR" plans. A typical SAR is an arrangement where an employer agrees to pay an employee an amount on a future date where the amount to be paid is based on the increase in the value of the employer's shares on that future date, over the value of those shares on the date the plan was instituted or the SAR "units" were allotted. In our reply to question 26 of the 1988 Canadian Tax Foundation Round Table we stated that, these kind of SARs would generally not be considered salary deferral arrangements ("SDA"s) as that term is defined in the Income Tax Act (the "Act"). As a result, the value of a SAR unit would not generally be included in the income of an employee until such time as the employee actually receives the amount or otherwise becomes entitled to receive an amount.

According to the XXXXXXXXXX submission, XXXXXXXXXX previously granted SAR units to certain of its employees. However, XXXXXXXXXX has not advised us of the terms of these units except that the employees have a right to exercise their rights under the units after XXXXXXXXXX years and they must exercise their rights and convert the units to cash within XXXXXXXXXX years. These are typical terms of a SAR. Accordingly, for the purposes of this reply, we will assume the arrangement is similar to the typical arrangements described in the above paragraph.

XXXXXXXXXX is offering its employees the opportunity of converting their existing SAR units into stock options with one unit being converted into an option to acquire one share of the employer. XXXXXXXXXX advises that these stock options will have the same exercise price, vesting and expiration terms as the original SAR units. XXXXXXXXXX states that the exchange will allow the employees to become shareholders of XXXXXXXXXX and, as shareholders, have a better opportunity to realize potential future appreciation in XXXXXXXXXX stock price. In addition, employees will gain the benefits of share ownership including the opportunity to receive dividends and to participate in a dividend reinvestment program which will allow the employees to use their dividend proceeds to purchase additional shares of XXXXXXXXXX.

XXXXXXXXXX Position

XXXXXXXXXX believes an employee should not be considered to have a taxable event at the time of conversion and that paragraph 7(3)(a) of the Act provides support for this position. If an employer has agreed to issue or sell shares of the employer to an employee that is dealing at arm's length with the employer, paragraph 7(3)(a) of the Act provides that, except as provided by section 7, the employee is deemed to have neither received nor enjoyed any benefit under or because of the agreement. XXXXXXXXXX states:

"... if there were no agreement there would be no potential benefit and this issue would not arise. So then the issue arises entirely by the fact that the employee has entered into the agreement; that is, if taxable it is only because he or she entered into the agreement. As a result, it should be that the employee is not taxable at the time he or she enters into the agreement."

Our Position

It is our view that, in general, no benefit will be included in the income of an employee at the time a unit under a SAR arrangement is converted into an option to acquire a share of the employer under an employee stock option plan. However, we caution that this position is only valid where there is an exchange of the SAR unit for the option and the employee does not otherwise receive any amount or right to receive an amount. For example, a receipt of a taxable benefit might occur at the time of an exchange if the arrangement provided for the acceleration of the vesting of the SAR and, because of the vesting, the employee obtained a right to receive cash for the unit. In this case, the value of the right would be taxable at the time of receipt even if the employee was allowed to exchange the right to acquire an option under the employee stock option plan.

In our review, we noted that under the XXXXXXXXXX proposal, the stock option will have the same "exercise price" as the SAR. However, a typical SAR does not have an "exercise price". As noted above, a SAR unit will generally have a value, at any particular time, that is equal to the increase in the value of a share of the employer's capital stock over the period the SAR unit is held. Typically this increase in value is measured from the "price" of a share of the capital stock on the date the SAR unit is issued. If XXXXXXXXXX proposes to use this base price under the SAR as the exercise price under the employee stock option plan, it should be noted that the provisions of subsection 110(1)(d) of the Act may not apply as expected. However, we cannot properly address this concern without having all relevant information.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.

Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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