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:
In file 1999-001449, we expressed opinions on the treatment of employee stock options for Canadian tax purposes where they contained some of the provisions typically found in U.S stock options. The writer has several questions based on our comments in that letter and in particular has asked if shares acquired under these arrangements would be prescribed shares.
Position:
General opinions were provided.
Reasons:
While the letter states the questions do not relate to a particular plan or client it appears that they do relate to a number of unidentified plans and clients or are, at the least, specific to an existing class of plans.
XXXXXXXXXX 2001-007148
W. C. Harding
September 18, 2001
Dear XXXXXXXXXX:
Re: Employee Stock Options and Prescribed Shares
This is in reply to your letter of February 22, 2001, in which you asked for our opinion on the application of the Income Tax Act (the "Act") and the Income Tax Regulations (the "Regulations") in situations where employees exercise certain employee stock options.
While you have indicated your enquiry does not relate to a particular plan or client, it appears that it may apply to a number of existing plans and may relate to the possible amendment of the wording used in those plans. Such situations may only be considered by us when they are the subject matter of a referral made to the tax services office of the parties involved. Accordingly, should you require any assistance with respect to any particular plan, you should provide the details of the plan to the appropriate tax services office for their consideration.
While we are unable to provide specific comments on the application of the Act at this time, we can provide the following general comments. Please note that these comments do not form an advance ruling and are not binding on the Canada Customs and Revenue Agency (the "CCRA").
In your letter, you advised that some U.S. based employee stock option plans provide one or more of a number of standard provisions. In particular, they frequently include the following options:
- "Swap Option" or "Swap": The swap allows employees to exercise the options and pay the option price, in full or in part, with shares the employees already own.
- "Certification Method": The certification method permits employees to certify that they already own shares (the "certified shares") of the employer, that have a total fair market value that is at least equal to the exercise price. When an employee exercises the option and uses this method, the employee will only receive new shares with a total value equal to the value of the stock option benefit and will not be considered to have disposed of the certified shares.
- "Reload Option": The reload option provides new options, equal to the number of options exercised, to employees who exercise their options. When the Certification Method is used, the employees will receive new options equal to the number of certified shares used to fund the exercise price. The reload options have an exercise price that is not less than the fair market value of the employer's stock on the date of grant of the reload options.
- "Tax Withholding Provision": The tax withholding provision permits employees to sell or redeem shares acquired under an option in order to pay any withholding taxes due on the exercise of the option.
- "Termination Penalty Clause": The termination penalty provides that an employee may be required to pay a cash penalty or surrender shares previously acquired under the stock option plan should the employee leave an employer within a certain period of time.
Your questions, based on the preceding information and our comments thereon, follow below. Please note that we have combined and rephrased a number of your questions:
Swaps
1. Would shares acquired under a Swap qualify as prescribed shares under Section 6204 of the Regulations?
Whether any particular shares are prescribed shares is a question of fact that must be determined on a case-by-case basis. Section 6204 of the Regulations defines a prescribed share. The definition is applicable to shares acquired under an option and does not have any specific application to shares used to acquire those shares. However, if shares acquired under an option can subsequently be used to acquire additional shares under another option, there could be adverse consequences because of the application of the Regulation.
Subparagraph 6204(1)(a)(iv) of the Regulations provides that the holder of a share of a corporation acquired under an option must not be able to cause the share to be redeemed, acquired or cancelled by the corporation or any specified person in relation to the corporation, otherwise than as the result of certain permitted conversions described in the provision. Accordingly, shares acquired under one option that may be used under a Swap to acquire additional shares may not qualify as prescribed shares. Similarly, because of the provisions of paragraph 6204(1)(b) of the Regulations, shares acquired under an option may not qualify as prescribed shares where the shares may be used within a two year period as part of a Swap or it is reasonable to expect the employees may use the shares under a Swap within that period.
2. If section 6204 of the Regulations applies to Swaps, would the Regulation apply to a plan that provides that the Swap will not apply to Canadian residents, provided all the other requirements for a share to be a prescribed share are met?
Section 6204 of the Regulations applies to all shares acquired under employee stock option plans. However, the consequences of its application can only be determined on a case-by-case basis. Accordingly, an answer to this question may only be provided in the context of an advance income tax ruling request related to a specific proposal. It should be noted, however, that section 7 of the Act could apply to non-residents who exercise options in certain situations.
3. Would shares qualify as prescribed shares if a stock option plan provides that Canadian residents could pay the exercise price with shares they already own, provided they have been holding such shares for at least two years and provided all other requirements for a share to be a prescribed share are met?
Our comments under 1. above would have to be considered. However, specific terms of a plan can only be considered in the context of an advance income tax ruling request.
4a. Would the shares qualify as prescribed shares if the plan provides that the applicable withholding taxes or the exercise price may be paid by the employee by any method of payment permitted by the Board of Directors of the corporation or a committee, including the surrender of shares to the employer?
Concerns similar to those addressed under 1. above would have to be considered. However, specific terms of a plan can only be reviewed in the context of an advance income tax ruling request.
4b. Would CCRA's opinion be different if it is proven that, notwithstanding such provision of the plan, a committee or the Board of Directors always prohibited employees from paying the exercise price with shares they already own?
Prohibitions relating to the shares acquired under the terms of a plan would need to be considered when applying the Regulations.
4c. Would a communication, rule or guideline from the employer confirming that they have always prohibited such a practice be sufficient to qualify the shares as prescribed shares?
If the plan is a proposed plan, these concerns may be answered in the context of an advance income tax ruling request. If they are in respect of an existing plan the details of the plan should be provided to the appropriate CCRA Tax Services Office for review.
5. If a committee or the Board of Directors sends a letter or memorandum to all Canadian employees telling them that they cannot Swap shares to pay the exercise price, would that be sufficient for the shares to qualify as prescribed shares or would an amendment to the plan or the agreement between each employee and the employer be required?
As noted above, a reply to this question should be based on a factual determination either in the context of an advance income tax ruling or on presentation of an existing plan to the appropriate CCRA Tax Services Office. There would be a concern with respect to how the rights and obligations of the parties could be modified by a memorandum. It should also be noted that while the removal of the Swap provisions may eliminate some concerns, we cannot state that this will result in the shares being prescribed shares on that basis alone.
Section 7 and paragraph 110(1)(d) of the Act apply where a qualifying person, usually an incorporated employer, agrees to issue shares to an employee. The provisions of the Act apply to the agreement between the employer and the specific employee and do not apply specifically to a master plan in itself. Changes in a specific employee's agreement may be made in the agreement itself or through reference to changes in the master plan.
6. Does CCRA agree that since section 6204 of the Regulations refers to the date of issuance of the shares, as long as the stock option plan is amended or modified before the option is exercised, the shares could qualify as prescribed shares, and that the modification does not have to be retroactive to the date of the agreement to issue shares?
Paragraph 110(1)(d) of the Act requires that a share must be a prescribed share at the time of its sale or issue. Section 6204 of the Regulations provides that a share will be a prescribed share at the time of its sale or issue if it meets the conditions specified in the Regulation at that time.
Certification Method
7. Has CCRA's position on Certification released in technical interpretation no. 1999-0014495, dated February 12, 2000, been changed or does CCRA still recognize that this method would not disqualify shares as prescribed shares and that the Certification Method does not trigger a disposition of the certified shares? Are there situations where that method would disqualify shares as prescribed shares?
In our letter, we did not specifically state that the shares acquired under the Certification process would be prescribed shares or that there would be no disposition of the shares. We stated this would be a question of fact. However, we did indicate that the Certification
Method appeared to be similar in nature to a stock appreciation right option (a "SAR") and that the same positions taken with respect to SARs would seem to be applicable. Accordingly, we would think that a disposition would not occur and a deduction under paragraph 110(1)(d) would normally be available.
We are not prepared to speculate on situations where shares would or would not be prescribed shares.
Reload Options
8. Would the Reload Option disqualify shares as prescribed shares and would the Reload Option prohibit an employee from claiming the paragraph 110(1)(d) deduction? Would CCRA's opinion be different depending on whether the Reload Option is created as a new option or a continuation of the initial option under corporate law?
Whether a Reload Option constitutes a new option or a continuation of the old option is a question of fact, which cannot be determined based on the limited information provided. However, it would seem to us that the inclusion of a Reload Option in an agreement would generally mean employees would receive shares and a right to acquire additional shares as a consequence of the exercise and disposition of the original option. The receipt of the right could constitute the receipt of a benefit at the time of its acquisition unless paragraph 7(3)(a) of the Act has application.
We cannot confirm how the inclusion of the option might effect the availability of a deduction under paragraph 110(1)(d) of the Act. For example, it may be reasonable to conclude that a portion of the amount employees must pay under the terms of the option will relate to the acquisition of the Reload Option so that the amount payable for the shares may be less than the fair market value of the shares at the time the agreement was established.
9. Should a Reload Option prohibit an employee from claiming the paragraph 110(1)(d) deduction, would an amendment to the option agreement entered into between the employer and the employee to rectify the exercise price be acceptable and have retroactive effect, given the reasoning found in technical interpretation no 9606145 dated April 3, 1996, which discusses John Amirault vs. The Queen?
The CCRA's general position on the consequences of the Amirault decision has been provided in the above-noted letter as well as in a number of other letters. However, its application to specific situations and circumstances cannot be provided except in the context of an advance income tax ruling. To reiterate our position, since the court has concluded that a change in option price is not a fundamental change to an option agreement, we can support a conclusion that the change in option price would not generally constitute a significant change in the terms of the stock option agreement and, as a result, would not result in a disposition of any rights under the agreement. A deduction under paragraph 110(1)(d) of the Act will be available if the new amount payable satisfies the conditions of subparagraph 110(1)(d)(iii) of the Act.
Tax Withholding Provisions
10. Would a share be disqualified as a prescribed share if an employer decides to redeem the share at fair market value in order to pay the withholding taxes due by an employee following the exercise of a stock option?
Please refer to our responses to questions 1. and 4. above.
11. What if the shares are sold by a broker on the open market or by the employer on behalf of the employee?
Except as specified in the Regulations, shares will not cease to be prescribed shares if employees may dispose of the shares. Accordingly, we would agree that, in general, an agreement could provide for employees to sell their shares on the open market either through a broker or through the employer.
Termination Penalty Clauses
12. Would shares be disqualified as prescribed shares if a provision in a stock option plan states that the employee will have to pay the employer a penalty, either in cash or by surrender of the shares to the employer, if the employee leaves the employer before a certain date?
In our opinion, shares would not fail to be prescribed shares solely because an agreement provides for a cash payment in such circumstances. With respect to the surrender of shares in order to pay a penalty, please refer to our responses to questions 1. and 4. above.
Subsection 6204(2)
13. Could an employee who was granted an employee stock option from a U.S. corporation rely on subsection 6204(2) of the Regulations in a situation where paragraph 6204(1)(b) of the Regulations would apply because of the existence of a Swap?
It is your understanding that the determination of whether a share is a prescribed share in such a case, would be made without reference to the right of redemption. However, you are concerned that subsection 6204(2) of the Regulations seems to only apply to private corporations.
Paragraph 6204(2)(c) of the Regulation provides that, for the purposes of applying subsection 6204(1) of the Regulations to a share, reference does not have to be made to any right or obligation to redeem, acquire or cancel the share or to cause the share to be redeemed, acquired or cancelled, if certain conditions as specified in the provision are met. As indicated in the August 28, 1997, Regulatory Impact Analysis Statement, subsection 6204(2) was added to the Regulations to ensure a share will not cease to be a prescribed share merely because a right or obligation exists to protect an employee against any loss with respect to the share, or to provide a market for the share. Accordingly, if it can be established that a Swap was provided for one of these reasons, the provision should apply assuming all other conditions are met. However, it is not clear to us how a Swap would satisfy either of these conditions given the description of a Swap as noted above.
There is no restriction on the application of the Regulation to private corporations.
We trust this explanation will be of assistance to you.
Yours truly,
Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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