31 May 2001 External T.I. 2001-0078945 - OPTION BENEFITS SUBSEQUENT DECREASE IN VALUE

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:

The writer made representations with respect to the timing and computation of benefits under paragraph 7(1)(a) of the Act where the value of the shares under the option decreases.

Position:

Provided general information and included commentary related to concerns on valuation declines experienced in 2000.

Reasons:

The benefit is calculated at the time of the shares acquisition and the time of the acquisition is a question of fact.

XXXXXXXXXX 2001-007894
W. C. Harding
May 31, 2001

Dear XXXXXXXXXX:

Re: Calculation of Benefits Under an Employee Stock Purchase Plan

This is in reply to your letter of March 13, 2001, concerning your participation in your employer's stock purchase plan. A copy of your correspondence addressed to the XXXXXXXXXX Tax Services Office was sent to us for reply on April 4, 2001.

With your letter you provided a copy of your employer's stock purchase plan. Basically, the plan allows employees to acquire shares of the employer over a two-year period, which is divided into four 6-month purchase periods. The plan also provides that the shares that may be purchased within a 6-month period may be acquired at a cost equal to the lesser of the fair market value of the shares at the start of the two-year period and the fair market value of the shares at the end of the particular six-month period minus a discount of 15%. Given the terms of your plan, you asked if it would be possible to take the position that the discount did not represent a reduction of the price of the shares but instead, reflected an additional allotment of shares with a value equal to 15% of the value of the shares otherwise purchased.

In our opinion, the terms of the plan clearly indicate that the purchase price of the shares to be acquired under the plan will be discounted by 15%. Accordingly, we do not agree that the interpretation you requested is available. However, we also note that the terms of the agreement also provided employees with an option to acquire the shares at their fair market value at the time the agreement was entered into without any discount. This type of provision is normally added to a plan in order to enable employees to utilize several provisions of the Income Tax Act (the "Act") designed to reduce or defer the recognition of the benefit from employment realized by an employee through the employee's participation in a stock purchase plan.

Employees who participate in a stock option or purchase plan will normally be able to acquire shares of the employer's capital stock for an amount that is less than the value of the stock at the time of the acquisition. The difference reflects the portion of the cost of the shares that the employer is willing to absorb on behalf of employees, and represents a benefit to the employees from their employment. Accordingly, the legislation requires the benefit to be included in the employees' income from employment at the time the shares are acquired.

To encourage more widespread use of employee stock option and purchase plans, which promote greater employee participation and increased productivity, a provision was added to the legislation, which provides that employees may claim a deduction from the amount included as a benefit. The deduction is generally available if the shares are ordinary common shares that the employees acquire through a stock option or purchase plan. However, there are several conditions that the employees must meet before the deduction can be claimed. In particular, the employees must deal at arm's length with their employer and must agree to pay an amount for the shares that is not less than the fair market value of the shares at the time the agreement was established.

As well, draft legislation now before the House of Commons will, in certain cases, provide for a deferral of the taxation of benefits from employees' participation in an employee stock option or purchase plan until the shares are sold. However, the proposals are also subject to some limitations. Most notably, the provisions will not apply in any situation where the deduction discussed in the previous paragraph is not available to offset the employment benefit. Accordingly, if the plan provides that employees may acquire shares for an amount that is less than the fair market value of the shares at the time the agreement was established, individuals may not be able to use this deferral option. If a plan provides that employees can elect to acquire shares at their fair market value at the time the agreement was established, employees that make such an election may be eligible to claim both the deduction referred to above and the deferral.

It has recently been brought to our attention that the benefits that must be reported by a number of employees for the year 2000 will be exceptionally large because the value of their employers' shares that they had agreed to acquire had increased significantly by the time the shares were acquired. It has also been noted that the value of the shares decreased shortly thereafter and that this has left a number of employees in a position of having to pay tax in respect of a benefit that is no longer reflected in the value of shares acquired. It is also our understanding that many of the employees may, in fact, not have the resources to pay the tax because of the decrease in the value of the shares.

As this situation is of great concern to a number of citizens, and since it appears any remedies will require a change to the law, Canada Customs and Revenue Agency (CCRA) officials raised the issue with officials of the Department of Finance. Finance officials are urgently reviewing a number of different cases, but this will take some time.

Consequently, all employees should file their 2000 income tax returns as required and either report the full amount of the benefit reported on their T4 information slips as income from employment or claim a deferral of the benefit to the extent possible, in accordance with the draft proposals presently before Parliament. Once Finance's review is completed and a course of action is decided upon, the CCRA will work with Finance to determine the impact on individual cases.

Employees should thus endeavour to pay the income taxes that are due on filing to the extent possible without causing themselves any severe hardship. If it is then determined that they cannot pay all of the tax payable, they should contact their local tax services office for further guidance. Officials of your tax services office will be alerted to the situation and the status of the review. If additional information is required, Mr. Wayne Harding of the Income Tax Rulings Directorate, Policy and Legislation Branch, will also be available to provide any necessary assistance to you or to the tax services office. Mr. Harding may be reached by calling 957-9769, or by writing to Place de Ville, 16th Floor, Tower A, 320 Queen Street, Ottawa, Ontario K1A 0L5.

I trust that these comments will be of assistance to you.

Yours truly,

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