2004 Ruling 2003-0040931R3 - Deferred Share Unit Plan with SAR Component

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: 1) Will proposed amendments to the plan to add units based on shares of related corporation and to add a conversion feature violate paragraph 6801(d)? 2) Will the Restricted Units (SARs) constitute SDAs?

Position: 1) No. 2) No.

Reasons: 1) Paragraph 6801(d) is not offended. 2) Participants have no right to receive an amount in respect of the units until retirement.

XXXXXXXXXX 2003-004093

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Corporation A") XXXXXXXXXX
XXXXXXXXXX ("Corporation B") XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of Corporation A. We also acknowledge the additional information provided with your submissions of XXXXXXXXXX which provided further information and expanded the ruling request to include Corporation B. We further acknowledge the information provided during several telephone conversations (XXXXXXXXXX).

This letter is based solely on the facts and proposed amendments described below. The documentation submitted with your request does not form part of the facts and proposed amendments and any references thereto are provided solely for the convenience of the reader.

We understand that, to the best of your knowledge and that of both Corporation A and Corporation B, none of the issues involved in this ruling request is:

(a) in an earlier return of Corporation A or Corporation B or a related person;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of Corporation A or Corporation B or a related person;

(c) under objection by Corporation A or Corporation B or a related person;

(d) before the courts; nor

(e) the subject of a ruling previously issued to Corporation A or Corporation B or a related person by the Income Tax Rulings Directorate.

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

Facts

1. Corporation A and Corporation B are taxable Canadian corporations. The expression "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Income Tax Act (Canada) (the "Act").

2. Corporation A and Corporation B file their tax returns at the XXXXXXXXXX Tax Services Office and deal with that office. The head office of Corporation A is located at XXXXXXXXXX, while the head office of Corporation B is at XXXXXXXXXX.

3. Corporation A and Corporation B are both publicly traded companies. Class A Limited Voting shares (each hereafter referred to as an "A Share") of Corporation A, and the common shares (each hereafter referred to as a "B Share") of Corporation B, trade on the XXXXXXXXXX.

4. Corporation A and Corporation B are related persons for purposes of the Act and, in particular, for purposes of paragraph 6801(d) of the Income Tax Regulations (the "Regulations").

5. Corporation A has established a comprehensive compensation and benefit program for eligible executive employees that includes an annual cash bonus plan (the "Management Incentive Plan A" or "MIP A") and a deferred compensation plan under the name of "Deferred Share Unit Plan" ("Plan A"). Corporation B has established a comprehensive compensation and benefit program for eligible executive employees that includes a management incentive plan ("MIP B") and a deferred share unit plan ("Plan B").

6. In addition, eligible employees of Corporation A are eligible to participate in an employee stock option plan to acquire shares of Corporation A, while eligible employees of Corporation B are eligible to participate in an employee stock option plan to acquire shares of Corporation B.

7. The MIP A is a short-term incentive plan that is part of the overall compensation structure put in place for eligible employees. The amount of the bonus award for each eligible employee for a particular fiscal year (which corresponds with the calendar year) is determined at the discretion of the XXXXXXXXXX ("Committee A") of the Board of Directors of Corporation A ("Board A"), and approved at the discretion of Board A. The MIP B is a short-term incentive plan which provides a cash bonus award for each eligible executive, as determined by the XXXXXXXXXX of the Board of Directors of Corporation B ("Committee B"). The MIP A bonuses and the MIP B bonuses are not quantified until February of the calendar year immediately following the fiscal year to which they relate.

8. Corporation A established Plan A effective XXXXXXXXXX. Designated senior officers of Corporation A, as well as of its subsidiaries ("Participants"), are eligible to participate in Plan A. Executives of Corporation B ("Members") are eligible to participate in Plan B. Plan A was not previously the subject of an advance income tax ruling request. Plan B was also established in XXXXXXXXXX and also has not previously been the subject of an advance income tax ruling request.

9. Each year, Participants may elect to receive all or a portion of their MIP A bonus to which they may be entitled in the form of deferred units ("Deferred A Units"), as further described below.

10. A Participant must indicate his/her decision to participate in Plan A by completing and filing a written election form with Corporation A. The election must be made and filed with Corporation A by the end of the first quarter of the fiscal year to which the MIP A bonus relates, before the Participant would otherwise be entitled to receive the MIP A bonus. However, when a Participant first participates in Plan A, the election in respect of the first fiscal year must be made and filed by the end of the fourth quarter of that fiscal year. An election, once made, may not be revoked for the year to which it relates.

11. One Deferred A Unit corresponds to one A Share.

12. Once MIP A bonuses are approved by Corporation A following the end of the fiscal year, each Participant is allocated Deferred A Units under Plan A. The number of Deferred A Units allocated to a Participant is equal to the adjusted dollar value of the MIP A bonus deferred by the Participant, divided by the closing price of one A Share on the XXXXXXXXXX on the date on which the MIP A bonus is awarded for the prior fiscal year (the "Notification Date").

13. Corporation A may, at its discretion, so as to increase the amount of Deferred A Units allocated to a particular Participant under paragraph 12 above, increase the dollar value of the MIP A bonus by a factor of up to XXXXXXXXXX times the actual amount of the MIP A bonus, for the purpose of determining the number of Deferred A Units allocated in paragraph 12 above. The aggregate of the actual MIP A bonus and the discretionary notional increase, if any, constitute the adjusted dollar value referred to in paragraph 12 above. The purpose of the discretionary notional increase is to recognize and reward the Participants who choose Deferred A Units over cash bonuses for their commitment to the long-term growth of Corporation A. The factor applied in respect of a Participant is dependent upon both the individual's performance and seniority.

14. Additional Deferred A Units are automatically allocated to Participants to reflect dividends paid on an equivalent number of A Shares to the total Deferred A Units held on the record date of such dividend. The number of additional Deferred A Units allocated to Participants is determined by dividing the dollar value of the notional dividends by the closing price of an A Share on the XXXXXXXXXX on the dividend payment date.

15. A Participant has neither legal ownership of nor beneficial interest in any shares by virtue of the allocation of Deferred A Units. For greater certainty, a Deferred A Unit does not entitle a Participant to any shareholder rights vis à vis Corporation A, including without limitation, voting rights, dividend entitlements or rights on liquidation.

16. A notional account is established for each Participant ("Notional Account"). The number of Deferred A Units allocated to the Participant and the value of those units is recorded in the Notional Account.

17. In the event of any stock dividend, stock split, combination or exchange of shares, consolidation, spin off or other distribution affecting the fair market value of A Shares, the number of Deferred A Units credited to a Participant's Notional Account is adjusted accordingly.

18. A Participant may appoint a beneficiary (who is a dependant or a relation of the Participant) to receive amounts under Plan A in the event of the Participant's death. If no beneficiary is designated, the personal representative of the Participant is entitled to receive such amounts. In this way, only the Participant, or, if the Participant is deceased, the Participant's dependant, relation, or legal representative, can receive amounts under Plan A.

19. The Deferred A Units allocated to a Participant under Plan A vest rateably over XXXXXXXXXX years, with XXXXXXXXXX vesting at the end of each fiscal year. However, the Participant does not have any right to receive any benefits under Plan A until termination of employment, resignation, retirement or death (which events are hereinafter referred to as "Retirement"). Retirement does not include the transfer of an employee to a related corporation.

20. In the event of the termination of employment of a Participant by Corporation A or a subsidiary, as applicable, within XXXXXXXXXX years of an allotment of Deferred A Units, the Participant is entitled to redeem the greater of (i) XXXXXXXXXX% of the Deferred A Units allocated to the Participant and (ii) the number of vested Deferred A Units. If the Participant chooses to terminate his or her employment, the Deferred A Units will vest in accordance with paragraph 19 above.

21. In the event of Retirement because of death, the Participant is immediately vested in all Deferred A Units allocated to his or her Notional Account.

22. All Deferred A Units under Plan A are to be redeemed and their value distributed to a Participant (or to the Participant's beneficiary or personal representative in the event of death) no later than XXXXXXXXXX months following Retirement. The amount of the benefits payable to a Participant is to equal the value of the Deferred A Units in his or her Notional Account, determined as of the date the Participant (or his or her designated beneficiary or personal representative) delivers a notice to Corporation A (the "Notice of Redemption"), or, if no such Notice of Redemption is received by Corporation A, on the first anniversary of the Retirement (in either case, referred to as the "Date of Redemption"). The value of a Deferred A Unit on the Date of Redemption is equal to the closing price of an A Share on the XXXXXXXXXX on such date.

23. The value of the Deferred A Units will be paid to the Participant in a cash lump sum, net of any statutory deductions.

24. Plan A is administered by a subcommittee of Board A. Corporation A pays all costs and expenses associated with administering Plan A.

25. Plan A may be amended or terminated by Corporation A at any time. Should Plan A be terminated by Corporation A, no further deferred share units would be issued, however, Plan A would continue to exist and no deferred share units could be redeemed prior to Retirement, as provided in paragraph 19 above. No amendment to or termination of Plan A can adversely affect the Deferred A Units allocated to the Participant's Notional Account without his or her consent. Notwithstanding the foregoing, any amendment or termination shall be such that the Deferred A Unit portion of Plan A continuously satisfies the requirements of paragraph 6801(d) of the Regulations, or any successor provision thereto.

26. Plan A is not funded.

27. No amount is to be paid to, or in respect of, a Participant under Plan A or pursuant to any other arrangement and no additional Deferred A Units can be granted to such Participant as compensation for a downward fluctuation in the value of A Shares nor will any other form of benefit be conferred upon or in respect of a Participant for such purpose.

28. Each year, Members may elect to receive their MIP B bonus award in the form of cash and/or deferred units ("Deferred B Units"), not exceeding the dollar value of the MIP B bonus award. For example, a Member who qualifies to receive a MIP B bonus award of $XXXXXXXXXX could elect to take $XXXXXXXXXX in cash and $XXXXXXXXXX worth of Deferred B Units under Plan B, as further described below. The election must be made and filed with Corporation B by the end of the first quarter of the fiscal year to which the MIP B bonus relates, before the Member would otherwise be entitled to receive the MIP B bonus. However, when a Member first participates in Plan B, the election in respect of the first fiscal year must be made and filed by the end of the fourth quarter of that fiscal year. An election, once made, may not be revoked for the year to which it relates.

29. The terms of Corporation B's Plan B for its Members mirror the terms of Corporation A's Plan A for its Participants in all material respects as described above. However, it should be noted that each Deferred B Unit corresponds to a common share of Corporation B, and, to emphasize, under the terms of the Plan B, Committee B may, at its discretion, increase the portion of the annual MIP B bonus award elected to be received in Deferred B Units, by a factor of up to XXXXXXXXXX times of the original amount, for the purpose of determining the number of Deferred B Units allocated to the Member. The factor applied in respect of a Member is dependent upon both the individual's performance and seniority. The purpose of the discretionary notional increase is to recognize and reward the Members who choose Deferred B Units over cash bonuses for their commitment to the long-term growth of Corporation B. Deferred B Units vest rateably over XXXXXXXXXX years, with XXXXXXXXXX vesting at the end of each fiscal year, and may only be redeemed on termination of employment, resignation, retirement or death. On redemption, the cash value of the Deferred B Units will be equal to the fair market value of the equivalent number of B Shares.

30. During the course of an executive's career, an executive may transfer employment from Corporation A to Corporation B (or a subsidiary of Corporation B) and vice versa. The current practice is for the executive to join the plan of his or her new employer and suspend participation in the plan of his or her former employer. For example, if an executive were transferred from Corporation A to Corporation B, no further Deferred A Unit awards would be made to the executive under Plan A. Instead, subsequent awards would be made under Plan B. Existing awards under Plan A would continue to vest, based on years of service with Corporation B. When the executive retired, terminated employment from Corporation B, or died, Corporation A would make a cash payment equal to the value of the Deferred A Units at such time. Similarly, Corporation B would make a cash payment equal to the value of the Deferred B Units at such time. The same process would apply where the executive transferred from Corporation B to Corporation A.

31. In addition, an executive who is employed by Corporation B may have certain responsibilities in regards to Corporation A. For example, it is the practice of Corporation A to name the chief financial officer of any company in which it acquires a majority interest. Part of such executive's responsibilities is to represent Corporation A's interests. Conversely, an executive of Corporation A may have responsibilities that relate to the management of Corporation B. Thus, Corporation A and Corporation B wish to have additional flexibility in their compensation plans to address such situations.

32. Both Plan A and Plan B are intended to qualify as plans that satisfy the conditions of paragraph 6801(d) of the Regulations.

Proposed Amendments

33. Corporation A proposes to amend Plan A as further described below. The "Amended Plan A" will be implemented only after the advance tax ruling is granted.

34. Under the proposed amendment, Committee A, at its discretion, may allocate a new type of unit ("Restricted Units") to a Participant within prescribed limits and on such terms and conditions established by Committee A from time to time, taking into account the value of the Deferred A Units and Restricted Units previously awarded to a Participant, in order that one of the main purposes of Plan A, namely the alignment of management's long-term interests with those of the shareholders of Corporation A, is met. The value of Restricted Units allocated to each Participant will be recorded in the Notional Account. No Restricted Units will be awarded under Plan B.

35. All of the provisions discussed above in paragraphs 8, 16 to 18, and 23 to 26, relating to Plan A and the Deferred A Units, will apply, mutatis mutandis, to the Restricted Units.

36. Restricted Units will not be adjusted for cash dividends paid on the A Shares.

37. All Restricted Units will vest rateably over XXXXXXXXXX years, with XXXXXXXXXX vesting at the end of each fiscal year. In the event of Retirement other than death, the Participant will redeem the number of vested Restricted Units, in addition to the Deferred A Units referred to in paragraph 19 or 20, as applicable. In the event of death, all Restricted Units become fully vested, in addition to the Deferred A Units referred to in paragraph 21.

38. All vested Restricted Units will be redeemed and their value distributed to a Participant (or to the Participant's beneficiary or personal representative in the event of death) no later than XXXXXXXXXX months following Retirement. The amount of the benefits payable to a Participant will be equal to the value of the vested Restricted Units in his or her Notional Account, determined as of the date the Participant (or his or her designated beneficiary or personal representative) delivers a Notice of Redemption to the Corporation, or, if no such Notice of Redemption is received by the Corporation, on the first anniversary of the Retirement (in either case, referred to as the "Date of Redemption").

39. The redemption value of a vested Restricted Unit will be equal to the difference between (a) the quoted market value of an A Share on the XXXXXXXXXX on the Date of Redemption and (b) the quoted market value of an A Share on the XXXXXXXXXX on the date of issue of the Restricted Unit. Where, on the Date of Redemption, the value of (a) for any particular vested Restricted Unit is less than the value of (b) for that Unit, a negative redemption value will result. Where the sum of all redemption values for all vested Restricted Units to be redeemed on the Date of Redemption is negative, the Participant may, at the discretion of Board A, be required to forfeit the number of vested Deferred A Units that correspond to the net negative redemption value of the Restricted Units.

40. A Participant has no legal ownership of or beneficial interest in the A Shares by virtue of the allocation of Restricted Units. For greater certainty, a Restricted Unit does not entitle a Participant to any shareholder rights vis à vis Corporation A or any related corporation, including without limitation, voting rights, dividend entitlements or rights on liquidation.

41. Plan A will also be amended to permit the Participant, with the consent of Board A, to direct Corporation A to use the net after tax proceeds from the redemption of the Deferred A Units and/or Restricted Units to purchase A Shares on the open market from a designated broker. Such direction would be made no later than the Date of Redemption. Any A Shares acquired by a designated broker on behalf of a Participant shall be delivered directly to the Participant forthwith as soon as practicable upon completion of such purchases. In no event shall Corporation A distribute assets to a Participant that consists of treasury shares of Corporation A or a related corporation.

42. Plan A and Plan B will be further amended to permit a Participant or Member (as applicable) to make and file an election referred to in paragraph 10 or 28 above (as applicable) by the last day of XXXXXXXXXX of the calendar year immediately following the fiscal year to which the MIP A bonus or MIP B bonus (as applicable) relates, before the Participant or Member would otherwise be entitled to receive the MIP A bonus or MIP B bonus.

43. Corporation A will also amend Plan A to add a new form of deferred share unit (the "Deferred AB Unit"), such that the value of one Deferred AB Unit will correspond to the value of one B Share. Deferred AB Units will otherwise have the same attributes as Deferred A Units. Corporation A will also amend its MIP A bonus plan to permit Participants to take a portion of their MIP bonus award in the form of Deferred AB Units.

44. Corporation B will amend Plan B to add a new form of deferred share unit (the "Deferred BA Unit"), such that the value of one Deferred BA Unit will correspond to the value of one A Share. Deferred BA Units will otherwise have the same attributes as Deferred B Units. Corporation B will also amend its MIP B bonus plan to permit Members to take a portion of their MIP bonus award in the form of Deferred BA Units.

45. Both Plan A and Plan B will be amended such that an executive of Corporation B may be a Participant in Plan A, and an executive of Corporation A may be a Member in Plan B.

46. Committee A will determine whether a Participant of Plan A may receive Deferred AB Units and whether a Member of Plan B may receive Deferred BA Units. The principal factors to be considered in making such determination are the professional responsibilities, career development and the alignment of compensation with growth of the corporate group as a whole, as measured by increase in shareholder value.

47. Both Plan A and Plan B will be amended to provide that periodically, at such time as determined by Corporation A or Corporation B (as applicable), and subject to approval by Committee A or Committee B (as applicable), a Participant or Member, as the case may be, may elect to convert previous allocations of deferred share units into another form of deferred share units offered in that same Plan. The election to convert a previous allocation of deferred share units into another form of deferred share units is irrevocable once made for that period. In no event will such conversion privilege be provided for the purpose of reducing the impact, in whole or in part, of any reduction in the fair market value of an A Share and/or a B Share.

48. Restricted Units awarded under Plan A may not be converted.

49. The conversion of each deferred share unit would be determined by the closing price of the applicable A Share or B Share, as the case may be, on the XXXXXXXXXX on the last trading day prior to the conversion date. For example, assume that in Year 1, a Corporation B executive deferred his or her bonus into 1,000 Deferred B Units and 1,000 Deferred BA Units. In Year 2, the executive elects to convert 500 of his/her Deferred B Units into additional Deferred BA Units. If, on the last trading day prior to the conversion date, the closing price of a B Share was $20 and the closing price of an A Share was $25, then the executive would have an additional 400 Deferred BA units credited to his/her Notional Account and 500 Deferred B Units debited from his/her Notional Account.

Purpose of the Proposed Amendments

50. The purpose for amending Plan A is to encourage the retention of employees of Corporation A who are believed to contribute significantly to the financial success of Corporation A, and to provide senior officers of Corporation A, or its subsidiaries, with compensation opportunities that will align their long-term interests with those of the shareholders of Corporation A.

51. The purpose of the proposed amendments is to provide an equity compensation plan to senior executives of Corporation A and Corporation B that more appropriately recognizes and rewards their contributions, over the life of their careers to the long term success of the two companies, as measured by the increase in value of the companies' publicly traded common shares.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed amendments and purpose of the proposed amendments, we rule as follows:

A. The proposed amendments, in and by themselves, will not cause the deferred share units portion of Plan A, nor Plan B, to not be a prescribed plan or arrangement as described in paragraph 6801(d) of the Regulations.

B. The proposed amendments, in and by themselves, will not cause the Restricted Units portion of Plan A to be a salary deferral arrangement ("SDA") as defined in subsection 248(1) of the Act.

C. The proposed amendments, in and by themselves, will not cause an amount to be included in the income of a Participant or Member, pursuant to subsection 5(1) or paragraph 6(1)(a) of the Act, solely as a result of allocating Restricted Units, Deferred BA Units or Deferred AB Units to the Participant's or Member's Notional Account, or upon the conversion of deferred share units.

D. The proposed amendments, in and by themselves, will not cause either Plan A or Plan B to constitute an investment contract as defined in subsection 12(11) of the Act, nor will they cause the allocation of Deferred AB Units or Deferred BA Units to constitute interest income from an investment contract pursuant to subsection 12(4) of the Act.

E. All payments under Amended Plan A to the Participants or their beneficiaries (where a Date of Redemption as described in paragraph 38 has occurred), in respect of the redemption of Restricted Units, will be taxable to the Participant in the year the payment is received as employment income under section 5 of the Act.

F. Subject to paragraph 18(1)(a) and section 67 of the Act, the proposed amendments, in and by themselves, will not cause any costs incurred in a year by Corporation A in administering Plan A in respect of employees of Corporation A, or by Corporation B in administering Plan B in respect of employees of Corporation B, to not be deductible in that year by Corporation A or Corporation B, respectively, in that year in accordance with section 9 of the Act.

G. Subject to paragraph 18(1)(a) and section 67 of the Act, any payments by Corporation A in satisfaction of the deferred share units and/or Restricted Units of a Participant who has become a Participant of Plan A pursuant to paragraph 45 above, will be deductible in computing the income of Corporation A in the year in which the payments are made, in accordance with section 9 of the Act, only to the extent that the payments are made in respect of the employment services rendered by the Participant while an employee of Corporation A.

H. Subject to paragraph 18(1)(a) and section 67 of the Act, any payments by Corporation B in satisfaction of the deferred share units of a Member who has become a Member of Plan B pursuant to paragraph 45 above, will be deductible in computing the income of Corporation B in the year in which the payments are made, in accordance with section 9 of the Act, only to the extent that the payments are made in respect of the employment services rendered by the Member while an employee of Corporation B.

I. All amounts payable under Plan A to or on behalf of the beneficiary of a Participant (where a Date of Redemption as described in paragraph 38 has not occurred), in respect of Restricted Units, as a result of a Participant's death, will constitute a right or thing held by the deceased Participant at the time of death for the purposes of subsections 70(2) and 70(3) of the Act.

The above rulings, which are based on the Act and Regulations in their present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided that the proposed amendments are implemented by XXXXXXXXXX.

Pursuant to paragraphs 13 and 29 above, Corporation A or Corporation B (as applicable) may notionally increase the dollar value of the MIP A bonus or MIP B bonus (as applicable) for the purpose of determining the number of deferred share units allocated to a Participant or Member (as applicable). The above Rulings will not apply should this discretion be exercised to allocate deferred share units and/or Restricted Units in order to reduce the impact, in whole or in part, of any reduction in the fair market value of an A Share and/or a B Share. Such event would, in and of itself, cause the deferred share unit portion of Plan A, or Plan B, to not be a prescribed plan or arrangement as described in paragraph 6801(d) of the Regulations.

Nothing in this ruling should be construed as implying that the CRA has reviewed or is making a determination in respect of the fair market value of any share referred to herein.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate