2004 Ruling 2004-0058171R3 - Stock options - exchange

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:

Whether subsection 7(1.4) of the Act applies to the exchange of an option for a substituted right which will entitle the employee to acquire a number of shares with a FMV equal the benefit under paragraph 7(1)(a) of the Act?

Whether subparagraph 110(1)(d)(iii) and paragraph 7(9)(b) are met?

Position:

Conditions in paragraphs 7(1.4)(a) and (b) are met. Provided that paragraph 7(1.4)(c) is met, rules in paragraphs 7(1.4)(d) through (f) will apply.

Provided that the Eligible Employee meets the arm's length test in clause 110(1)(d)(iii)(B) of the Act, subparagraph 110(1)(d)(iii) will be met

Reasons:

Analysis of the Act

XXXXXXXXXX 								2004-005817

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This is reply to your letters of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above taxpayer. We also acknowledge the information in your subsequent submissions of XXXXXXXXXX.

We understand that, to the best of your knowledge and that of the taxpayer, none of the issues involved in the ruling request is:

(i) in an earlier return of the taxpayer or a related person,

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) under objection by the taxpayer or a related person,

(iv) before the courts, or if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

(v) the subject of a ruling previously issued to the taxpayer or a related person by this Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter (the "Act"), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

Definitions and Abbreviations

"Board" means the board of directors of the Company.

"Committee" means the compensation committee of the Board or, if no compensation committee is appointed, the Board.

"Common Shares" means common shares of the Company.

"Company" means XXXXXXXXXX.

"Current Market Price" means the weighted average trading price of the Common Shares on the XXXXXXXXXX (or if not listed on the XXXXXXXXXX, then such other stock exchange as the Common Shares may then be listed and as designated by the Board) for the five trading days immediately prior to the date of the grant or, if such Common Shares are not listed on any stock exchange, at fair market value as determined by the Committee.

"Current Price" means, the closing price of the Common Shares immediately prior to exercise or exchange of options.

"Draft Plan" means the stock option plan to be implemented by the Group.

"Exercise Price" means the Current Market Price on the grant date.

"Eligible Employee" means an officer or key employee of the Company or of a corporation with which Company does not deal at arm's length. An officer or key employee of a partnership, where the Company or a corporation with which the Company does not deal at arm's length is a partner and no agreements between the partners specify which partners employ which employees, will also be eligible to participate.

"Group" means, collectively or individually, the Company, XXXXXXXXXX (an XXXXXXXXXX partnership) and any subsidiary or partnership controlled directly or indirectly by any of the foregoing.

"Plan" means the existing XXXXXXXXXX Stock Option Plan.

"Optionee" means an Eligible Employee that has been granted options under the Plan or the Draft Plan.

"Substituted Right" means a right which will entitle the Optionee to acquire on exercise the following number of Common Shares:

Number of Common   =   Number of Common    x   (Current Price - Exercise Price)
                      Shares                       Shares under the                            Current Price
     		                           exchanged options

XXXXXXXXXX

Facts

1. The Company is a public corporation and a taxable Canadian corporation. The Common Shares of the Company trade on the XXXXXXXXXX and are widely held. The expressions "public corporation" and "taxable Canadian corporation" have the meanings assigned by subsection 89(1).

The Company's head office is located at XXXXXXXXXX. It is serviced by the XXXXXXXXXX Tax Services Office and files its income tax returns with the XXXXXXXXXX Tax Centre.

2. The Group operates XXXXXXXXXX businesses.

3. The purpose of the Plan is to develop the interests of the officers and key employees of the Group in the growth and development of the Group. The relevant terms of the Plan are as follows:

a) The Plan is administered by the Committee pursuant to rules of procedure fixed by the Board.

b) The Committee identifies the Eligible Employees for purposes of the Plan. Non-employee directors are not eligible to participate in the Plan.

c) The Committee may grant options to purchase Common Shares to Eligible Employees. The Plan restricts the total number of Common Shares that may be issued under the Plan and restricts the total number of Common Shares that may be issued to specific Eligible Employees.

d) All options have an expiry date and no option may be exercised beyond XXXXXXXXXX years from the date of grant. In addition, all options expire no later than XXXXXXXXXX days after the Optionee ceases to be employed by the Group.

e) When granting options under the Plan, the Committee, in its sole discretion, will determine whether any vesting requirements will apply to the particular options. If there are vesting requirements, the Committee will choose the method of vesting and the vesting dates.

f) An Optionee may exercise his or her options by delivering a written notice to the Company specifying the number of Common Shares to be acquired under the options. The written notice must be accompanied by the Optionee's payment for the Exercise Price of the Common Shares.

g) Where there are subdivisions, consolidations or reclassifications of the Common Shares, the payment of stock dividends by the Company or other relevant changes in the capital of the Company, the Committee may amend the options held by the Optionees to reflect such amendments to the Common Shares.

h) A written agreement is entered into by the Company with each Optionee setting out the number of Common Shares that may be purchased under the option, the Exercise Price, the vesting dates, if any, the expiry date and any other terms established by the Committee.

i) The Board may amend, including without limiting the generality of the foregoing, the expiry date of any option (provided that no option may be exercised beyond XXXXXXXXXX years from the date of grant), the vesting date of any option, or the conditions upon which an option may vest. The Committee may discontinue the Plan at any time, provided, however, that no such amendment may, without the consent of the Optionee, alter or impair any option previously granted to an Optionee under the Plan. The Plan and any option previously granted shall not be amended without the prior consent of the XXXXXXXXXX and such other exchange on which the Common Shares are listed.

j) All options are personal property of the Optionee and are not assignable.

4. Under the Plan, certain Eligible Employees have been granted options to acquire Common Shares.

Proposed Transactions

5. Subject to the receipt of a favorable advance income tax ruling from the Canada Revenue Agency ("CRA"), the Company will amend the Plan. The Plan will be amended to include the following:

a) An Optionee will have the right to exchange his or her existing options for a Substituted Right. This right will be exercised when the Optionee delivers written notice to the Company specifying the number of options being exchanged. The exchanged options shall terminate upon such exchange and the Optionee shall cease to have further rights under such options.

b) When the Optionee exercises his or her Substituted Right, the Company will issue the required number of Common Shares in the name of the Optionee.

6. Subject to the receipt of a favorable advance income tax ruling from the CRA, the Company will implement the Draft Plan. Except for minor differences, the relevant terms of the Draft Plan will be the same as those listed in 3 above and will include the amendment proposed in 5 above. Furthermore, the Draft Plan will provide that if an Optionee elects to exercise his or her options, the Company may, in its sole discretion, require the Optionee to exchange his options for Substituted Rights.

7. Once the Draft Plan is implemented, the Company will only issue options under the Draft Plan.

Purpose of the Proposed Transactions

8. The purpose of the proposed amendments to the Plan and of the implementation of the Draft Plan is to encourage the acquisition of Common Shares by the Eligible Employees by reducing the financial burden associated with the acquisition of such Common Shares. The ability of Company to force the employee to take Substituted Rights in exchange for the employee's options is included in the Draft Plan to enable Company to control the number of shares it issues under its stock option plans and, hence control the market dilution created as a result of exercised of stock option.

Rulings Given

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

A. Where an Optionee exchanges an option for a Substituted Right in a manner described in 5 and 6 above, he will be considered to have satisfied the conditions in paragraphs 7(1.4)(a) and 7(1.4)(b). Provided that paragraph 7(1.4)(c) is satisfied, the rules in paragraphs 7(1.4)(d) through (f) will apply in respect of a Substituted Right received by the Optionee.

B. The acquisition of Common Shares by an Optionee following the exercise of the option or the Substituted Right will result in the application of paragraph 7(1)(a).

C. Provided that the Exercise Price represents the fair market value of the Common Shares at the time an option was granted under the Plan or the Draft Plan and provided that the other conditions in paragraph 110(1)(d) are satisfied, an Optionee who acquires Common Shares following the exercise of the option or the Substituted Right will be entitled to a deduction under paragraph 110(1)(d) and will satisfy the condition in paragraph 7(9)(b).

D. The Draft Plan will not constitute a salary deferral arrangement as defined in subsection 248(1).

E. The Draft Plan will not constitute a retirement compensation arrangement as defined in subsection 248(1).

The above advance income tax rulings, which are based on the Act in its 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 Advance Income Tax Rulings, dated May 17, 2002, and are binding on the CRA provided the proposed transactions are implemented before XXXXXXXXXX.

In addition, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

a) the taxation of options if they are provided to officers and employees of companies retained by the Group to provide management functions to the Group;

b) the taxation of options provided to the personal holding company of an Eligible Employee; or

c) any other tax consequence relating to the facts, proposed transactions or any transaction or event taking place either prior to the proposed transactions or subsequent to the proposed transactions, whether described in this letter or not, other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch