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: Will a deduction under paragraph 110(1)(d) of the Act be available where a benefit under subsection 7(1) of the Act is deemed to be received as a result of exercising an employee stock option that includes a "reload stock option"?
Position: No. Based on the description of the "reload stock option" contained in the stock incentive plan reviewed, the share acquired under the original option would not be a "prescribed share" for purposes of paragraph 110(1)(d) of the Act.
Reasons: The restrictions contained in subparagraph 6204(1)(a)(iv) of the Income Tax Regulations concerning prescribed shares, provide that the holder of a share acquired under an option must not be able to cause the share to be redeemed, acquired or cancelled by the corporation issuing the share.
October 25, 2005
HAMILTON TSO HEADQUARTERS
Janice Hurley G. Allen
Employer Compliance Audit (613) 952-9853
2005-014984
XXXXXXXXXX - Reload Stock Option
This is in reply to your memorandum dated September 6, 2005 and further to your telephone conversation of October 5, 2005 (Hurley/Allen), concerning the reload stock option feature described in the XXXXXXXXXX (the "Plans"). In your memorandum, you request our views concerning whether employees who are deemed to have received a benefit under subsection 7(1) of the Income Tax Act (the "Act"), as a result of exercising stock options with the reload feature, would be eligible for a deduction under paragraph 110(1)(d) of the Act.
Based on the information provided in the Plans and the XXXXXXXXXX describing the reload stock option feature, our understanding of how the reload stock option feature functions is as follows:
1. An employee must hold a stock option (the "Original Option") to acquire shares of XXXXXXXXXX.
2. An employee must exercise the Original Option and use XXXXXXXXXX shares to pay the exercise price under the Original Option.
3. At exercise, the employee will be granted reload stock options at the current market price for the same number of shares that were used to exercise the Original Options.
Paragraph 110(1)(d) of the Act requires, inter alia, that shares acquired under an employee stock option agreement must be "prescribed shares", as defined in section 6204 of the Income Tax Regulations (the "Regulations"), at the time that the shares are sold or issued.
Subsection 6204(1) of the Regulations contains restrictions concerning the terms and conditions of a share, or any agreement in respect of the share or its issue, that must be satisfied at the time of the share's issue if the share is to be a prescribed share for purposes of paragraph 110(1)(d) of the Act. In particular, subparagraph 6204(1)(a)(iv) of the Regulations provides that the holder of a share acquired under an employee stock option agreement must not be able to cause the share to be redeemed, acquired or cancelled by the corporation issuing the share, except under certain conditions specified in subsection 6204(2) of the Regulations. As the Plans require an employee to use the cashless exercise or swap method under the reload option feature, in our view, the employee has an immediate right to redeem shares in contravention of subparagraph 6204(1)(a)(iv).
Also, paragraph 6204(1)(b) of the Regulations provides that for a share to be a prescribed share, a corporation cannot reasonably be expected to redeem the share or reduce the share's paid up capital within two years of the share's issue, otherwise than as part of certain reorganizations.
Accordingly, in our view, it would appear that shares acquired under the Original Option that may be used to acquire additional shares of XXXXXXXXXX, as described under the reload option feature, would not be prescribed shares for purposes of paragraph 110(1)(d) of the Act.
As discussed in your telephone conversation (Hurley/Allen), we note that in Section XXXXXXXXXX of the XXXXXXXXXX Stock Incentive Plan, fair market value is defined to include the following; "Fair Market Value" as of any date and in respect of any share of Common Stock means the lowest reported trading price on such a date. As the fair market value of a share, that can be acquired under an employee stock option, at the time that the option was granted is essential in determining whether the "exercise price test" in subparagraph 110(1)(d)(ii) of the Act is satisfied, i.e., the exercise price under the employee stock option must be at least equal to the fair market value of the share that may be acquired under the option at the time that the option was granted (less any amount paid by the employee to acquire the option), we would question whether the above definition of "Fair Market Value" is appropriate. As a result, we would suggest this issue be discussed with the Valuations Section of your TSO.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. 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 electronic library version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Roberta Albert, CA
Manager
Deferred Compensation Arrangements and Retirement Plans
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch
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