23 March 2006 External T.I. 2005-0157521E5 - Tax Treatment of Employee Stock Options

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) How will stock options provided to employees of a Canadian corporation by a XXXXXXXXXX public corporation that was the parent corporation when the options were issued but is no longer related be treated when exercised? 2) How should employees report the stock option benefit? 3) How should they make an election to defer the stock option benefit?

Position: 1) As long as the XXXXXXXXXX corporation has agreed to sell or issue shares, section 7 will apply. 2) The employee must include the benefit as employment income in the year of exercise unless a valid deferral election is made. 3) Written election to the person that would have been required to report the benefit, but for the election to defer, within the timeframe provided in subsection 7(10) of the Act.

Reasons: 1) Subsection 7(1) is clear. 2) The law is clear. 3) Subsections 7(8) and (10).

XXXXXXXXXX 							2005-015752
P. Kohnen, CMA
March 23, 2006

Dear XXXXXXXXXX:

Re: Technical Interpretation - Employee Stock Options

This is in response to our telephone conversations (XXXXXXXXXX/Kohnen) and your submissions in 2005 to the Winnipeg Tax Services Office, which has been forwarded to our attention for our response. As was noted during our telephone discussions, you have narrowed the issues for which a response is required. You have requested that we provide our comments on how certain stock option benefits granted to your employees, who are resident here in Canada, will be treated for tax purposes and how such benefits are to be reported. You also wanted to know how employees should make an election to defer their stock option benefits.

The above-referenced forwarded submission provided details concerning the facts and transactions that apply to your request. It should be noted that we have not taken any steps to confirm the accuracy of these statements. We have summarized the most significant assumptions, including those discussed during our telephone discussions, as follows:

1. In XXXXXXXXXX was a subsidiary of XXXXXXXXXX a large corporation that is not a resident of Canada. Shares of XXXXXXXXXX are listed on stock exchanges in XXXXXXXXXX and elsewhere, but are not listed in Canada.

2. During XXXXXXXXXX granted certain employees of XXXXXXXXXX options to acquire common shares of XXXXXXXXXX. The exercise price of each option at the date of the grant was not less than the fair market price of the underlying XXXXXXXXXX share at that date.

3. On XXXXXXXXXX sold all of the shares which it had held in XXXXXXXXXX to an unrelated party, such that XXXXXXXXXX is no longer a part of the XXXXXXXXXX group of companies. Subsequent to the disposition of shares XXXXXXXXXX are not related corporations.

4. The expiry dates of these outstanding options were accelerated such that some were revised to expire within XXXXXXXXXX months of the sale of XXXXXXXXXX with the remainder of the options expiring within XXXXXXXXXX years of the sale date.

5. The option holders are Canadian residents. Some have retired from XXXXXXXXXX since being issued the options.

Our comments

As is noted in paragraph 1 of Interpretation Bulletin IT-113R4 - Benefits to Employees - Stock Options, which is available on our website at www.cra-arc.gc.ca, subsection 7(1) of the Income Tax Act (the "Act") will apply when a particular corporation has agreed to sell or issue shares of that corporation or shares of another non-arm's length corporation to an employee of either the particular corporation or of any corporation with which it does not deal at arm's length. Section 7 of the Act will not apply if the benefit conferred by the stock option agreement is not received by reason of the employee's employment.

It should be noted that section 7 of the Act is applicable where a non-resident corporation has agreed to sell or issue shares to individuals employed in Canada by a corporation with which the non-resident corporation does not deal at arm's length.

Pursuant to subsection 7(4) of the Act, if a person was an employee when they received the option to acquire shares but subsequently ceased to be an employee prior to the exercise or transfer of their rights under the option agreement, section 7 will continue to apply to the determination of the benefit to that person.

Pursuant to paragraphs 6(1)(a) and 7(1)(a) of the Act, an employee who exercises an option and acquires shares is generally required to include in employment income, in the taxation year in which the shares are acquired, a benefit equal to:

• the fair market value of the shares at the time the shares are acquired by the employee

less:

• any amount paid or payable by the employee for the shares, and
• any amount paid by the employee to acquire the right to acquire the shares.

The income inclusion under paragraphs 6(1)(a) and 7(1)(a), referred to above, may also be deferred by virtue of subsection 7(8) if the employee qualifies and makes a valid election to defer the inclusion of the benefit under subsection 7(10) of the Act. The deferred benefit would be included in the employee's income in the year the employee disposes of the security, the year the employee dies or at the time the employee ceases to be resident in Canada, whichever occurs first.

As was noted during our latest telephone conversation, the employee must file such election, in the form of a letter, before January 16 of the year following the year in which the acquisition of shares occurs, with the person that would have been required to report the benefit, had the employee not so elected. Please see the section entitled Employee Security Options in Guide T4037 - Capital Gains, which is available on our website at the address noted above, for further details. Employees who elect to defer their benefit must complete form T1212 - Statement of Deferred Security Options Benefits each year and file it with their personal tax return.

Pursuant to paragraph 153(1)(a) of the Act, every person paying salary, wages or other remuneration in a year, other than amounts described in subsection 212(5.1) of the Act, must deduct and withhold tax in accordance with the rules prescribed by the Income Tax Regulations (the "Regulations"). Pursuant to subsection 200(1) of the Regulations, the payer must report the payment on an information return (in this case the T4 Information Slip) in prescribed form.

Based on the information provided, in our view, XXXXXXXXXX, as the corporation that has agreed to sell or issue shares to the employees, will be considered to be the "payer" of the stock option benefit for purposes of subsection 153(1) of the Act unless it receives reimbursement, in whole or in part, either directly or indirectly, in respect of the benefit. Thus, any election by an employee, under subsection 7(10) of the Act, to defer the inclusion of the benefit, by virtue of subsection 7(8) of the Act, should be filed with XXXXXXXXXX. However, it may be advisable, given the facts specific to this situation, for a copy of any such election to be forwarded to XXXXXXXXXX as well.

We trust that the above comments will be of assistance to you. Please feel free to contact Phil Kohnen at (613) 957-2093 should you require further information.

Yours truly,

Roberta Albert, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate