Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: In a particular situation, when did a corporation agree to issue shares of its capital stock to certain of its employees? (Participants).
Position: At the time an exercise notice is sent by the corporation to the Participants.
Reasons: In this case, the exercise notice is the document by which the corporation unilaterally commits itself to the Participants to issue the shares of its capital stock.
May 29, 2007
OUTAOUAIS AND ROUYN-NORANDA TSO Headquarters
Mr. Alain Déziel Income Tax Rulings Directorate
Team leader
Audit and Enforcement Division Guy Goulet, CA, M.Fisc.
Rouyn-Noranda (819) 986-8098
2006-021740
Request for Interpretation - Paragraph 110(1)(d)
This is in response to your email of December 8, 2006, requesting our comments on the application of paragraph 110(1)(d) in the Particular Situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
The Particular Situation as you have presented it to us is as follows:
1. XXXXXXXXXX ("Opco"), XXXXXXXXXX ("Holdco"), XXXXXXXXXX ("Holdco 1") and XXXXXXXXXX ("Holdco 2") are Canadian-controlled private corporations within the meaning of subsection 125(7) that have their head office in the Province of Quebec.
2. On XXXXXXXXXX, Holdco held XXXXXXXXXX% of the shares of the capital stock of Opco, namely XXXXXXXXXX common shares. At the same date, the shares of the capital stock of Holdco were held in the following proportions by the following persons: XXXXXXXXXX% by Holdco 1; XXXXXXXXXX% by Holdco 2; XXXXXXXXXX% by XXXXXXXXXX and XXXXXXXXXX% by XXXXXXXXXX. Also, on that same date, all of the shares of capital stock of Holdco1 were held by XXXXXXXXXX. Finally, on the same date, the shares of the capital stock of Holdco2 were held in the following proportions by the following persons:
XXXXXXXXXX% by XXXXXXXXXX; XXXXXXXXXX% by XXXXXXXXXX and XXXXXXXXXX% by XXXXXXXXXX.
3. On XXXXXXXXXX, all of the issued and outstanding common shares of the capital stock of Opco were exchanged for XXXXXXXXXX Class A preferred shares of the capital stock of Opco. Immediately following that transaction, Opco issued XXXXXXXXXX common shares of its capital stock to Holdco for cash consideration of $XXXXXXXXXX. Immediately following those transactions, the aggregate fair market value (FMV) of the issued and outstanding common shares of the capital stock of Opco was $XXXXXXXXXX, or $XXXXXXXXXX per share.
4. On XXXXXXXXXX, Opco established a plan for the grant of options to purchase shares of its capital stock ("the Plan") for the benefit of certain of its employees ("Participants").
The Plan provides in particular that:
(a) The Board of Directors of Opco may from time to time grant options ("Options") to Participants and set the exercise price.
(b) The shares covered by the Plan are XXXXXXXXXX common shares of the capital stock of Opco.
(c) The expiry terms of the Options. In summary, each year, XXXXXXXXXX% of the Options granted to a Participant expire. Also, in no event shall the Options survive the fifth anniversary of the date of grant of the Options.
(d) A written agreement between Opco and the Participant shall record each Option granted under the Plan.
(e) The Compensation Committee shall determine annually the number of Options exercisable ("Exercisable Options") by each Participant for the current year by issuing to the Participants an exercise notice ("Exercise Notice").
(f) Upon receipt of an Exercise Notice, a Participant may elect to exercise his or her Exercisable Options to acquire Common Shares of Opco or request Opco to repurchase them for consideration equaling to the market value of the shares covered by the Exercisable Options at the time the Exercise Notice is sent less the exercise price ("Cancellation Price").
5. On XXXXXXXXXX, Opco signed an agreement with each of the Participants to grant options to purchase shares of the Corporation's capital stock (the "Grant Agreement"). In total, Opco granted XXXXXXXXXX Options to the Participants as follows:
XXXXXXXXXX
Each Grant Agreement provided, inter alia:
(a) The number of Options granted to the Participant.
(b) The exercise price ($XXXXXXXXXX), the terms of grant, the determination of the FMV of the Common Shares in the capital stock of Opco and the time periods for exercise.
(c) The Options may be exercised in part by the Participant from the day an Exercise Notice is issued to the Participant.
(d) Upon receipt of an Exercise Notice, the Participant may elect to exercise his or her Exercisable Options to acquire Common Shares of Opco or request Opco to repurchase his or her Exercisable Options for a consideration equal to the Cancellation Price.
(e) The expiry date of the Options.
6. On XXXXXXXXXX, the Compensation Committee of Opco issued Exercise Notices. Each Exercise Notice specifies, inter alia, the number of Options the Participant is entitled to exercise, the Cancellation Price, the Exercise Price and the choice offered to the Participant between exercising his or her exercisable Options in order to acquire common shares of Opco or requesting the repurchase of the exercisable Options for a consideration equivalent to the Cancellation Price.
The Participants were granted the right to exercise the following number of Options:
XXXXXXXXXX
The Cancellation Price per option was $XXXXXXXXXX on XXXXXXXXXX and $XXXXXXXXXX on XXXXXXXXXX.
7. On XXXXXXXXXX, each Participant who received an Exercise Notice sent a notice of redemption ("Redemption Notice") to Opco requesting the redemption of their exercisable Options for a consideration equivalent to the Cancellation Price. The table below sets out the Cancellation Price per Participant for those two years:
XXXXXXXXXX.
8. For the years XXXXXXXXXX the Participants have seen the following number of Options expire:
XXXXXXXXXX.
9. The FMV of a share of the capital stock of Opco was $XXXXXXXXXX on XXXXXXXXXX, $XXXXXXXXXX on XXXXXXXXXX and $XXXXXXXXXX on XXXXXXXXXX.
10. For the XXXXXXXXXX taxation years, the Participants, who requested Opco to redeem their Options, recognized the following tax consequences in their income tax returns:
- They included in their income a benefit conferred by virtue of employment, equivalent to the amount received (Cancellation Price) under paragraph 7(1)(b).
- They deducted in computing their taxable income under paragraph 110(1)(d) an amount equal to one-half the value of the benefit under subsection 7(1).
Your Question:
You wish to know whether the Participants were entitled to deduct an amount equal to one-half of the value of the benefit deemed to have been received under subsection 7(1) in 2004 and in XXXXXXXXXX under paragraph 110(1)(d).
Paragraph 110(1)(d) provides that, in computing a taxpayer's taxable income for a taxation year, there may be deducted one-half of the amount of the benefit deemed by subsection 7(1) to have been received by the taxpayer in the year in respect of a security that a particular qualifying person has agreed to sell or issue under an agreement, or in respect of the transfer or other disposition of rights under the agreement, if certain conditions are satisfied.
One of the conditions to be met in situations where the rights under the agreement have not been acquired by the taxpayer as a result of a disposition of rights to which subsection 7(1.4) applies is that the amount payable by the taxpayer to acquire the security under the agreement is at least equal to the amount, if any, by which the FMV of the security at the time the agreement is entered into exceeds the amount paid by the taxpayer to acquire the right to acquire the security, in accordance with clause 110(1)(d)(ii)(B) [sic, (A)].
In the past, the CRA has on a few occasions had to interpret the phrase "at the time the agreement is entered into" in clause 110(1)(d)(ii)(B) [sic, (A)]. In response to Question 22 of the Canadian Tax Foundation's Annual Conference held in Montreal from November 23 to 25, 1987, the CRA stated:
It is our opinion that the expression "at the time the agreement was made" contained in subparagraph 110(1)(d)(iii) would refer to the date on which the option to acquire a specific number of shares at a specific price is granted to the employee by the employer.
Also, in the technical opinion dated February 7, 1988, and numbered E55180, the CRA indicated that this expression "refers to the date on which the corporation unilaterally undertakes to sell or issue the shares of its capital stock.
In this case, the condition in clause 110(1)(d)(ii)(B) [sic, (A)] would be satisfied if the time of the agreement were found to be XXXXXXXXXX, the date that Opco established the Plan and signed a Grant Agreement with each Participant. However, it appears to us that the Grant Agreement is not the appropriate agreement for purposes of applying clause 110(1)(d)(ii)(B) in this situation.
First, it appears to us that Opco did not undertake to issue shares of its capital stock when the Plan was established and the Grant Agreements were signed. In our view, Opco's obligation to issue shares of its capital stock arose when its Compensation Committee issued Exercise Notices to Participants on XXXXXXXXXX. For this reason, we believe that the "time of agreement" occurs only on those two dates, as it is at those time that Opco undertook by unequivocal act of will to assume certain obligations pursuant to the Grant Agreements. Prior to the issuance of the Exercise Notices, it is our view that Opco had no obligation to issue shares of its capital stock and that Participants had no right in this regard, and Participants were not able to exercise their Options until they received an Exercise Notice from the Compensation Committee.
Furthermore, we are of the view that the essential terms of the agreement were not definitively fixed on XXXXXXXXXX as the Participants did not know how many Options they would eventually be able to exercise before their Options expired. In fact, they did not even know whether they would be able to benefit from the Plan before their Options expired. They had to await Opco, through its Compensation Committee, issuing Exercise Notices. That is when they would know whether they would be able to exercise Options and if so, how many.
To illustrate this, we will take the example of XXXXXXXXXX. He was granted XXXXXXXXXX Options on XXXXXXXXXX under the Plan and the Grant Agreement. During the XXXXXXXXXX taxation year, the Opco Compensation Committee did not send him an Exercise Notice. Consequently, he was not entitled to exercise any Options for that particular taxation year. In addition, XXXXXXXXXX of his Options expired. On XXXXXXXXXX, Opco, through its Compensation Committee, sent an Exercise Notice to XXXXXXXXXX regarding XXXXXXXXXX Options. By issuing that Exercise Notice, Opco unilaterally undertook to issue XXXXXXXXXX common shares of its capital stock. In addition, XXXXXXXXXX of the Options expired in XXXXXXXXXX.
Consequently, we are of the view that the Exercise Notice constitutes the document by which Opco unilaterally commits itself to the Participants to issue shares of its capital stock. We are also of the view that it is at the time the Exercise Notice is issued that an agreement is formed for the purposes of section 7(1) and paragraph 110(1)(d). XXXXXXXXXX. Consequently, for purposes of the condition in clause 110(1)(d)(ii)(A), we must take into account the FMV of a common share of the capital stock of Opco on the date the Exercise Notices were issued.
In the present case, it is our view that the amount payable by the participant to acquire a share pursuant to the Exercise Notice is not at least equal to the amount by which the FMV of the security at the time the agreement was entered into exceeds the amount, if any, paid by the taxpayer to acquire the Option for the purposes of clause 110(1)(d)(ii)(B) [sic, (A)].
Furthermore, the fact that the Participants who did not directly or indirectly hold shares in the capital stock of Opco have seen substantially all of their Options expire each year without being able to exercise them, while some of the Participants who directly or indirectly held shares of the capital stock of Opco have been able to exercise substantially all of their Options before they expire, may be an indication that subsection 7(5) would apply in this case. This subsection provides that the provisions of section 7 do not apply where a benefit granted by the agreement has not been received in respect of, in the course of, or by virtue of the employment. Thus, section 7 does not apply to situations where the benefit granted by an agreement was received by a person as a shareholder (directly or indirectly) of a corporation. In such a situation, it would be other provisions such as subsections 15(1) or 246(1) that would apply. Whether a person has received a benefit from a corporation as a shareholder or in the capacity of, in the course of, or by virtue of employment is a question of fact that can only be resolved after a thorough analysis of all relevant facts. To the extent that a further analysis of the facts would lead you to conclude that in this case some of the Participants received the benefit of the issuance of the Exercise Notices in a capacity other than by virtue of an office or employment, we are of the view that section 7(5) could be invoked.
For your information, unless exempted, 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, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that our comments are of assistance.
Best regards,
Ghislain Martineau
for the Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate.
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