7 February 2018 External T.I. 2016-0673331E5 - Stock Options - CCPCs

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 the provisions of section 7 will apply to the hypothetical situation provided?

Position: No. The FMV of the stock options will be included in the employee’s income under subsection 5(1) and paragraph 6(1)(a) when the options are transferred to the employee.

Reasons: The requirements of subsection 7(1) have not been met.

XXXXXXXXXX								2016-067333
I. Schnitzer
February 7, 2018

Dear XXXXXXXXXX:

Re: Stock Options of a Canadian Controlled Private Corporation (“CCPC”)

We are writing in reply to your email of October 26, 2016 requesting our views on the application of the employee stock option rules in section 7 of the Income Tax Act (the “Act”) to the following hypothetical situation:

• Serviceco, Opco and Parentco are CCPCs.
• Serviceco deals at arm’s length with Opco and Parentco. Opco is wholly-owned by Parentco.
• Serviceco enters into an agreement with Opco to provide consulting services to Opco.
• The consulting fees include stock options (“Options”) issued by Opco to Serviceco that give Serviceco the right to acquire common shares of Parentco at a price equal to the fair market value (“FMV”) of Parentco’s shares at the time the Options are issued.
• The employment contract of an employee of Serviceco (“Employee”) provides that Serviceco will pay the Employee a fixed salary plus a percentage of the Options that Serviceco receives from Opco.
• Serviceco transfers 6,000 Options to the Employee in Year 1 pursuant to the employment contract.
• The Employee exercises all of the Options in Year 2 just prior to Parentco making an initial public offering of its shares. The FMV of the Parentco shares acquired by the employee, net of the exercise price paid by the Employee on the Options, is $300,000.

The Employee disposes of the Parentco shares in Year 3.

In particular, you have asked that we confirm that paragraph 7(1)(a), subsection 7(1.1) and paragraph 110(1)(d) will apply with respect to the Options such that the Employee will be required to include the $300,000 net benefit from the Options in income only in Year 3 when the Employee disposes of the Parentco shares and that the Employee will be entitled to a 50% deduction on that benefit. You have also asked that we confirm that no amount will be included in the Employee’s income under paragraph 6(1)(a) in either Year 1 as a result of Serviceco transferring the 6,000 Options to the Employee or in Year 2 as a result of the Employee exercising the Options and acquiring Parentco’s shares. Finally, you have asked whether the tax consequences would differ if Serviceco held the Options in trust for the Employee or if Opco and Parentco were not CCPCs. We apologize for the delay in our reply.

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Section 7 applies only where a corporation has agreed to sell or issue its shares (or shares of a non-arm’s length corporation) to an employee of the corporation (or a non-arm’s length corporation). If there is no such agreement, section 7 cannot be applied.

In the situation you have described, Opco has agreed to sell shares of Parentco to Serviceco. Since Serviceco is not an employee of either Opco or Parentco (or for that matter not an employee at all), the requisite conditions for the application of section 7 will not be met. Even if it were possible to consider that the Employee was a party to the option agreement, section 7 would still not apply because the Employee is not employed by either Opco or Parentco and Serviceco deals at arm’s length with both Opco and Parentco. In addition, no deduction will be available to the Employee under paragraph 110(1)(d) since that provision applies only in situations where subsection 7(1) applies.

Where section 7 does not apply to an option benefit provided to an employee, the normal rules in subsection 5(1) and paragraph 6(1)(a) will apply. In this situation, the Employee received the 6,000 Options in Year 1 as compensation for services rendered to Serviceco as an employee. Accordingly, the FMV of the Options, determined at time the Employee received the Options, will be included in the Employee’s income for Year 1 under subsection 5(1) and paragraph 6(1)(a). The determination of FMV is a question of fact. It is the CRA’s view that the intrinsic value of an option is not reflective of its FMV; rather, a valuation method that is appropriate in the circumstances should be used to determine the FMV.

The tax consequences that result from the Employee’s exercise of the Options in Year 2 and the disposition of the optioned shares in Year 3 will depend on the facts. For information, refer to Interpretation Bulletin IT-479R, Transactions in Securities.

An arrangement where an employer contributes property to a trust, on behalf of an employee of the employer, may constitute an “employee benefit plan” or an “employee trust” as those terms are defined in subsection 248(1). For information on the tax implications of providing employment benefits by means of an employee benefit plan or employee trust, refer to Interpretation Bulletin IT-502, Employee Benefit Plans and Employee Trusts.

The tax consequences described above do not depend on the status of Opco and Parentco as CCPCs.

We trust that our comments will be of assistance to you.

Yours truly,

Dave Wurtele
Acting Section Manager
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch