27 March 1990 Ministerial Correspondence 59264 F - Employees' Taxation under Stock Option Plan

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.

March 27, 1990

Dear Sirs:

Re:  Subsection 7(1) of the Income Tax Act (the "Act")

This is in reply to your enquiry dated December 11, 1989, relating to the taxation of employees under variations of a stock option plan.  You outlined three situations exactly as follows:

Situation 1

1.     Employee is issued a restricted share, which for all practical purposes, is the same as a common share except that it cannot be transferred or sold for four years from the date of issue to the employee.  The employee receives dividends on each share and each share carries with it voting rights similar to those of a normal common shareholder.

2.     At the end of the four-year period, the company issues to the employee a share of common stock in exchange for the restricted share.

3.     If the employee is terminated within the four-year period, the employee forfeits the restricted share.  However, if the termination is due to death, disability or retirement, the company may exchange all or part of the restricted share for common shares but is under no obligation to do so.

Situation 2

1.     A common share is legally' issued in the name of the employee and is held by the employee.  The certificate bears an appropriate legend during the restricted stock period referring to the restrictions applicable to such shares.

2.     The restricted legend will be removed four years after the award provided the individual is still employed by the company.

3.     If the employee terminates employment prior to the four-year period, the stock is forfeited (unless the Plan organizing Committee in its sole discretion allows the employee to retain the shares).

4.     The restrictions on the share are that the employee may not sell, pledge, transfer, or dispose of the stock during the four-year period applicable to such award.  The employee is entitled to receive dividends and is entitled to normal voting rights.

Situation 3

1.     Restricted shares are issued to employee and are held by the company.

2.     The shares may not be sold, signed, transferred, pledged or disposed of during the restricted period.

3.     If the employee terminates employment before the end of the service period required for the shares to vest, the employee will be entitled to a prorated portion of the number of shares.

4.     At the end of the restricted period, the employee will receive one common share for each restricted share granted under the plan.

5.     During the restricted time period the employee receives additional remuneration equal to the amount of dividends that would be paid on those shares.  In addition, the employee is also entitled to the right to vote for each share held.

You have questioned whether section 7 of the Act is applicable in the above situations; specifically, you have questioned whether the Department would consider that an "agreement to sell or issue shares" exists and, further, whether the employee has "acquired" the shares and if so, the calculation or valuation of any benefit.

We are of the opinion that a section 7 benefit exists in each of the above situations.  An agreement to issue shares seems apparent.  As discussed in paragraph 2 of interpretation bulletin IT-113R3, the word "issue" means to deliver unissued shares of a corporation, including to deliver unissued shares for no monetary consideration.  We have previously expressed the opinion that section 7 of the Act applies where an employer grants shares to employees at no cost.  Paragraph 7(1)(a) of the Act, applies at the time shares are "acquired" by the employee although the shares may not have been issued at that time; the preamble to subsection 7(1) indicates that an agreement to issue shares is sufficient.  (see the Thirty-fifth Tax Conference, 1983, "Issues in Income Tax Administration" page 794). An agreement would normally take the form of "an offer by the employer to sell or issue its shares to the employee, who upon accepting the offer, agrees to be bound by its terms which may easily take the form,of restrictions on the disposition of the share over a period of time.  When an employee acquires the shares, he acquires them pursuant to an agreement, in that the employee has agreed to acquire the shares and the employer has agreed to the acquisition by the employee.

As discussed in paragraph 6 of interpretation bulletin IT-113R3, where an employee acquires shares pursuant to an agreement the provisions of which prohibit transfer of the shares for a period of time, the employee is considered to have "acquired" the shares within the meaning of section 7.  It is a question of fact as to when shares are acquired.  The agreement may or may not state the time at which title to the shares is acquired by the employee; where it does not, the incidents of title must be examined. Reference must be made to such factors as the right to dividends, voting rights and rights on dissolution.  Although your correspondence does not address rights on dissolution, it would appear that the shares are arguably acquired by the employees in each situation at the time the share or restricted share is issued. This opinion, however, is not conclusive as we are not cognizant of all relevant details; we are unsure, for example, what "voting rights similar to those of a normal shareholder" means as described in situation 1.  It is also unclear what "additional remuneration equal to the amount of dividends that would be paid" could be intended to mean (could it be considered anything other than dividends?).  In situation 3, you state that the shares are issued" to the employee but held by the company.  Does this mean that while physical possession of the shares remain with the employer, title has in fact passed to the employee? The fact that the shares are not paid for does not negate an acquisition nor does the potential of forfeiture in certain circumstances.  We expect an employee who has acquired shares to be at risk for changes in their values.

As discussed in your correspondence and paragraph 6 of interpretation bulletin IT-113R3, a discount in calculating the fair market value of the shares is permissible where; the share agreement prohibits transfers of the share for a period of time. While we disagree with the suggestion that the value of the, share may be considered "nil" because of the restrictions described, the calculation of the quantum of the appropriate discount is a valuations question.  Should you require assistance in this regard you may contact the valuations section of your local district taxation office.

We trust that the above comments have been of assistance to you.

Yours truly,

P.D. FUOCOfor DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch