23 October 1989 Income Tax Severed Letter 7-4316 - [Employee Investment Act (British Columbia)]

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.

REVENUE CANADA TAXATION   REVENU CANADA IMPOT
MEMORANDUM                NOTE DE SERVICE

DATE October 23, 1989
TO/A OFFICER ANALYSIS     FROM/DE  Financial Industries Division
                                   Blair P. Dwyer

FILE DOSSIER 7-4316

SUBJECT: OBJECT: Employee Investment Act (British Columbia)

The organization of this memo follows the organization of the memo to Provincial and International Relations.

Deductibility of Set-Up Costs

Expenses of negotiating and evaluating an ESOP or an EVCP relate more to the set-up of the plan rather than the issuance of shares under the plan. Such costs will include the creation of a separate class of shares, determination of valuation methods for the shares, and the terms and conditions of the shares. These are all prohibited deductions within paragraph 16 of IT-341R . The establishment of a plan is not similar to the preparation of a prospectus. A prospectus is a disclosure document (i.e. it discloses something the terms of which have already been established). In contrast, an ESOP and an EVCP represent what must be established before a preparation of a prospectus can even commence.

We were not asked whether expenses incurred by the employer would be deductible as general expenses of providing benefits to employees. I spoke with Duncan Jones (Personal and General Section) on this possibility. He advised that the Personal and General Section had not dealt with the issue. At first glance, this deduction may well be possible. While no employee benefit as such is involved, the employer may well be incurring the expense to keep his employees satisfied and increase their productivity. This will be a question of fact; after discussing the point with my chief, we decided not to address the matter. I note that paragraph 7(3)(b) of the ITA applies only to the deemed benefit under section 7 and does not prohibit a deduction for out-of-pocket expenses incurred by an employer in connection with setting up a plan or issuing shares under a plan (i.e. expenses of having share certificates printed up).

Reimbursement of Set-Up Costs

In respect of the ITA 6(1)(a) issue, see a letter dated March 9, 1988 from R.G. D'Aurelio of the Provincial and International Relations Division to XXXX concerning Ontario's Employee Share Ownership Plan Act.

We discussed the ITA 12(1)(x) issue with Brian Darling. Gerry Lalonde of Finance argued that 12(1)(x) should not apply because the reimbursement decreased the related expense under 12(1)(x)(vi) and IT-273R . Gerry argued that it was irrelevant that the expense involved was non-deductible. While not entirely convinced of this argument, we concluded that an expense in 12(l)(x)(vi) must be the same expense that was mentioned in 12(1)(x)(iv). If 12(l)(x)(vi) related only to deductible expenses, then 12(l)(x)(iv) included only reimbursements of deductible expenses Whichever meaning of "expense" prevailed, 12(1)(x) did not apply in this case.

Redemption of Shares

While we were sympathetic to arguments that the shares should not be short-term preferred shares, we were unable to come to this conclusion. Such a conclusion would have required reference to the retraction feature to establish fair market value, which would have been directly contrary to the legislation.

On the application of minority discounts., I spoke with John Welley of Valuations. See also Information Circular 89-3 [paragraphs 5(h) and 6(b)] as well as Decision Summary 6121-2 (December 12, 1986) concerning clause 186(4)(b)(ii) of the ITA.

An interesting technical issue arises as to whether the exclusion in subparagraph (a)(i) of the short-term preferred share definition applies to fair market value provisions contained in

i) both an agreement relating to the share and the share terms and conditions; or

ii) only an agreement relating to the shares.

The issue arises because the first four lines of paragraph (a) state as follows:

is a share where, under the terms and conditions of the share, any agreement relating to the share or any modification of such terms, conditions or agreement [...]

However, subparagraph (a)(i) refers only to "an agreement in respect of a share" without mentioning the terms and conditions of the share.

In our case, the statute requires that the retraction right be included in the ESOP or the EVCP ("an agreement") rather than in the terms and conditions of the share. Consequently, we did not have to address this issue.

Depository Arrangement

While the wording of the Act and the Regulations ("shares ... held by a depository") are wide enough to authorize a trust relationship, the actual authorized terms and conditions stop short of creating a trust. The depository does no more than hold the share certificates; it has no interest in the shares themselves and is not registered as an owner thereof. The depository holds a physical asset (the piece of paper on which the certificate is printed) and not the intangible asset evidenced by the share certificate. The registered shareholder cannot-demand the certificate for a 3 year period; this is in conformity with the laws of bailment, since a bailee can insist on holding goods until the purpose of the bailment has been fulfilled. See Waters, Law of Trusts in Canada, Chapter 1, "Distinction Between Trusts and Bailment". Wayne Douglas (Deferred Income Plans & Trusts) concurred with this approach.

Deductibility of Interest on Money Borrowed To Acquire Shares

This portion of the memo paraphrases the position given in response to question 39 at the 1981 Round Table.

Qualified Investment Status

I had Wayne Douglas (Deferred Income Plans & Trusts) review the comments under this heading.

Repayment of Tax Credits

Repayment of the tax credit is analogous to the imposition of a special tax on proceeds received in selling the shares. It is like recapture of CCA arising on the disposition of a capital asset.

Since the amount of the original tax credit will not reduce the cost base of the shares involved, making repayment of the tax credit deductible from proceeds of disposition would give the selling employee a double tax benefit.

Reduction in Withholding,

Chris Savage indicated she would talk to Source Deductions about this issue.

Subsection 15(1)

To the extent a benefit arises under an ESOP, the benefit would arise in respect of, in the course of or by virtue of the employee's employment. Consequently, subsection 7(3) of the ITA would prohibit the inclusion of a benefit under section 15.

Subsection 7(3) would not apply in the case of an EVCP. While a technical benefit may exist, and technically may not be exempt under paragraph 15(1)(c), the benefit is minimal and incapable of quantification. Accordingly, we would not seek to tax it under subsection 15(1). See

a) a memo to Harold Forsythe from C.B. Darling, dated January 19, 1961, concerning Dividend Reinvestment Plans;

b) a ruling dated 5/2/81 (13-1484) given to XXXX and

c) a memo to the Policy Decision File on subsection 15(1), dated June 16, 1982, concerning Dividend Reinvestment Plans and Stock Dividend Plans.

Investment Protection Account

The bank that maintains the account seems to be performing the normal function of a bank holding a deposit. The bank is a debtor of the depositor, and in this case pays money out of the account (i.e. repays its debt) only on presentation of a document signed by the corporation and the administrator. During the time the money is in the account, the bank has no trust duties or powers in respect of the money. I discussed this matter with Wayne Douglas.