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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Application of section 7 where options granted as payment in kind for services performed by a management company.
Position: Section 7 will not apply unless the option is granted to an employee of the issuer or the corporations are not at arm's length and the option is granted to an employee of the management company.
Reasons: Wording in section 7. Definition of employee by statute and by jurisprudence.
XXXXXXXXXX 990214
G. Kauppinen
Attention: XXXXXXXXXX
November 16, 1999
Dear Sirs:
Re: Stock Options Issued to a Corporation
This is in reply to your letter dated January 27, 1999 wherein you requested our opinion on the application of section 7 of the Income Tax Act ("Act") assuming the following:
a) an individual employed by a corporation (Corp. A ) provides services on behalf of Corp. A to another corporation (Corp. B),
b) Corp. B pays in part for the services rendered by Corp. A by way of the issuance of stock options (to purchase Corp. B shares) to Corp. A..
A fundamental condition necessary for the application of section 7 to any agreement to sell or issue securities (i.e. shares of a corporation or units of a mutual fund trust) is that the agreement must be between the corporation or mutual fund trust (or a corporation or mutual fund not dealing at arm's length with the first-noted corporation or mutual fund trust) ("qualifying persons") and an "employee" of one of these entities.
If the person who receives the option is not an "employee" of any "qualifying person" as defined above, then section 7 can never apply. The word "employee" is defined in subsection 248(1) of the Income Tax Act ("Act") to include an "officer". The word "officer" is defined in the definition of "office" in subsection 248(1) of the Act to include an individual entitled to a "fixed or ascertainable stipend or remuneration" and also includes a director of a corporation.
Also, by definition in subsection 248(1) of the Act, an individual means a person other than a corporation. In our opinion it follows that a corporation can never be considered to be an "employee" for the purposes of section 7 of the Act.
As noted in our document 970172, to which you have referred, the decision in Scott v. the Queen (91 DTC 5268 confirmed by 94 DTC 6193) ("Scott") is indicative of the general presumption that the existence of an employee/employer relationship in the context of the potential applicability of section 7 is a question of fact. In the Scott situation the court decided that the appellant Scott was an employee of the corporation from which he received the options for purposes of section 7 of the Act. Also, in arriving at its decision, the court disregarded the fact that, in form, the appellant Scott was employed by a management firm which provided his services to the corporation which ultimately agreed to issue the stock options to him.
In our opinion, it follows from the reasoning in Scott that in any situation where a management corporation is offering the services of its employees to another corporation the following generalizations can be made:
a) It will always be a question of fact (if the two corporations are not related) whether the two corporations are dealing at arm's length (paragraph 251(1)(b) of the Act.). If the corporations are not dealing at arm's length and the option is granted to the employee of the management corporation then, pursuant to its pre-amble, section 7 of the Act will apply.
b) Even if the corporations are dealing at arm's length, the employee of the management corporation may also be considered an employee of the corporation for which the services are being performed depending upon the particular fact situation, and section 7 could apply if options are issued to that employee.
In our document 9231755, to which you also referred, we concluded that section 7 would apply where a stock option was issued to a corporation under the amended rules of the Vancouver Stock Exchange ("VSE"). These rules require, in part, that the individual be an employee of the corporation granting the option either by definition ( e.g. the recipient of the option is a director of the grantor corporation) or factually as in Scott. Also, the VSE rules require that the individual entitled to the option must be the sole shareholder of the corporation which ultimately exercises the option from the time the option is issued until the time it is exercised. In document 9231755 we opined that paragraph 7(1)(c) of the Act would be applicable at the time the option was granted since the individual was transferring his or her rights under the option agreement to his or her wholly-owned corporation at that time (even if the options were issued in the recipient corporation's name). This position was developed in response to a potential abuse of the Act wherein a bone fide employee of the corporation granting the stock option could attempt to avoid the application of section 7 by having the option exercised by his or her wholly-owned holding company rather than personally.
Therefore, in answer to your specific query, if Corp. A. and Corp. B deal at arm's length and the individual is not an employee of Corp. B, it is our opinion that:
a) Section 7 of the Act is not applicable,
b) Corp. A will be required to include in computing its income from business the fair market value of the stock options of Corp. B at the time the stock options are paid or payable to Corp. A pursuant to section 9 of the Act,
c) if the Corp. B stock option is exercised so that Corp. A acquires Corp. B shares, an amount will be required to be included in computing Corp. A's income from business pursuant to section 9 and subsection 248(28) of the Act equal to the amount, if any, by which the fair market value of the Corp. B shares at the time that Corp. A acquires them exceeds the total of:
(i) the amount paid or to be paid by Corp. A to Corp. B to acquire the shares, and
(ii) the amount included in income in (b) above
and
d) the adjusted cost base to Corp. A of the shares of Corp. B acquired by Corp. A will be computed pursuant to the provisions of subsection 52(1) of the Act.
We trust the foregoing comments are of assistance.
Yours truly,
P. Spice
for Director
Financial Industries Division
Income Tax Rulings
and Interpretations Directorate
Policy and Legislation Branch
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