7 October 2016 APFF Roundtable Q. 21, 2016-0655901C6 F - Section 7 and bonus paid in share

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7(1); 7(1.1); 89(1) "paid up capital" 84(1)

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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: 1) Will section 7 and subsection 7(1.1) apply to the issuance of shares when those shares are issued as a payment of a bonus granted in accordance with an employment contract that provides for such a bonus when certain conditions are met?
2) If the employment contract provides the employee with the choice to receive the bonus in cash or in shares and the employee chooses to receive the bonus in shares, will our answer be the same?
3) A CCPC has issued shares of a particular class of its capital stock to its employee as payment of a bonus. What would be the amount added to the PUC of the particular class of shares?

Position: 1) Question of facts and law.
2) Yes.
3) Question of corporate law.

Reasons: 1) If an arrangement is fully discretionary, it will not be an agreement to issue shares for the purpose of section 7. To fall within the scope of section 7, an arrangement to issue or sell shares must be a legally binding agreement meaning that legal rights and enforceable obligations are created. This was confirmed in Transalta Corp. v. the Queen (2012 DTC 1106), where the Tax Court concluded that a discretionary arrangement was not an agreement for purposes of section 7.
2) The fact that the employee has the choice to receive the payment of the bonus in cash or in shares does not preclude the application of section 7 if the arrangement is a legally binding agreement to issue shares.
3) Paragraph 2 of IT 463R2: "Since subparagraph (b)(iii) of the definition of "paid-up capital" provides that the amount of the paid-up capital of a class of shares is initially determined without reference to the provisions of the Income Tax Act , the calculation is based on the relevant corporate law rather than tax law."

2016 APFF ROUNDTABLE

Question 21

Bonus payable in shares to an employee

A small business corporation ("SBC") agrees with one of its employees in its employment contract that he will be entitled under certain conditions to a bonus payable in shares. The maximum amount of the value of the shares agreed upon in the employment contract is $50,000. At the end of the year, if the conditions allowing the employee to earn the bonus are met, the corporation will assess the fair market value of its shares and determine the number of shares to be issued to the employee as a bonus.

As an example, assume that the employee would be issued shares with a fair market value of $50,000 for the year 2016.

Questions to the CRA

(a) Can you confirm that the issue of the shares will be governed by section 7 (and particularly subsection 7(1.1)) so that no taxable income will be included in the employee's income for the year of issue of the shares? The amount of income will be included under section 7 only in the year of the disposition of the shares.

(b) If the employment contract provides that the employee may elect to be paid $50,000 in cash or shares and the employee chooses payment in shares, can you confirm that your answer is the same as above?

(c) Can you confirm that the corporation will be able to add an amount of $50,000 to the paid-up capital of the shares it so issues without tax consequences to the employee (see Aylward v The Queen (footnote 1))?

CRA response to Q.21(a) and (b)

Section 7 of the Act applies where a corporation has agreed to sell or issue its shares or securities of a qualifying person with whom it does not deal at arm's length to an employee of the particular qualifying person or of a qualifying person with which the particular qualifying person does not deal at arm's length. Consequently, an agreement under which an employer undertakes to issue or sell securities must exist between the parties in order for section 7 to apply.

In the case of TransAlta Corporation v. The Queen, the Tax Court of Canada ("Court") concluded that section 7 did not apply to bonuses granted under a share purchase plan based on performance. Indeed, the Court found that the plan was not an agreement to sell or issue shares for the purposes of section 7 since the plan was expressly discretionary and no legal rights or obligations had been created. According to the Court, the words "agreed" and "agreement" in section 7 signify a legally binding agreement, that is to say, the granting of legal rights to employees and the creation of corresponding obligations of the employer. The CRA is of the view that this principle must be applied in analyzing whether or not an arrangement comes within section 7.

The question whether in a particular case an agreement is an agreement to issue shares for the purposes of section 7 is one of fact and law which cannot be resolved until consideration of all relevant facts and documents. Consequently, it is not possible for us to determine whether or not section 7 is applicable in respect of the situations presented.

For example, in the situation where an employer establishes an arrangement under which it undertakes to award a bonus based on the employee reaching certain measurable performance objectives and the employer agrees to pay this bonus in shares, then this arrangement could be an agreement contemplated by section 7.

On the other hand, if an employer establishes an arrangement under which it has full discretion to award a bonus or has full discretion as to the mode of payment of this bonus (in shares or in cash), the discretion of the employer under this arrangement would ensure that it could not be an agreement for purposes of section 7 because there is no enforceable commitment to issue shares.

It is possible that an arrangement which is not initially within section 7 due to the employer's discretion as to whether or not to grant shares could become an agreement in which section 7 applies at the time the employer undertakes to issue shares. This could be the case in the situation where an employer establishes an arrangement under which an employee is entitled to a bonus ranging from 0 to 100 shares payable within two years from the date of the arrangement. After the first year, the employer exercises its discretion and sets the amount of the bonus at 75 shares, which is payable in shares at the end of the year if the employee is still employed by the employer. In this situation, we consider that the employer's undertaking [“engagement”] to pay the bonus in shares is an agreement for purposes of section 7 from the time that the employer sets the value of the bonus at 75 shares.

Subsection 7(1.1) modifies when an employee is deemed to have received a benefit in respect of shares of a corporation under paragraph 7(1)(a). One of the conditions for applying this rule is that the corporation in question is a CCPC at the time it agreed to issue a share of its capital stock. Subject to the comments made above, it is possible that subsection 7(1.1) applies where an agreement gives an employee the choice between a bonus in shares or a bonus in cash and the employee chooses payment in shares. We are of the view that the choice of the employee, in itself, does not preclude an undertaking from being an agreement to issue shares. In such a situation, the time when the employee is deemed to have received a benefit because of the application of paragraph 7(1)(a) as modified by subsection 7(1.1) is the taxation year in which the employee disposed of or exchanged the securities rather than the taxation year in which the shares were acquired.

CRA response to Q.21(c)

The long-standing position of the CRA regarding the starting point for calculating the PUC of a class of shares, in subparagraph (b)(iii) of the definition of "paid-up capital" in subsection 89(1), is described in paragraph 2 of the Interpretation Bulletin IT-463R2 as follows:

“Since subparagraph (b)(iii) of the definition of "paid-up capital" provides that the amount of the paid-up capital of a class of shares is initially determined without reference to the provisions of the Income Tax Act, the calculation is based on the relevant corporate law rather than tax law.”

For example, subsection 26(1) of the Canada Business Corporations Act ("CBCA") provides that "[a] corporation shall maintain a separate stated capital account for each class and series of shares it issues.”

Furthermore, subsection 26(2) CBCA provides that "[a]corporation shall add to the appropriate stated capital account the full amount of any consideration it receives for any shares it issues.”

Thus, the practice of the CRA is to determine the PUC of any particular class of shares in the capital stock of a corporation by examining, in particular, the share register, minutes of Board meetings , resolutions or by-laws passed at those meetings, financial statements, notes to the financial statements, deeds of sale, rollover tax forms and by considering the corporate law and applicable generally accepted accounting principles.

To the extent that the liabilities of the CCPC were reduced by an amount not less than $50,000, subsection 84(1) would not be applicable by reason of the exception in paragraph 84(1)(b).

In finishing, the above comments disregard the possible application of other provisions of the Income Tax Act given the absence of information on the subsequent transactions which were carried out in respect of shares issued by the corporation.

Response 21 (a) and (b) prepared by
Catherine Ayotte
(613) 670-8897
October 7, 2016
2016-065590

Response 21(c) prepared by
Jean Lafrenière
October 7, 2016
613-670-9013

FOOTNOTES

Due to our system requirements, the footnotes contained in the original document are reproduced below:

1 97 DTC 1097 (TCC)
2 Qualifying person has the meaning given under subsection 7(7).
3 2012 TCC 86
4 CANADA REVENUE AGENCY, Interpretation Bulletin IT-463R2 Archived, Paid-up Capital, September 8, 1995.

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Text of Severed Letter

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.

Principales Questions: 1) Will section 7 and subsection 7(1.1) apply to the issuance of shares when those shares are issued as a payment of a bonus granted in accordance with an employment contract that provides for such a bonus when certain conditions are met?
2) If the employment contract provides the employee with the choice to receive the bonus in cash or in shares and the employee chooses to receive the bonus in shares, will our answer be the same?
3) A CCPC has issued shares of a particular class of its capital stock to its employee as payment of a bonus. What would be the amount added to the PUC of the particular class of shares?

Position Adoptée: 1) Question of facts and law.
2) Yes.
3) Question of corporate law.

Raisons: 1) If an arrangement is fully discretionary, it will not be an agreement to issue shares for the purpose of section 7. To fall within the scope of section 7, an arrangement to issue or sell shares must be a legally binding agreement meaning that legal rights and enforceable obligations are created. This was confirmed in Transalta Corp. v. the Queen (2012 DTC 1106), where the Tax Court concluded that a discretionary arrangement was not an agreement for purposes of section 7.
2) The fact that the employee has the choice to receive the payment of the bonus in cash or in shares does not preclude the application of section 7 if the arrangement is a legally binding agreement to issue shares.
3) Paragraph 2 of IT 463R2: "Since subparagraph (b)(iii) of the definition of "paid-up capital" provides that the amount of the paid-up capital of a class of shares is initially determined without reference to the provisions of the Income Tax Act , the calculation is based on the relevant corporate law rather than tax law."

TABLE RONDE FÉDÉRALE 2016
APFF-CONGRÈS 2016

Question 21

Boni payable en actions à un employé

Une société exploitant une petite entreprise (« SEPE ») convient avec un de ses employés dans son contrat d’emploi qu’il aura droit à certaines conditions à un boni payable en actions. Le montant maximum de la valeur des actions convenu dans le contrat d’emploi est de 50 000 $. À la fin de l’année, si les conditions permettant à l’employé de mériter son boni sont remplies, la société évaluera la juste valeur marchande de ses actions et déterminera le nombre d’actions à émettre à l’employé à titre de boni.

À titre d’exemple, tenons pour acquis que l’employé se ferait émettre des actions ayant une juste valeur marchande de 50 000 $ pour l’année 2016.

Questions à l’ARC

a) Pouvez-vous confirmer que l’émission des actions sera visée par l’article 7 L.I.R. (et particulièrement le paragraphe 7(1.1) L.I.R.) et qu’aucun revenu imposable ne sera inclus dans le revenu de l’employé pour l’année d’émission des actions? Le montant du revenu sera inclus en vertu de l’article 7 L.I.R. seulement l’année de la disposition des actions.

b) Si le contrat d’emploi prévoit que l’employé pourra, à son choix, se faire payer le 50 000 $ en argent ou en actions et que l’employé choisit le paiement en actions, pouvez-vous confirmer que votre réponse est la même que ci-dessus?

c) Pouvez-vous confirmer que la société pourra ajouter un montant de 50 000 $ au capital versé des actions émises sans conséquence fiscale pour l’employé (voir notamment la cause Aylward v The Queen (footnote 1) )?

Réponses de l’ARC aux questions 21 a) et 21 b)

L’article 7 L.I.R. s’applique lorsqu’une société a convenu d’émettre ou de vendre de ses titres ou des titres d’une personne admissible (footnote 2) avec laquelle elle a un lien de dépendance à l’un de ses employés ou à l’un des employés d’une personne admissible avec laquelle elle a un lien de dépendance. Par conséquent, une convention en vertu de laquelle un employeur s’engage à émettre ou vendre des titres doit exister entre les parties afin que l’article 7 s’applique.

Dans la cause Transalta Corporation c. La Reine (footnote 3) , la Cour canadienne de l’impôt (« Cour ») a conclu que l’article 7 L.I.R. ne s’appliquait pas à des bonis accordés en vertu d’un régime d’actionnariat fondé sur le rendement. En effet, la Cour a conclu que l’arrangement n’était pas une convention d’émettre ou de vendre des actions pour les fins de l’article 7 L.I.R. puisque ce régime était expressément discrétionnaire et qu’aucun droit ni aucune obligation juridiques n’avaient été créés. Selon la Cour, le sens des mots « convenu » et « convention » à l’article 7 L.I.R. vise un engagement exécutoire en droit, c’est-à-dire l’octroi de droits juridiques aux employés et la création d’obligations correspondantes pour l’employeur. L’ARC est d’avis que nous devons appliquer ce principe lorsque vient le temps d’analyser si un arrangement est visé ou non par l’application de l’article 7 L.I.R.

La question de savoir si dans une situation donnée un arrangement constitue une convention d’émettre des actions aux fins de l’article 7 L.I.R. en est une de faits et de droit qui ne peut être résolue qu’après un examen de tous les faits et documents pertinents. Par conséquent, il nous est impossible de déterminer si l’article 7 L.I.R. serait applicable ou non à l’égard des situations présentées.

Par exemple, dans la situation où un employeur met en place un arrangement en vertu duquel il s’engage à attribuer un boni à la condition que l’employé atteigne certains objectifs mesurables de performance et que l’employeur s’engage à payer ce boni en actions, alors cet arrangement pourrait être une convention visée par l’article 7 L.I.R.

Par contre, si un employeur met en place un arrangement en vertu duquel il a la pleine discrétion d’attribuer un boni ou qu’il a la pleine discrétion sur le mode de paiement de ce boni (en action ou en argent), la discrétion de l’employeur en vertu de cet arrangement fera en sorte que l’arrangement ne sera pas une convention visée par l’article 7 L.I.R. car l’engagement d’émettre des actions n’est pas exécutoire.

Il est possible qu’un arrangement qui n’est pas initialement visé par l’article 7 L.I.R. en raison de la discrétion de l’employeur d’octroyer ou non des actions devienne une convention auquel l’article 7 L.I.R. s’applique au moment où l’employeur s’engage à émettre des actions. Tel pourrait être le cas dans la situation où un employeur prépare un arrangement en vertu duquel un employé aura droit à un boni variant de 0 à 100 actions payable dans les deux ans de la date de l’arrangement. Après la première année, l’employeur exerce sa discrétion et fixe le montant du boni à 75 actions, qui sera payable en actions à la fin de l’année si l’employé est toujours à l’emploi de l’employeur. Dans cette situation, nous considérons que l’engagement de l’employeur de payer le boni en actions est une convention visée par l’article 7 L.I.R. au moment où l’employeur fixe la valeur du boni à 75 actions.

Le paragraphe 7(1.1) L.I.R. vient modifier le moment où un employé est réputé avoir reçu un avantage relativement à des actions d’une société selon l’alinéa 7(1)a) L.I.R. L’une des conditions d’application de cette règle spéciale est que la société en question soit une société privée sous contrôle canadien (« SPCC ») au moment où elle a convenu d’émettre une action de son capital-actions. Sous réserve des commentaires que nous avons faits précédemment, il est possible que le paragraphe 7(1.1) L.I.R. s’applique lorsqu’une convention donne à un employé le choix entre un boni en actions ou un boni en argent et que l’employé choisit le paiement en actions. Nous sommes d’avis que ce choix de l’employé, en soi, n’empêche pas un engagement d’être une convention d’émettre des actions. Dans une telle situation, le moment où l’employé est réputé avoir reçu un avantage en raison de l’application de l’alinéa 7(1)a) L.I.R. tel que modifié par le paragraphe 7(1.1) L.I.R. est l’année d’imposition où il a disposé des actions ou les a échangés plutôt que l’année d’imposition où il a acquis les actions.

Réponse de l’ARC à la question 21 c)

La position de longue date de l’ARC concernant le point de départ du calcul du capital versé d’une catégorie d’actions, au sous-alinéa b)(iii) de la définition de « capital versé » au paragraphe 89(1) L.I.R., est décrite au paragraphe 2 du bulletin d’interprétation IT-463R2 (footnote 4) comme suit :

« Le montant du capital versé d’une catégorie d’actions est d’abord déterminé, selon le sous-alinéa b)(iii) de la définition de « capital versé », sans égard aux dispositions de la Loi de l’impôt sur le revenu. C’est la loi sur les sociétés applicable, et non les lois fiscales, qui règle le calcul de ce montant. »

À titre d’exemple, le paragraphe 26(1) de la Loi canadienne sur les sociétés par actions (« LCSA ») édicte que « [l]a société tient un compte capital déclaré distinct pour chaque catégorie et chaque série d’actions ».

Par ailleurs, le paragraphe 26(2) LCSA prévoit que « [l]a société verse au compte capital déclaré pertinent le montant total de l’apport reçu en contrepartie des actions qu’elle émet ».

Ainsi, la pratique de l’ARC est d’établir le capital versé d’une catégorie d’actions du capital-actions d’une société en examinant notamment, le registre des valeurs mobilières, les procès-verbaux des assemblées du Conseil d’administration, les résolutions ou règlements adoptés lors de ces réunions, les états financiers, les notes complémentaires aux états financiers, les actes de vente, les formulaires de roulement fiscaux et en considérant la loi sur les sociétés et les principes comptables généralement reconnus applicables.

Dans la mesure où le passif de SEPE était diminué d’un montant non inférieur à 50 000 $, le paragraphe 84(1) L.I.R. ne serait pas applicable en raison de l’exception prévue à l’alinéa 84(1)b) L.I.R.

En terminant, les commentaires ci-dessus font abstraction de l’application possible d’autres dispositions de la Loi de l’impôt sur le revenu compte tenu du manque d’information sur les opérations subséquentes qui seraient réalisées à l’égard des actions émises par la société.

Réponses 21a) et b) préparées par
Catherine Ayotte
(613) 670-8897
Le 7 octobre 2016
2016-065590

Réponse 21c) préparée par
Jean Lafrenière
Le 7 octobre 2016
613-670-9013

FOOTNOTES

En raison des exigences de nos systèmes, les notes de bas de page contenues dans le document original sont reproduites ci-dessous :

1 97 DTC 1097 (CCI)
2 Personne admissible a le sens donné au paragraphe 7(7) L.I.R.
3 2012 CCI 86
4 AGENCE DU REVENU DU CANADA, bulletin d’interprétation IT-463R2 archivé, Capital versé, 8 septembre 1995.

Summaries

Summary Under

Tax Topics - Income Tax Act - Section 7 - Subsection 7(3) - Paragraph 7(3)(a)

s. 7 can govern bonuses paid in shares where discretion ceases prior to the issuance

In accordance with the terms of the employment contract, a Canadian-controlled private corporation pays a bonus to an employee which is payable in shares. Will the share issuance be governed by s. 7, particularly s. 7(1.1)? What if the employee has the choice to be paid the sum in cash or shares? CRA responded:

[I]n the situation where an employer establishes an arrangement under which it undertakes to award a bonus based on the employee reaching certain measurable performance objectives and the employer agrees to pay this bonus in shares, then this arrangement could be an agreement contemplated by section 7. …

[I]f an employer establishes an arrangement under which it has full discretion to award a bonus or has full discretion as to the mode of payment of this bonus (in shares or in cash), [this] discretion… would ensure that it could not be an agreement for purposes of section 7… .

It is possible that an arrangement which is not initially within section 7 due to the employer's discretion as to whether or not to grant shares could become an agreement in which section 7 applies at the time the employer undertakes to issue shares. This could be the case [where]…[a]fter the first year, the employer exercises its discretion and sets the amount of the bonus at 75 shares, which is payable in shares at the end of the year if the employee is still employed by the employer. …

[T]he choice of the employee…does not preclude an undertaking from being an agreement to issue shares.

Summary Under

Tax Topics - Income Tax Act - Section 84 - Subsection 84(1) - Paragraph 84(1)(b)

PUC of shares issued in satisfaction of bonus equal to bonus amount

After noting that it considers that where a Canadian-controlled private corporation has agreed in writing “to award a bonus based on the employee reaching certain measurable performance objectives and the employer agrees to pay this bonus in shares,” then the value of the shares generally will not be included in the employee’s income when issued by virtue of ss. 7(3)(a) and 7(1.1), CRA addressed the question, can the corporation add the full $50,000 bonus amount to the paid-up capital of the shares it so issues, and stated:

To the extent that the liabilities of the CCPC were reduced by an amount not less than $50,000, subsection 84(1) would not be applicable by reason of the exception in paragraph 84(1)(b).

Summary Under

Tax Topics - Income Tax Act - Section 7 - Subsection 7(1.1)

7(1.1) applicable to non-discretionary bonus payable in shares

CRA considers that where a Canadian-controlled private corporation has agreed in writing “to award a bonus based on the employee reaching certain measurable performance objectives and the employer agrees to pay this bonus in shares” equal in value to the bonus amount, then the value of the shares generally will not be included in the employee’s income when issued by virtue of ss. 7(3)(a) and 7(1.1). In addition, although an arrangement in which the employer has full discretion as to whether to award the bonus or as to the mode of payment will not come within the s. 7 rules, such a discretionary arrangement could become a qualifying one if, for example, “after the first year, the employer exercises its discretion and sets the amount of the bonus at [say] 75 shares, which is payable in shares at the end of the year if the employee is still employed by the employer.”

The right of the employee to elect to be paid in cash does not detract from this analysis if that right is not exercised.

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7 October 2016 APFF Roundtable Q. 21, 2016-0655901C6 F - Section 7 and bonus paid in share

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