23 July 2008 Internal T.I. 2008-0280301I7 - Excluded right or interest

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 shares of an employer corporation that were acquired by an employee as a condition precedent to receiving stock options under a long term incentive plan and that have certain restrictions as to their disposition would be considered to be a right of the employee under a plan or arrangement referred to in subparagraph (a)(vii) of the definition of "excluded right or interest" in subsection 128.1(10) of the Income Tax Act?

Position: No.

Reasons: See memo.

								July 23, 2008

	Vancouver Tax Services Office			HEADQUARTERS
	Robert Thomson					Income Tax Rulings
	International Tax Advisor	  		Directorate
	Pacific Region					S. Leung, CA
(613) 952-4666

								2008-028030

Excluded Right or Interest XXXXXXXXXX (the "taxpayer")

We are writing in reply to your email of May 28, 2008 in which you requested our view as to whether the common shares in the capital stock of XXXXXXXXXX purchased by the taxpayer as a condition precedent to receiving stock options referred to in the situation described below meet the description in subparagraph (a)(vii) of the definition "excluded right or interest" in subsection 128.1(10) of the Income Tax Act (the "Act"). We also acknowledge the receipt of the following documents from you: Employment Agreement and XXXXXXXXXX .

The taxpayer was resident in Canada when he was employed as XXXXXXXXXX . Under the XXXXXXXXXX (the "Plan"), the taxpayer was entitled to purchase shares of XXXXXXXXXX at the price at which the shares were offered under XXXXXXXXXX initial public offering (the "IPO Price"). On XXXXXXXXXX , the taxpayer purchased XXXXXXXXXX shares of XXXXXXXXXX (XXXXXXXXXX post-split) for $XXXXXXXXXX per share price (the "Purchased Shares") and, as a result of such purchase, received XXXXXXXXXX matching options (XXXXXXXXXX post-split) under the Plan to purchase shares at the IPO Price. All the Purchased Shares and the shares to be acquired as a result of the exercise of the options are hereunder collectively called the "Restricted Shares". The options had a term of XXXXXXXXXX years and vested at a rate of XXXXXXXXXX % per year. The Plan provided that XXXXXXXXXX might, in connection with the granting of such options, impose certain conditions as to the ownership of the Restricted Shares. During the term of the taxpayer's employment the sale of the Restricted Shares was limited to XXXXXXXXXX % per year (the earliest date of sale was XXXXXXXXXX ) up to a maximum of XXXXXXXXXX % of the total shares held by the taxpayer. The Purchased Shares are not taxable Canadian property within the meaning assigned under subsection 248(1) of the Act. No stock options have been exercised by the taxpayer as of to-date. The taxpayer emigrated from Canada to the U.S. on XXXXXXXXXX . On his XXXXXXXXXX T1 tax return the taxpayer reported a deemed disposition of the Purchased Shares. The reported sale proceeds were $XXXXXXXXXX , the adjusted cost base was $XXXXXXXXXX and the capital gain was $XXXXXXXXXX . The taxable capital gain was $XXXXXXXXXX . The taxpayer posted security for the tax liability in connection with such taxable capital gain. The Purchased Shares have not been disposed of by the taxpayer as of to-date.

The stock options will expire at the end of XXXXXXXXXX . Currently the strike price of the options exceeds the market value of the shares of XXXXXXXXXX . The current market value of the Purchased Shares is also less than the IPO Price at the time these shares were purchased. The taxpayer is a Canadian citizen and has never been a U.S. citizen. The taxpayer now views that subparagraph (a)(vii) of the definition of "excluded right or interest" in subsection 128.1(10) of the Act should have applied to the Purchased Shares such that there should not have been a deemed disposition of such shares immediately before his emigration from Canada.

Our Comments

It is our view that the attributes of the Purchased Shares in the case at hand are similar to those of the restricted shares in a restricted share program commonly found in U.S. corporations. The similarities are that continued employment with the company for a specified number of years is usually required and the executive is allowed to exercise the voting rights attached to the shares, as well as to receive any dividends paid on such shares. Under a restricted stock plan, it is the view of the Canada Revenue Agency that essentially all the rights and conditions of ownership have passed to the executive and therefore the executive is subject to Canadian income tax upon the grant of the restricted stock. Similarly, in the case at hand, all the incidences of ownership of the Purchased Shares were vested in the taxpayer when he acquired the shares in XXXXXXXXXX and the taxpayer would carry the risks of gain or loss on the disposition of such shares.

It is our view that the Purchased Shares would not be considered to meet the description in subparagraph (a)(vii) of the definition of "excluded right or interest" in subsection 128.1(10) of the Act for the following reasons.

1. Not a Right or Interest under a Plan or Arrangement

Subparagraph (a)(vii) of the definition of "excluded right or interest" in subsection 128.1(10) of the Act states:

"Excluded right or interest of a taxpayer who is an individual means

(a) a right of the individual under, or an interest of the individual in a trust governed by,

...

(vii) a plan or arrangement (other than an employee benefit plan) under which the individual has a right to receive in a year remuneration in respect of services rendered by the individual in a year or a prior year;"

Under this subparagraph, to qualify as an "excluded right or interest" for the purposes of paragraph 128.1(4)(b) of the Act, the right of an individual has to be a right of that individual under a plan or arrangement under which the individual has a right to receive remuneration in respect of services rendered in a year or a prior year. Generally, a share in the capital stock of a corporation is considered to be a bundle of rights entitling the holder to certain rights and benefits of the corporation that issued the share. In the situation outlined above, although the Purchased Shares were acquired by the taxpayer as a condition precedent to receiving stock options (i.e., future remuneration) and there are restrictions as to the timing of the disposition of such shares, it is doubtful that such Purchased Shares could be said to be rights of the taxpayer under a plan or arrangement under which the taxpayer has a right to receive in a year remuneration in respect of services rendered by the taxpayer in a year or a prior year. This is so because a share right is simply a general and separate right of its own that has nothing to do with a right of the taxpayer under a plan or arrangement under which the taxpayer has a right to receive remuneration. Where the taxpayer has a right to receive shares in the future as part or all of his remuneration under a plan or arrangement, such right may qualify as an "excluded right or interest" within the meaning described in subparagraph (c) of that definition in subsection 128.1(10) of the Act (namely, stock option). However, the Purchased Shares in this case simply do not constitute such rights.

2. Not Future Benefits or Other Payments

When the definition of "excluded right or interest" in subsection 128.1(10) of the Act was first introduced, it is noted in the Technical Notes of March 2001 that an individual's excluded rights or interests includes rights of the individual to future benefits or other payments under certain plans or arrangements, many of which are employer-sponsored or legislated in nature. The Technical Notes then gave several examples of what it meant to be a right referred to in subparagraph (a)(vii) of that definition. They are salary deferral arrangements, unfunded bonus deferrals, self-funded leaves of absence, and phantom stock plans. In the situation at hand the Purchased Shares do not seem to have any characteristics similar to those provided in these examples. We fail to see how the Purchased Shares constitute rights of the taxpayer to future benefits or other payments under certain plans or arrangements. We note that none of the documents you submitted indicate that the taxpayer would not be entitled to the dividends or voting rights with respect to the Purchased Shares (the restrictions merely concern with the timing of the disposition of these shares). Hence, in the case at hand, it is our view that all the incidences of ownership of the Purchased Shares were vested in the taxpayer once they had been purchased. Any gain or loss on the disposition of such shares would accrue to the taxpayer from the date of their acquisition. Hence, the Purchased Shares themselves do not represent rights to the taxpayer to future benefits or other payments under a plan or arrangement under which the taxpayer has a right to receive in a year remuneration in respect of services rendered in the year or a prior year. All one could say is that the acquisition of these shares constitutes a condition precedent for the taxpayer acquiring rights (stock options) to future benefits; the Purchased Shares themselves are not rights to future benefits.

3. Not Deferred Income To Be Taxed in Canada

It is our view that subparagraph (a)(vii) of the definition of "excluded right or interest" is intended to allow a deferral of tax by excluding from a deemed disposition at emigration certain rights or interests to future benefits or other payments with respect to remuneration received for the rendering of services in a year or a prior year because Canada generally reserves the right under a bilateral tax treaty to tax such benefits on account of income when they are received, unless such taxation is specifically prohibited under the treaty. In the case at hand, the future proceeds of disposition of the Purchased Shares would not generate income from remuneration but capital gains on the disposition of capital property. If the Purchased Shares are considered excluded rights or interests, Canada would lose the right to tax the gains accrued to the date of departure. Had the value of the shares increased after the date of departure, Canada would not tax the gain accrued after the date of departure. Hence, it is imperative that Canada would tax the accrued gain on departure.

4. No Specific Exemption Similar to that in Subsection 7(1.6)

Unlike subsection 7(1.6) of the Act, there is no provision in the Act to exclude the Purchased Shares in the situation at hand from a deemed disposition at emigration of the taxpayer. Subsection 7(1.6) states:

"For the purposes of this section [section 7] and paragraph 110(1)(d.1), a taxpayer is deemed not to have disposed of a share acquired under circumstances to which subsection [7](1.1) applied solely because of subsection 128.1(4)."

Under subsection 7(1.1) of the Act, the employee who exercises an option to acquire shares of a CCPC (that is either his or her employer or a corporation not dealing at arm's length with his or her employer) and who, after the acquisition, deals at arm's length with the CCPC, would not be required to include in computing his or her income the benefits he or she receives at the time of the exercise of the stock options until the shares of the CCPC are disposed of. Subsection 7(1.6) is there to exempt the employee from a deemed disposition of such shares when the employee emigrates from Canada 1 . One may argue that the shares acquired under circumstances to which subsection 7(1.1) applied represent rights of an individual under a plan or arrangement under which the individual has a right to receive in a year remuneration in respect of services rendered in the year or in a prior year such that the description in subparagraph (a)(vii) of the definition of "excluded right or interest" in subsection 128.1(10) of the Act would be met. However, such argument is not tenable, otherwise there would not be any need for the existence of subsection 7(1.6) in the Act. Therefore, absent a specific provision in the Act similar to subsection 7(1.6), the Purchased Shares in this case should not be considered to be excluded rights or interests that are exempt from a deemed disposition required by paragraph 128.1(4)(b) of the Act.

Conclusion

It is our view that the Purchased Shares of XXXXXXXXXX acquired by the taxpayer in XXXXXXXXXX as a condition precedent to receiving stock options would not be considered to be an "excluded right or interest" within the meaning of subparagraph (a)(vii) of that term in subsection 128.1(10) of the Act.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Request for this latter version should be made by you to Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Yours truly,

Olli Laurikainen, CA
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

1 However, this exemption does not seem to extend to shares acquired under circumstances to which subsection 7(8) applied where taxation of stock option benefits with respect to public company shares is deferred because of an election made under subsection 7(10) of the Act.