28 June 1990 Income Tax Severed Letter ACC9596 - Stock Bonus 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.

June 28, 1990

APPEALS BRANCH RULINGS DIRECTORATE
Appeals & Referrals Division Financial Industries
Division
W.C. Harding
Att: D. M. Beamish (613) 957-8962
Section Chief
C-9596
Subject: 24(1)

TOPIC: APPLICATION OF SECTION 7 TO "STOCK BONUS PLAN"

This is in reply to your memorandum of May 29, 1990 requesting our comments on the subject matter of the above-noted appeal.

POINT: DEFINITION OF "ISSUE".

Appeals' position:

Par. 2 of IT 113R3 defines issue as:

• "to deliver unissued shares of a corporation including unissued shares for no monetary consideration."

COMMENT:

IT 113 pars. 3 and 4 state:

• 3. In the opening words "to sell or issue shares' in section 7 the word "sell" is interpreted as meaning to sell at a fixed or ascertainable price but not as including an outright gift. If an employing corporation agrees to sell to an employee, at less than fair market value, shares of another corporation with which it does not deal at arms length, the employee will be subject to tax pursuant to section 7 in respect of the benefit he received; but if the shares are given to the employee for no consideration, section 7 does not apply and the benefit to the employee is taxable under paragraph 6(1)(a).
• 4. The word "issue" means to issue treasury shares of a corporation, including an issue of treasury shares for no monetary consideration. Therefore section 7 applies where an employing corporation agrees to issue to an employee its own shares, or to have issued those of a corporation with which it does not deal at arms length, at less than fair market value or for no monetary consideration. However, if the corporation merely issues its shares to an employee as a bonus and not pursuant to an agreement, section 7 does not apply and the benefit is taxable under paragraph 6(1)(a).

IT-113R was subsequently reworded to remove all discussion of the meaning of the "sell". It also deleted the reference to "treasury" but substitute "unissued" in its place. A new Paragraph 3 was also added to indicate that a stock bonus plan would thereafter be covered under section 7.

IT-113R2 and 113R3 continued the same paragraphs.

The IT files dating back to IT-23 Document an on going discussion on the topic of issue vs re-issue vs sell. It was noted that in the drafting of IT-113R the wording of paragraph 2 was changed from that of IT-113 "to issue shares from treasury" to "to deliver previously issued or unissued share'. This was then changed to; "to deliver unissued shares" on publication. The final version appears to have been adopted on the basis of a memo wherein the author sated that the writer preferred the "stand in old (paragraph) 4 re issue, ie must be unissued shares". However, it is of note that the old version did not say that. It said "issue means to issue treasury shares." Hence it may be that the IT in saying "unissued shares" only means "treasury shares.

23

The author of the IT Bulletin then states:

• "While...'Issue' in the Income Tax Act usually means the transfer of previously unissued share... I would be reluctant to state in the bulletin that Sec. 7 does not apply where a corporation has to reacquire its own shares before transferring them (for no consideration) to an employee."

In our opinion, the word "sell" was not employed in the section for the reasons given above but was used to clearly establish that the tax avoidance provision was to apply to a broader set of circumstances then only an issuance of treasury shares and does not have any basis in whether or not an amount will be deductible by the payer. Whether the corporation sells or reissues reacquired shares will not change the deductibility of any reacquisition cost.

Debates of The House of Commons, April 10. 1953 at page 3720 quote the then Minister of Finance, Mr. Abbot, as stating:

• "This is a new section which relates to benefits to employees as the result of stock option agreements....

During the last week or so since the bill received first reading I have had numerous representations regarding this clause in the bill which is designed to take care of a loop-hole which now exists in our law with respect to stock option plans....

(On the special lump sum tax abatement) A further point in this connection is that although the benefits received by the employee under stock purchase or stock option plans are regarded as income from office or employees does not charge it against its profit and loss account of purposes of corporation income tax.

• ...it was felt that it was necessary to prevent an abuse of these stock option devises through allowing employees, perhaps executives of a corporation, to get very large benefits which would not be taxable."

In other words, the section was primarily directed to closing a loophole in the law by taxing employees on any form of stock option or stock purchase plan and it was presumed that no expenses would be deductible whether it was in the form of a sale or issue of shares.

In conclusion, it remains our view that the legislature was not attempting to be narrow in the use and application of the word issue but was using the term in a more general way to recognize that the term sell would not cover all abuses; that in reading the present IT the phrase "previously unissued shares" should be read as including any shares which have been returned to treasury. We would further consider it inappropriate to treat those parties who sell reaquired shares for no consideration on a different basis form those who reissue such shares as part of a bonus.

POINT: THERE IS NO AGREEMENT TO ISSUE SHARES AS REQUIRED BY SECTION 7.

Taxpayer's position:
24(1)

Appeals' position:
24(1)

COMMENT:
24(1)

ADDITIONAL COMMENT:

The taxpayer's counsel has noted the 1963 Fowler case to support his position that section 7 does not apply to stock bonus plans. The Department's position on this was changed with the introduction of IT-113R. At that time the department determined that a bonus was a form of unilateral agreement covered by section 7.

23

We also note that under subsection 7(1) an employee must only
acquire shares under an "agreement to sell or issue shares". In
our opinion, it is not necessary h=that the shares not be
re-issued to the employee for the section to apply but merely
h=that he acquire the shares under an agreement to sell or issue
shares. In our opinion, if an option or bonus is given under a
prospectus which provides, 24(1) that the bonus
shares will be issued to the employee but may be re-issued to him
form treasury at the employer's discretion, section 7 will still
apply. In other words the Act does not concern itself with
whether or not the employee is party to the source of the shares
be it form treasury or the open market.

POINT: THERE IS NO ISSUE OF SHARES

Taxpayer's position:
24(1)

Appeals' position

Although paragraph 3 of IT113R3 [IT-113R3] provides that bonus and stock option plans are to be treated equally under the act it may be that Section 7 only has application to bonuses of a company's own shares that are issued gratuitously to the employees i.e. where a benefit is deemed to have been received under section 7(1).

COMMENT:

Subsection 7(1) is clear in that it applies "where a corporation
24(1) has agreed to sell or issue shares of the capital
stock of the corporation 24(1) to an employee of
the corporation or of a corporation with which it does not deal
at arm's length 24(1) Accordingly:

• (i) 24(1)
• (ii) The source of the shares has no bearing on this wording of the provision (however see our comments below).

POINT: REGULAR SECTION 5 BONUS SHOULD NOT BE TREATED UNDER SECTION 7.

Appeals' position:

"From the information available it appears 24(1)

COMMENT:

When a cash bonus is paid to an employee and he has the option to use the bonus to buy shares we have consistently maintained that subsection 7(3) will not apply to deny a deduction to the company for the amount of the bonus. The option will still be covered by section 7 and if the employee acquires any shares at less then their F.M.V. an additional assessment would be applicable at the time of the acquisition. We have, however, consistently maintained that a bonus paid with the requirement that it be used to acquire shares will not be afforded such treatment.

POINT: DENIAL OF LAID OUT COSTS.

Taxpayer's position:

Paragraph 7(3)(b) has no application as it does not state that the corporation should be denied a deduction where it has incurred an actual cost in the course of remunerating its employees.

Appeals position:

The type of bonus plan we feel falls within the provisions of section 7 is where shares of a company are issued at no out of pocket cost to the taxpayer.

24(1)

COMMENT:

There is a substantial amount written on whether or not a corporation dealing in its own shares ever incurs out of pocket "costs". As noted above, the legislators did not consider there to be a deductible expense but wrote 7(3) to ensure that no cost could be presumed. On this point and in brief:

• (i) as far back as 1938 the CPA handbook in chapter 17 stated in a committee report that:
• "your committee can see no essential difference between (a) the purchase and retirement of a corporation's own common stock and the subsequent issue of common shares, and (b) the purchase and resale of its own common stock .... Accordingly,... it does not believe that as a broad general principle, such transactions should be reflected in earned surplus (either directly or through inclusion in the income account).
• (ii) the CICA handbook at 3240 concludes:
• "Where a company acquires its own shares and subsequently resells them, no part of the proceeds should be taken into income. Where a company resells shares that it has acquired, any excess of the proceeds over cost should be credited to contributed surplus; any deficiency should be charged to contributed surplus to the extent that a previous net excess form resale is included therein, otherwise to retained earnings."
• (iii) Paragraph 54(c) of the Act also underlines the general intent and meaning of the Act as it provides:
• "disposition" of any property...includes... but for grater certainty, does not include...
• (iv) any issue by a corporation of a share of its capital stock or any other transaction that, but for this paragraph, would be a disposition by a corporation of a share of its capital stock;"

In other words it is within the spirit of the Act that a corporation should not treat any transactions on account of its own shares as being on income account.

With respect to the wording of section 7(3)(b), the initial words are quite explicit as to whom they apply:

"Where a corporation 24(1) has agreed to
sell or issue share... to an employee ...of a corporation
with which it does not deal at arms length 24(1)
(b) the income for a taxation year of the corporation
24(1) or of a corporation with which it does deal at
arms length 24(1) ..."

In our opinion there is a strong case to deny the deduction of any costs related to a section 7 benefit. However, we have, as a matter of administration, agreed that when a company has to acquire its shares on the open market to fulfil its obligations under an employee stock plan, and it has thereby incurred costs, it would be equitable to allow those costs on the basis that the provision was not written with the intent of denying such specific charges.

In the present case
24(1)

for Director
Financial Industries Division
Rulings Directorate

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