Section 7

Parentco funded and administered a performance share plan (“PSP”) for employees of group companies, including Canco (a subsidiary). A PSP award is a conditional award of Parentco shares to be delivered upon vesting, which occurs based on performance conditions which are measured over the subsequent 3-year period. A vested award may be settled in either shares or the cash equivalent, at the discretion of Canco or Parentco. Canco makes reimbursement payments to Parentco pursuant to a recharge agreement for the value of shares distributed to Canco’s employees in satisfaction of vested PSP awards.

There was insufficient information to determine whether s. 7 could have applied even absent Transalta. Headquarters stated:

[S]ection 7 does not apply where an employer contributes to a trust and the trust uses the contributions to purchase employer shares (or shares of a corporation with which it does not deal at arm’s length) on the open market for eventual distribution to its employees. Instead, the arrangement is subject to the EBP rules.

The (corporate) shareholders of Holdco (a Canadian-controlled private corporation) wish to accommodate the purchase of shares of the Holdco for an operating subsidiary (Opco) by an Opco key employee on an earnout basis and with the key employee’s purchase being governed by the s. 7 rules. (This cannot be accommodated by issuing treasury shares of Holdco or Opco to the key employee on an earnout basis as the governing Business Corporations Act requires that shares is be fully-paid on issuance.) Under the ruled-upon transactions:

1. The Holdco shareholders transfer a portion of their Holdco common shares on a s. 85(1) rollover basis to Opco in consideration for tracking preferred shares of Opco;
2. The key employee immediately purchases those Holdco common shares from Opco in consideration for five annual instalments, with each annual instalment based on the most recent year’s earnings (plus, in the case of the first instalment, the opening shareholders’ equity), with adjustments to the purchase price on any IPO or business acquisition; and
3. Each instalment payment is immediately dividended by Opco to the Holdco shareholders on the tracking preferred shares.

This purpose of accessing the s. 6 rules for a sale of non-treasury shares was noted, but not ruled upon.

Holdco, which owns substantially all of the shares of Opco, agrees to sell shares of Opco to one of Opco's employees at a price which is intended to be at fair market value, although "it is possible that the fair market value ultimately determined may be greater." Does s. 7 apply? CRA responded:

Section 7… applies where a corporation agrees to sell or issue shares of the corporation or shares of a corporation with which it does not deal at arm's length to an employee of either corporation or to an employee of another corporation with which it does not deal at arm's length. As the situation you describe meets these conditions, …section 7… would apply.

At the very moment of the acquisition by employees of shares under a stock options agreement, it is agreed that their shares will be subsequently sold to an arm's length purchaser. The sales agreement contains an earnout clause. Do ss. 7(1) and 110(1)(d) apply to amounts received under the earnout clause? After noting that the s. 7(1)(a) benefit was based only on the excess of the fair market value of the shares over the exercise price at the time of acquisition (and any amount paid for the options), CRA stated (TaxInterpretations translation):

Determining the FMV is a question of fact. ... [T]he earnout clause had become known before exercise of the options. In these circumstances,…the value of the rights under this clause must be taken into account in determining the FMV of the shares and be used in the computation of the benefit determined under paragraph 7(1)(a).

If subsection 7(1.1) applies…[it] will not change the value of the benefit which the employee is deemed to receive… . [T]he amounts [subsequently] received by virtue of the earnout clause relate to the sale of the shares and not to the exercise or disposition of the options…[and] are not a benefit under section 7… .

CRA noted that "generally, an RSU that provides an employee with the right to acquire a share of an employer, subject to certain vesting conditions, would be subject to section 7." See summary under s. 248(1) – salary deferral arrangement – para. (k).

A non-resident parent acquires its own shares on the open market and resells those shares to its Canadian subsidiary at fair market value. By virtue of an agreement between the subsidiary and its employees, the subsidiary subsequently transfers the shares to them for no monetary consideration. Should the subsidiary be considered to have agreed to issue or sell the shares for purposes of s. 7, and would s. 7(3)(v) preclude a deduction by the subsidiary. CRA responded (TaxInterpretations translation):

In the context of section 7, the term "sell" should be read in relation to the term "issue." An issuance of shares has a specific meaning and refers to the delivery of unissued shares by a corporation including the issuance of unissued shares for no monetary consideration. Consequently, for purposes of section 7, the term "sell" generally is intended to include all situations which do not entail the issuance of shares and where an Employer transfer to an employee shares in its capital or those of a corporation with which it does not deal at arm's length.

…[T]he fact that the employee acquires the shares without monetary consideration is not, in itself, a factor which prevents concluding that the Employer has agreed to issue or sell shares in accordance with section 7. On that basis, if all the other conditions of section 7 are satisfied, the agreement between the parties will be contemplated by section 7 In such circumstances, the cost of acquisition by the Employer will not be deductible…[under] paragraph 7(3)(b).

An employee of a CCPC transfers stock options to a protective trust in his favour, with the options eventually being distributed to the employee before their exercise. CRA found that as the trust did not exercise the options, s. 7(1)(c) had no application, and that s. 7(1)(a) applied on exercise of the options. Accordingly, s. 7(1.1) could apply to the shares which the employee acquired under the options.

A cashless exercise method of exercising employee stock options is utilized under which identical shares are sold short through a broker, with the proceeds of that sale then being applied to pay the employee's exercise price. Accordingly, a portion of the shares issued by the employer are used to cover the short sale.

After referring to Guide T4130, p. 24 and stating that the s. 7(1)(a) benefit is computed on the basis of the shares' fair market value "at the moment of their acquisition," CRA stated (TaxInterpretations translation):

… [I]n the context of a short sale, the CRA is generally of the view that an employee has acquired the shares of the employer at the moment the employer transfers the shares to the employee and they are paid for. Where the shares are not issued directly to the employee but instead to the broker for the employee's benefit, the CRA is of the view that the employee has acquired the shares at the moment the employer remits the shares to the broker and they are paid for.

Ruling respecting a deferred share unit plan under which the board of directors in its discretion could elect to pay the director participants in treasury shares, shares purchased on the exchange, or in cash net of applicable withholding taxes, that s. 7(1)(a) will apply to the fair market value of the treasury shares issued to a participant, and s. 6(1)(c) will apply to include in income of the participant the amount of applicable withholding tax withheld and remitted by the employer.

An employee generally will acquire shares pursuant to a stock option plan at the time of exercise. In the case of utilization of the cashless exercise method, the date of settlement of the associated short sale by the broker generally will be the date the employee is considered to acquire securities from the employer.

Regarding convertible preferred shares issued to an employee, CCRA stated:

[W]hen the preferred shares were issued, the corporation agreed to issue or sell common shares. In addition, for the purposes of the benefit provided for in paragraph 7(1)(a), common shares are acquired when the preferred shares are converted. This benefit is equal to that portion of the value of the common shares that, at the time the employee acquired them, is in excess of the amount the employee paid to acquire the preferred shares.

Before going on to describe the application of the ss. 7(1.1) and 110(1)(d.1) rules to shares issued for no consideration by a CCPC to employees, CCRA stated:

[T]he provisions of section 7 … which deem a benefit to have been received by an employee by reason of employment, are applicable where a corporation has issued shares of its capital stock to its employees for no consideration.

Where two trusts and a corporation are the limited partners and a second corporation is the general partner of a partnership, benefits under a stock option plan set up in respect of the partnership will be covered by ss.7 and 110(1)(d). "There are no agreements in place which limit the employment relationship of any of the employees of the partnership to any of the corporate or trust partners. Consequently, each of the employees of the partnership are considered to be employees of each of the partners of the partnership for the purposes of section 7."

A change to the vesting of options granted under a stock option plan would not result in a new plan being created for income tax purposes. Respecting a situation where the exercise price for options issued on the last day of a month was equal to the average closing price on the NASDAQ for the trading days from the 15th day of the preceding month to the 15th day of the current month, CCRA could not give a definition answer respecting whether the exercise price would qualify as "fair market value"

Confirmation that where employees of the general manager of two partnerships sit on the board of directors of corporations on behalf of their employer, they are not required to report directors' fees and stock options paid to them as directors of the company. When the stock options are exercised, the partnerships will be considered to have received business income equal to the excess of the fair market value of the underlying securities at the time of exercise over the exercise price.

American depositary shares would be considered to be shares for purposes of s. 7, as CRA previously had concluded that they were shares for purposes of s. 146(1).

Where the employees of a partnership are granted stock options by a corporate partner, they generally will be considered to be employees of each partner unless there is a contrary indication (for example, agreements between the partners specifying which partners employ which employees). Where the facts would lead to a conclusion that an employee is employed by a particular corporate taxpayer, s. 7 will apply where the employee is granted options to acquire shares of that partner.

"When a person enters into an agreement to sell certain shares but retains the option to pay cash instead of delivering the shares, we would not consider it to be an agreement to sell shares. However, it would be our position that an agreement to sell shares exists where the vendor simply pays cash to the purchaser who must use it to purchase the shares."

Where an employee surrenders her rights under a phantom stock plan and receives an option to acquire shares in the employer company with an exercise price equal to the difference between the fair market value of the shares at the time the option was granted and the value of the units under the phantom stock plan surrendered by her, the value of the surrendered units will be included in her income, but such amount will be considered to be paid by her for the right to acquire the shares under the stock option plan for purposes of ss.7(1) and 110(1)(d)(ii).

The employee would be considered to have "acquired" shares where he is issued a restricted share which cannot be transferred or sold during the initial four years and which is exchanged for an unrestricted common share at the end of the four-year period, or where the restricted shares are issued to the employee but held by the company.

An employee who otherwise would be entitled to receive, say, 30 shares of the employer’s parent (ParentCo) as a result of restricted share units (“RSUs”) vesting, instead is only issued 18 shares to reflect that the employer (EmployerCo) will make a cash payment to the Receiver General on behalf of the employee on account of the required income tax withholding on the taxable benefit under s. 7(1) arising in the year of issuance.

In finding that s. 7(3)(b) prohibited EmployerCo from claiming a deduction for this payment in computing its income, CRA stated:

[A] portion of the rights of the employee under the RSU Plan is considered to have been disposed of by the employee in exchange for EmployerCo paying the required income tax withholdings arising from the issuance of shares of ParentCo under the RSU Plan. Consequently, the employee is deemed to have received a benefit under paragraph 7(1)(b) equal to the amount of income tax remitted by EmployerCo on behalf of the employee.

Since the benefit … arises from the issuance of shares, paragraph 7(3)(b) precludes a deduction by EmployerCo in respect of that benefit.

A Canadian-controlled private corporation issues treasury shares to the employee holder of a stock option (with a fair market value exercise price) equal in value to the in-the-money value of the option . CRA stated:

The scenario you have described results in an employee disposing of the employee’s rights under a stock option for consideration equal to the stock option’s intrinsic or in-the-money value where the consideration is paid in employer treasury shares. In this scenario, paragraph 7(1)(b)...will apply and not paragraph 7(1)(a).

In the course of the acquisition of shares in the capital of a Corporation, it cancels stock options of certain employees for an amount corresponding to the shares' value. However, as the final determination of the per share purchase price depends on the outcome of litigation to which the Corporation is party, part of the agreed amount is retained. Must the retained amount be included in the value of the consideration for the disposition of the stock options pursuant to s. 7(1)(b)? Can an employee request an amendment of the employee’s tax return for the year of disposition of the stock options if, in a subsequent year, the retained amount is not paid to the employee? CRA responded (TI translation):

[T]he term "value of the consideration for the disposition" under paragraph 7(1)(b) includes a receivable from the employer. Therefore…if the agreed price for the options includes the amount retained at the moment of the disposition of the stock options subject to a possible future reduction, the retained amount would be a part of the value of the consideration for the disposition under paragraph 7(1)(b).

Furthermore, if the employees have received a benefit described in paragraph 7(1)(b) which has been correctly treated as taxable in the year of disposition of the stock options, the employees would not be able to amend their declared income for that year.

In an exchange of employee stock options in a takeover situation which does not satisfy the conditions in s. 7(1.4), will the value of the old options exchanged to acquire the new options be considered "the amount, if any, paid by the employee to acquire those rights" for purposes of s. 7(1)(b)? CRA responded that in this situation:

[W]here the provisions of subsection 7(1.4) do not apply, the exchange of stock options will result in a disposition of the exchanged options for the new options and the application of paragraph 7(1)(b)… .

…[T]he reference in subparagraph 7(1)(b)(ii) to "the amount, if any, paid by the employee to acquire those rights (under the employee stock option)" refers to an amount paid by the employee to acquire the rights under the employee stock option that is being disposed of, i.e., the exchanged option. …[T]he value of the exchanged options at the time of the exchange/disposition would not be considered part of "the amount, if any, paid by the employee to acquire the rights disposed of under the exchanged options". However, the new options acquired as a result of the exchange will have a cost equal to the value of the exchanged options at the time of the exchange.

On December 1, an employee advised his broker of his intention to exercise his 5,000 employee options and to monetize them. On the same day, the broker short sold 5,000 shares at the market value $20 per share. When the short sale settled on December 5, the broker paid $100,000 to the public-corporation employer as the $75,000 subscription price for those shares (their market value was $20.75 per share), and as $25,000 to the employee (($20 - $15) x 5,000 options) less source deductions.

The employer calculated a taxable benefit of $28,750 pursuant to s. 7(1)(b) (the market value of the issued shares of $20.75, less the exercise price).

Does CRA agree with the above taxable benefit computation and, if so, can the employee take a capital loss of $0.75 per share? CRA responded:

The situation you submitted to us does not allow us to clearly identify the legal relationships between the various parties involved and, as a result, the tax consequences related to that series of transactions. A detailed analysis of all contracts and agreements is necessary to determine whether the employee has acquired securities under the agreement and comes within paragraph 7(1)(a) or if he has instead transferred his rights under the agreement and is then subject to paragraph 7(1)(b). The CRA is, however, prepared to consider that issue as part of an advance income tax rulings request … .

The taxpayer surrendered his stock options to his arm’s-length employer for consideration that was payable partly up front and partly in instalments that were conditional on the employee’s continued employment for a specified period (a condition which he satisfied) and came due in years subsequent to that of the surrender. In finding that the taxpayer was required to include the full consideration paid or payable for the surrender in his income under s. 7(1)(b) notwithstanding that a portion of that consideration was not paid, the Directorate stated:

The Act does not provide any qualification if the consideration for the disposition of the options is accompanied by a balance of sale, nor does it provide any relief in the event that the purchaser of the options fails to meet the purchaser’s obligations with respect to the payment of the option purchase price. Subsection 8(2) expressly provides that only amounts under section 8 are deductible in computing a taxpayer's income from an office or employment.

Canadian employees of a Canadian subsidiary of a foreign parent had "subscription rights" to acquire unlisted ordinary shares of the foreign parent. The subscription rights plan provided that, for reasons relating to the tax rules in the foreign jurisdiction, at the time of the grant of such right, the employee also would acquire a non-interest bearing bond of the parent at an appropriate discount. In addition, under put and call agreements with a non-resident corporation ("Putcallco") the employee could cause Putcallco to acquire the employee's foreign parent shares (after exercise of the subscription right) at their fair market value at the time of such exercise (as determined under a formula), and Putcallco could acquire the subscription rights for their fair market value (as also determined under the formula) in the event the individual ceased to be an employee. The foreign parent and the Canadian subsidiary had agreed that when a subscription right was exercised by an employee, the Canadian subsidiary would be obliged to pay to the foreign parent the amount by which the fair market value of the shares acquired by the employee exceeded the exercise price.

The granting by the Canadian subsidiary to the employees of the right to surrender their subscription rights to it for a cash amount equal to the difference between the fair market value of a foreign parent share (determined on the same formula basis) and the exercise price would not result in a disposition under s. 7(1)(b) or result in a conferral of a benefit by the Canadian subsidiary on the foreign parent under s. 15(1).

If an existing stock option arrangement under which only the employee has the right to elect to receive cash instead of shares has changed so that the employer has the right to pay the employee cash instead of shares, this will not cause an immediate disposition pursuant to s. 7(1)(b).

"When section 7(1)(b) applies to the exchange of an old option for a new option, it is our opinion that, for the purposes of any subsequent application of sections 7 and 110(1)(d) of the Act, the new options will have a cost equal to the value of the old option at the time of the exchange. Accordingly, if the new options are subsequently exercised, the provisions of paragraph 7(1)(a) will result in a reduction of the benefit otherwise determined at that time, by that value. If the value of the two options is not equal at the time of the exchange, the series of transactions may result in the inclusion of benefits that exceeds the value ultimately received."

Where an employee may elect to receive cash instead of shares under an employee stock option plan, any benefit will be included in her income under s. 7(1). However, if the decision to pay cash rather than issue shares remains with the employer, any cash actually paid will be included in her income under s. 5(1) or s. 6(1)(a).

Where a stock option plan provides that, at the time the option otherwise would be exercisable, the employee may elect to receive cash in lieu of shares and the employee so elects, the amount received by the employee will be included in his income pursuant to s. 7(1)(b), and a deduction will be available under paragraph 110(1)(d) if the provisions of that paragraph are otherwise met.

What are the tax consequences of an employee stock option being contributed to a TFSA? CRA responded:

[T]he property must be contributed to the TFSA at its fair market value (FMV) and the contribution is subject to the holder's unused TFSA contribution room. …The CRA is of the view that the intrinsic value of a warrant, option, or similar right is not reflective of the property's FMV.

Where a TFSA exercises an employee stock option, pursuant to paragraph 7(1)(c)… the employee is deemed to have received a benefit in the taxation year that the TFSA exercises the option equal to the amount by which the value of the shares acquired under the option exceeds the total of the amount paid by the TFSA to acquire the shares and the amount, if any, paid by the employee to acquire the option.

[P]roposed amendments were announced to prohibit asset transfer transactions (swaps) between TFSAs and other registered and non-registered accounts.

Where an arm's length employee transfers options to a personal holding company for no consideration, he will not, except as provided by s. 7, be deemed to have received or enjoyed any benefit under or because of the options or their transfer to the corporation. Under s. 7(1)(c), he will realize a benefit when the corporation exercises the options during his lifetime or, if the options are exercised after his death, the corporation will be deemed to receive employment income under s. 7(1)(c) on exercise.

Regarding the transfer of convertible preferred shares, which had been issued by the employer, by an employee to the individual’s RRSP, CCRA indicated:

• There is no income inclusion to the employee under s. 7(1)(c) at the time the convertible preferred shares are transferred to the RRSP, but the employee must include in income a benefit when the trust exercises the option to convert the preferred shares, generally equal to the FMV of the common shares less the total amount paid by the employee to acquire the preferred shares.
• On such transfer, the employee/annuitant will be entitled to a deduction pursuant to s. 146(5) in an amount equal to the FMV of the convertible preferred shares.
• The employee may claim a s. 110(1)(d) deduction provided the conditions thereof are satisfied.
• Where the common shares are sold by the RRSP trust and the funds received are distributed to the employee/annuitant, the amount received constitutes a benefit under s. 146(1) and is included in computing the employee's income pursuant to s. 146(8), i.e., there is a second inclusion.

"Where an employee stock option is a qualified investment for an RRSP trust and it is disposed of by the employee to his or her RRSP or spousal RRSP, it is the Department's general position that the employee would not have any immediate income inclusion as the result of such disposition. However, the employee will have an income inclusion, as of the date that the RRSP exercises the option, equal to the amount that the fair market value of the shares acquired on the exercise date exceeds the exercise price paid by the RRSP for such shares."

Where an employee has transferred a stock option to her RRSP, the difference between the value of the share and the exercise price will be included in her income upon exercise of the stock option by the RRSP trust. If the conditions in s. 110(1)(d) are met, she will be entitled to the 1/4 deduction under s. 110(1)(d).

S. 110(1)(d.01) provides for an additional ½ deduction (so as to result in a nil taxable income inclusion) where the s. 110(1)(d) deduction was available for a s. 7(1)(a) stock option benefit and there is a timely gift of the optioned security to a qualified donee. CRA confirmed that this deduction is not available to reduce a s. 7(1)(e) benefit realized on death notwithstanding a donation of the shares following death by, for example, the estate to a qualified done.

How does s. 7(1)(e) apply if a deceased employee held unvested stock options which therefore are not exercisable after death? CRA stated:

…Where the terms of the owned unexercised stock option provide that the stock options are automatically cancelled in the event of the employee's death, the value of the options immediately after death, and the paragraph 7(1)(e) benefit, will be nil. If the employee stock options are not vested prior to the employee's death, the employee would not own unexercised stock options prior to their death and paragraph 7(1)(e) would not apply.

CRA stated:

Where an employee stock option provides that the option is automatically cancelled on death of an employee, the value of the option immediately after death will be nil with the result that no amount will be included in the deceased's income in accordance with paragraphs 7(1)(e) and 6(1)(a).

In a situation where the stock option provides that the deceased's estate may exercise the option within a limited period after the employee's death, paragraph 7(1)(e) may result in an income inclusion. Subsection 164(6.4) is intended to provide relief in such situations.

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.

Two corporations, each having a sole shareholder, are partners of a partnership ("S.E.N.C.") which, in turn, pays salaries directly to each such shareholder. How does s. 5(2)(b) of the Employment Insurance Act (providing that insurable employment does not include “the employment of a person by a corporation if the person controls more than 40% of the voting shares of the corporation”) apply? CRA responded:

[E]mployment with the S.E.N.C. is employment with its partners. Thus, no EI premium would be required in respect of the employment of the taxpayer controlling more than 40% of the voting shares of the corporation, which is a partner of the partnership.

The replacement of a SAR plan of a private-company (CCPC) employer with an agreement to acquire its preferred and common shares that is subject to s. 7 will not be an immediate taxable event. S.7(3)(a) will limit the recognition of any benefits that might arise as a result of this conversion, and the employees will not receive any amount as a result of the agreement to waive any rights under the SAR. Notwithstanding that the corporation will add to its stated capital account maintain in respect of the common shares and preferred shares an aggregate amount not exceeding its estimate of the current accrued liability owing to the executives under the SAR plan.

Ruling that s. 7(3)(a) would govern a plan under which a Canadian-controlled private corporation agrees to issue common shares and preferred shares to executives in replacement of a SAR plan and the executives have the right to sell the shares in specified circumstances to the corporate employer or (where it is advantageous to the executive from a tax perspective) to a nominee of the corporate employer.

Where an arm's length employee transfers options to a personal holding company for no consideration, he will not, except as provided by s. 7, be deemed to have received or enjoyed any benefit under or because of the options or their transfer to the corporation. Under s. 7(1)(c), he will realize a benefit when the holding company exercises the options during his lifetime or, if the options are exercised after his death, the company will be deemed to receive employment income under s. 7(1)(c) on exercise.

A s. 7 employee stock option plan can be implemented in substitution for an existing SAR Plan without any immediate tax consequences. "However, we caution that this position is only valid where there is an exchange of the SAR unit for the option and the employee does not otherwise receive any amount or right to receive an amount. For example, a receipt of a taxable benefit might occur at the time of an exchange if the arrangement provided for the acceleration of the vesting of the SAR and, because of the vesting, the employee obtained a right to receive cash for the unit."

Where an employee has contributed employee stock options to his RRSP, by virtue of s. 7(3)(a) there would be no income inclusion at the time of the transfer to the RRSP, and the employee would be entitled to a deduction under s. 146(5) or (5.1) equal to the fair market value of the option at the time of the transfer. When the RRSP exercised the option, there would be an income inclusion to the employee under s. 7(1)(c) at that time.

Where an employee transfers employee stock options to a wholly-owned corporation ("Holdco"), then by virtue of s. 7(3)(a) a benefit from his stock option rights will only be taxed when Holdco exercises the option under s. 7(1)(c) or disposes of the option rights under s. 7(1)(d). No amount will be included in the employee's income as a result of the transfer of the stock options to Holdco. Where, in order to avoid the application in s. 7, the employee disposes of his Holdco shares to the public-company employer before Holdco exercises the options, the Agency would have to consider whether s. 245(2) should be applied.

Where an employee exercises his or her SAR rights and the property received is shares of a CCPC that is the employer, the provisions of s. 7 will apply to the issuance of the shares.

Where Canadian employees of a Canadian corporation are eligible to participate in an employee stock option plan of an indirect U.S. public-corporation parent, amounts paid by the Canadian employer to the U.S. parent to reimburse it for the difference between the option price and the amount actually paid by the U.S. parent in order to purchase the shares for distribution to the Canadian employees, will not be deductible by virtue of s. 7(3)(b).

"If a benefit is received by an individual qua employee, paragraph 7(3)(a) requires that it be taxed under section 7 and not under any other provision in Part I of the Act."

CRA confirmed that it was appropriate to consider taking into account stock-option compensation expenses incurred by Canco in relation to its Canadian employees as a component of what would be a charge complying with the s. 247(2) transfer-pricing rules for their services to a non-resident affiliate, even where such stock compensation costs were non-deductible pursuant to s. 7(3)(b).

Conversely, stock-based compensation expenses of a non-resident affiliate could be relevant in determining what was a charge by the parent to Canco that accorded with the arm’s length principle under s. 247(2). For example, where the Canadian taxpayer is part of a group that is held by a related non-resident public corporation, and the public corporation issues shares to the employees of its group, including the employees of the Canadian taxpayer, that charge would be the compensation the Canadian taxpayer pays to the other corporation and, in those circumstances, s. 7(3)(b) would generally apply and s. 112(1)(e) might allow a deduction if its conditions are met.

Under an RSU plan established by the U.S. public-company parent (“USCo”) of CanCo, awards of RSUs are made to participants, including CanCo employees, each February. The RSUs vest on a pro-rata basis over a three-year period and are payable upon vesting in common shares of USCo, except that USCo may, in its discretion, decide that some or all of the RSUs are to be settled in cash rather than Shares.

Under a recharge agreement between USCo and CanCo, CanCo will reimburse USCo for expenses relating to RSUs that are settled by USCo with participants who are employees of CanCo (the “Reimbursements”). Although it is required to make Reimbursement payments in advance, CanCo does not claim a deduction for a Reimbursement until the relevant RSUs are settled.

The Directorate was asked whether s. 7(3)(b) would apply to deny the deduction by CanCo of the Reimbursements. After citing Transalta for the proposition that “a discretionary arrangement that does not give employees the right to require that equity-based compensation be paid in the form of shares rather than cash is not an agreement to sell or issue shares for purposes of section 7,” it stated:

… USCo can unilaterally decide to settle RSUs payable to CanCo employees in the form of cash rather than issuing Shares. In such circumstances there would be no agreement to issue shares for purposes of section 7 and paragraph 7(3)(b) would not apply to prohibit CanCo from deducting amounts paid to reimburse USCo under the Agreement.

However, it went on to indicate that because the Plan was a salary deferral arrangement (it vested too late to satisfy para. (k)), s. 18(1)(o.1) generally prohibited a deduction.

Each employee of a Canadian subsidiary (“EmployerCo”) of a U.S. parent (“ParentCo”) is granted restricted share units (“RSUs”). Each RSU entitles the employee to receive one share of ParentCo, with such shares being issued as the RSUs vest (which occurs as to 1/3 on each of the first, second, and third anniversary of the date of grant). EmployerCo will make a cash payment to the Receiver General on behalf of the employee on account of the required income tax withholding on the taxable benefit under s. 7(1) arising in the year of issuance, with the number of shares issued to the employee under the RSU plan correspondingly reduced.

For example, if 30 units (regarding shares worth $4,500) vested on the 1^st anniversary of grant, the employee might, for example, only be issued 18 instead of 30 shares, having regard to the cash remittance by EmployerCo of $1,800 to the Receiver General as source deductions respecting the s. 7 benefit. Is EmployerCo allowed to deduct this cash payment?

In finding that s. 7(3)(b) prohibited the employer (or any other person) from claiming a deduction in respect of the benefit in computing income, CRA stated:.

Under the circumstances described in your letter, a portion of the rights of the employee under the RSU Plan is considered to have been disposed of by the employee in exchange for EmployerCo paying the required income tax withholdings arising from the issuance of shares of ParentCo under the RSU Plan. Consequently, the employee is deemed to have received a benefit under paragraph 7(1)(b) equal to the amount of income tax remitted by EmployerCo on behalf of the employee. In reference to your example, the employee was considered to have disposed of 12 RSUs in exchange for $1,800, which is the benefit deemed to have been received by the employee under paragraph 7(1)(b).

Since the benefit as described in your letter arises from the issuance of shares, paragraph 7(3)(b) precludes a deduction by EmployerCo in respect of that benefit.

Parentco funded and administered a performance share plan (“PSP”) for employees of group companies, including Canco (a subsidiary). A PSP award is a conditional award of Parentco shares to be delivered upon vesting, which occurs based on performance conditions which are measured over the subsequent 3-year period. A vested award may be settled in either shares or the cash equivalent, at the discretion of Canco or Parentco. Canco makes reimbursement payments to Parentco pursuant to a recharge agreement for the value of shares distributed to Canco’s employees in satisfaction of vested PSP awards.

Before addressing whether such payments were deductible under s. 32.1 or 9, the Directorate stated:

[P]aragraph 7(3)(b) does not apply to prohibit a deduction for Canco’s PSP expenditures … .. Given the discretionary nature of the method for settling awards under the PSP, a PSP award is not a legally binding agreement to issue shares and thus not an agreement to which section 7 applies.

However, there was insufficient information to determine whether s. 7 could have applied even absent Transalta. The Directorate stated:

[S]ection 7 does not apply where an employer contributes to a trust and the trust uses the contributions to purchase employer shares (or shares of a corporation with which it does not deal at arm’s length) on the open market for eventual distribution to its employees. Instead, the arrangement is subject to the EBP rules.

In response to several enquiries from auditors on the meaning of “agreement” for the purposes of ss. 7 and 110(1)(d), the Directorate first referenced the Placer Dome, Chrysler and McAnulty decisions, and stated:

These cases stand for the proposition that an arrangement to issue or sell shares need not be a detailed written contract to fall within the scope of section 7 or paragraph 110(1)(d), but nonetheless must create legally binding rights and enforceable obligations.

This principle was confirmed in Transalta… .

The Directorate then discussed this issue in the context of various types of plans.

Respecting a discretionary share bonus plan (where “the corporation determines at the end of the [3-year] period the number of shares earned and whether the bonus would be paid in the form of shares issued from treasury or cash equivalent.,” it stated:

Because the corporation’s commitment remains fully discretionary at all times, the arrangement does not give rise to a legally binding agreement for the purposes of section 7. Therefore, where the corporation opts to settle the bonus by issuing shares, paragraph 7(3)(b) does not apply to prohibit the corporation from deducting the bonus expense.

Similarly, a fully discretionary stock bonus plan without a cash option will also fall outside section 7 where the granting of the awards and the issuance of the shares is made concurrently. However, if the eventual issuance of the shares is subject to time or other objective vesting conditions, it is our view that section 7 would apply. …

A share bonus plan that has been designed to avoid the application of paragraph 7(3)(b) (by the inclusion of a discretionary cash settlement option) will also need to… [qualify as a] three-year bonus plans… deferred share unit plan… .

Respecting a SAR or DSU plan, because “there is no agreement to issue shares…[i.e.,] the corporation is free to choose the form in which the payment will be made (which includes cash) [a]ccordingly, paragraph 7(3)(b) will not apply… .

The “Plan” provides for shares of USco to be issued to employees of its Canadian subsidiary (Canco) under the Deferred Stock, Restricted Stock, Performance Shares, Stock Appreciation Rights and Stock Options component of the Plan as well as making the “ESPP” available to them. Canco deducted the reimbursement payments it made to USco respecting the costs incurred by USco in issuing its common shares at a discount to Canco’s employees, claiming under Transalta that a legally binding agreement to issue shares did not exist for s. 7 purposes.

SARs

A Stock Appreciation Right provided a right to receive a payment in cash or shares, as selected by the Compensation Committee. The Directorate stated:

The issue of shares or payment in cash in satisfaction of the SAR is at the Committee’s complete discretion. Accordingly, Transalta will apply and paragraph 7(3)(b) will not apply to deny Canco a deduction.

Performance Shares

Under the Performance Shares Deferred Stock Agreement USco provided an award letter attached to the PSDSA specifying that the employee may obtain a targeted number of Performance Shares which are earned over a 3 year period based on the employee’s performance. After the 3 year period, the employer determines the total number of Performance Shares earned by the employee and at that point the appropriate number of shares of Deferred Stock are issued and delivered to the employee. CRA stated:

Based on the PSDSA, section 7 has application as USco appears to have a legal obligation to issue shares to a Canco employee… and… does not appear to have discretion concerning how to settle Performance Shares. Accordingly…paragraph 7(3)(b) should apply.

Other

USco did not appear to have discretion concerning how to settle Deferred Stock grants, Restricted Stock and a Non-Qualified Stock Options; and the ESPP obligated it to issue the number of subscribed-for shares. Therefore, s. 7(3)(b) applied respecting these.

Pubco (a Canadian public corporation) issues stock options (the “Options”) to certain employees (the "Participants") with an exercise price not less than the FMV of the shares on the date of grant. Pubco accounts for the transactions surrounding the granting and exercise of an Option in accordance with Section 3870 of the CICA Handbook, such that it records a "stock-based compensation expense" when an Option is granted and when a share is issued on Option exercise. The Directorate stated that the presumption s. 7(3)(b):

prevents Pubco from deducting in computing its income an amount of expense calculated on the exercise of an Option and the issue of a share that results in a taxable benefit under paragraph 7(1)(a) … [so that] the "stock-based compensation expense" … is not deductible by Pubco in computing its income for income tax purposes … .

[Alcatel] does not alter our interpretation of paragraph 7(3)(b) set out above.

A corporate employer contribute amounts to a newly-established trust from time to time, and the trustee uses those contributions to acquire shares of the employer from the employer or non-arm’s length shareholders thereof. The trust holds the shares for the benefit of the specific employees through the use of accounts established for the employee, and the shares may then be distributed by the trust to the employees at a future date on the occurrence of an event such as the employees' termination of employment. CRA stated:

[S]ubsection 7(2)… will apply when the shares held in the trust are allocated to the accounts of the employees. As a consequence… paragraph 7(3)(b)… will apply to limit the reduction of the employer's income for any year as a consequence of the distribution of shares to an employee under the arrangement. To clarify…where it is evident, from its inception, that the arrangement is subject to subsection 7 of the Act, it is our view that an employer cannot deduct any amounts with respect to any contributions made by the employer under the arrangement. …

[However] section 7… will not apply to situations where an employer contributes an amount to a trust and the trust uses the funds to acquire shares through open market transactions. Instead, we have taken the view that in these circumstances, the EBP provisions of the Act will apply. Furthermore, we have indicated that where a trust acquires some shares from an employer or a related corporation and other shares on the open market, CRA is, in general, prepared to apply the EBP provisions of the Act with respect to the shares acquired on the open market and the provisions of section 7 to the remaining shares.

The two equal partners (“PartnerCo1” and “PartnerCo2”) of “Partnership” subscribe for voting redeemable retractable preferred shares of a corporation (“ManagementCo”) which had been newly formed by them. ManagementCo hires employees to fulfill its new contract to manage the Partnership and grants the employees options to acquire non-voting common shares of ManagementCo (the “Option Shares”) with an exercise price equal to their current modest fair market value and specified vesting and forfeiture conditions. In general, vested options may be exercised on the occurrence of a specified exit event (e.g., IPO or sale of the Partnership assets), or after XX years of service (or earlier “not for cause” termination or death. The options may be physically exercised, or cash-surrendered for their in-the-money value, at the optionee’s election. The preferred share proceeds will then be used by ManagementCoto acquire shares of a newly-incorporated subsidiary (“ManagementSubCo”) which, in turn, will use those proceeds to acquire an interest in the Partnership. The optionees will have the right to sell Option Shares to PartnerCo1 and PartnerCo2 for an amount not exceeding their fair market value.

Ruling that where options are cash-surrendered, ManagementCo may deduct the gross amount of the cash payment made by it.

Under the employee stock option plan, optionees had the right to elect to receive cash (the "Put"), subject to a redacted right of the employer to decline to pay cash. Furthermore, optionees had the right to use the Put cash to subscribe for common shares which were differenct from those subject to their options, namely, flow-through shares. The pUt was exercised, and the cash so applied.

S. 7(3)(b) did not apply. CRA stated:

Although the election by the employee to receive cash in lieu of receiving shares under the stock option agreement is subject to the right of XXXXXXXXXX to decline to pay cash, XXXXXXXXXX , in our opinion, the employee still has the right to elect to receive cash and our position in paragraph 11 of IT-113R4 will apply (document 2000-0063133).

Would s. 7 apply to an employee benefit plan ("EBP") thatacquires treasury shares of a corporation that is related to the employer who contributes to the EBP? CRA responded:

In the context of a ruling request, we would review all of the facts to determine whether there would be an agreement to issue shares and whether section 7 of the Act would be applied to the particular situation.

We have previously concluded that, where employer contributions to a trust established for the benefit of its employees are used to acquire treasury shares of the employer corporation or a corporation related to the employer corporation, the plan or arrangement will be considered to constitute an agreement to sell or issue shares as contemplated by section 7 of the Act. Where this is the case, the employee will include a taxable benefit under section 7 of the Act and the employer will be denied a deduction for its contributions that are used to acquire the shares pursuant to paragraph 7(3)(b) of the Act. This result was supported by...Chrysler Canada...and...Placer Dome... .

In response to a request for further clarification of the CRA position respecting a stock option plan where the employer can elect to pay the employee cash instead of issuing shares at the exercise price, the Agency stated that it was its view that "no agreement is entered into until the corporation decides that it will issue shares to an employee upon that employee's exercise of an option. It is at that time that the option in respect of the employee will be subject to the provisions of section 7 ... ."

Furthermore, "the result in Kaiser...is not inconsistent with our position that the payment by an employee of cash rather than shares pusuant to the terms of a stock option plan will, in the absence of evidence to the contrary (e.g. the fact situation in Kaiser)...be a deductible expense to the employer."

Canadian employees of a Canadian subsidiary of a foreign parent had "subscription rights" to acquire unlisted ordinary shares of the foreign parent. The subscription rights plan provided that, for reasons relating to the tax rules in the foreign jurisdiction, at the time of the grant of such right, the employee also would acquire a non-interest bearing bond of the parent at an appropriate discount. In addition, under put and call agreements with a non-resident corporation ("Putcallco"), the employee could cause Putcallco to acquire the employee's foreign parent shares (after exercise of the subscription right) at their fair market value at the time of such exercise (as determined under a formula), and Putcallco could acquire the subscription rights for their their fair market value (as also determined under the formaula) in the event the individual ceased to be an employee. The foreign parent and the Canadian subsidiary had agreed that when a subscription right was exercised by an employee, the Canadian subsidiary would be obliged to pay to the foreign parent the amount by which the fair market value of the shares acquired by the employee exceeded the exercise price.

An employee right to cash-surrender the subscription right to the Canadian subsidary is subsequently granted. Ruling that the Canadian subsidiary will be entitled to claim a deduction in computing its income under s. 9(1) equal to the amount paid in cash to an employee who exercises the cash-out right.

Where Canadian employees of a Canadian corporation are eligible to participate in an employee stock option plan of an indirect U.S. public-corporation parent, amounts paid by the Canadian employer to the U.S. parent to reimburse it for the difference between the option price and the amount actually paid by the U.S. parent in order to purchase the shares for distribution to the Canadian employees, will not be deductible by virtue of s. 7(3)(b).

If employer contributions under an employees profit sharing plan can be used to purchase treasury shares, s. 7 will apply and the employer will be denied a deduction pursuant to s. 7(3)(b).

Where a Canadian subsidiary acquires shares of its U.S. parent for cash and the parent then issues the shares to Canadian executives of the Canadian subsidiary at the subsidiary's direction, s. 7(3) will apply to grant the deduction to the Canadian subsidiary.