Equity-based incentive plans have in recent years become a
common component of the compensation package for executive
employees in Canada. Employers often design the plans in such
a way as to enable the employer to claim a tax deduction for the
value of the equity-based compensation. In the case of
treasury shares issued under stock bonus plans, the Canada Revenue
Agency (CRA) has historically taken the position that the value of
treasury shares issued under such plans is not deductible by the
employer for tax purposes. However, a recent decision of the
Tax Court of Canada allowed the employer to deduct the fair market
value of treasury shares issued to executive employees under a
discretionary stock bonus program.
Section 7 of the Income Tax Act (Canada) (Act) governs the
taxation of stock option plans. Subsection 7(3) of the Act
denies the deduction of the value of treasury shares issued under
such plans where a corporation "has agreed" to sell or
issue securities to an employee. The subsection also applies
to ensure an employee is not considered to have received a taxable
benefit under any other provision of the Act because of the
"agreement". This subsection has often been used by
the CRA to deny the deduction of the value of treasury shares
issued under stock bonus plans.
However, in Transalta Corporation v. R, the Tax Court of
Canada ruled that Transalta could claim a deduction for the fair
market value of the shares it issued to employees under its
'Performance Share Ownership Plan'. In brief, each year
employees were informed whether they had been selected by the Human
Resources Committee for participation in the plan and were eligible
receive a bonus at the end of the award's 3-year term. At the
end of the term Transalta would determine, in its sole
discretion, whether and to what extent the award would be paid
in cash or by the issuance of treasury shares. In each
taxation year under appeal Transalta increased its stated capital
account by an amount equal to the fair market value of the shares
issued under the plan on the basis that the shares were issued for
past service, and claimed a corresponding deduction for those
The key to the Court's decision is its interpretation of the
words "agreement" and "agree" in subsection
7(3) of the Act as requiring a legally binding agreement to issue
shares. The Court found that the plan was explicitly
discretionary and did not create legally binding rights or
enforceable obligations, prior to the delivery of the shares, to
receive an award. It therefore concluded that the plan was
not caught by section 7, and the deductions were therefore not
denied by subsection 7(3).
The CRA did not appeal the Court's decision and it remains
to be seen whether an amendment to the Act will be pursued.
Although the CRA has previously expressed the view that no expenses
would be deductible (whether in the form of a sale or issuance of
shares) with respect to any form of stock option or stock
purchase plan as a result of the application of section 7 (see,
e.g. ACC-9596), it may see the proposed addition of section 143.3
as being sufficient. Proposed section 143.3 acts to deny the
characterization of the cost of granting of an option or issuing
shares as an expenditure in certain circumstance, including those
where no binding agreement to do so exists. Interestingly, however,
that provision would not have applied to reduce the deductions
taken in this case.
Employers that provide equity-based incentive plans that issue
treasury shares on a discretionary basis may wish to review their
plans with their advisors to determine the appropriate tax
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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