Canada: Employee Stock Options: Do We Have An Agreement?

In the fall of 2015, the Liberal government threatened to end the preferential tax treatment for certain employee stock options. But after much opposition, Finance Minister Morneau eventually backed off. In 2016, the Canada Revenue Agency issued comments on those rules, following up on the Tax Court's decision in Transalta v. The Queen (2012 TCC 86).     

Employee stock option rules

The rules for taxing employee benefits arising from an agreement to acquire shares or mutual fund units of an employer are found in section 7 of the Income Tax Act. In general terms, the rules state that no benefit arises when options or rights are granted to employees; the benefit is determined when shares are actually acquired or the rights are otherwise disposed of for consideration. Where securities are issued, the benefit is computed at the time of exercise as the excess of the share value over the exercise price paid by the employee. The employee is entitled to claim a separate 50 per cent stock option deduction, provided certain conditions are met: the shares must be prescribed shares (generally, straightforward common shares), and the exercise price paid by the employee must be equal to or greater than the value of the shares at the time the rights were granted. Generally, tax must be withheld on these benefits, which often requires an immediate sale of some of the shares to fund the tax.

For Canadian-controlled private corporations (CCPCs), the 50 per cent deduction is also available to employees if the shares are owned for at least two years before disposition. The benefit arising from CCPC shares is computed at exercise but taxation is deferred until the shares are sold. No source withholding of tax is required in respect of CCPC stock option benefits. 

Gains accruing after share issuance will generally be treated as capital gains. For CCPC shares, the holder may be eligible to claim the lifetime capital gains deduction to shelter capital gains (but not the stock option benefit), provided the various other requirements to claim the deduction are satisfied, including a minimum level of active business assets in the corporation and a two-year holding period for the subject shares.

Employer deductions

Generally, employers are denied a deduction for the cost of the securities issued to employees where section 7 applies. If the corporation pays cash to acquire the rights, other than pursuant to a takeover scenario, the payment is generally deductible, though the employee will be denied the 50 per cent deduction. However, the employer generally may elect to forego deducting the payment, which restores the employee's deduction.

The Transalta decision

Section 7 states that the various rules apply only where there is an agreement for the issuance of the shares. In Transalta, the Tax Court confirmed that "agreement" means a binding legal agreement or enforceable obligation to issue the shares. In that case, the employer issued shares for zero consideration pursuant to a performance incentive plan wherein the issuance of shares was entirely based on the employer's qualitative assessment. The corporation successfully argued that the section 7 rules did not apply. The arrangement did not constitute an "agreement" since the issuance of shares was entirely at the company's discretion and was not enforceable by the employee. Thus, the company was able to deduct the cost associated with issuing the shares. The employees were essentially indifferent, as they would be fully taxed on the benefit realized in any event. 

2016 CRA comments

In the fall of 2016, the Rulings Directorate of the CRA addressed questions about this decision, confirming its view that, where the issuance of shares is entirely at the discretion of the employer, the usual rules governing employee stock rights might not apply. The CRA stated that "discretionary bonus" plans similar to the Transalta plan, in which employers allocate shares based on qualitative performance assessments, will not be subject to section 7. Instead, benefits will likely be fully taxable to the employee with no 50 per cent deduction and fully deductible to the employer. This position provides comfort that simply paying a discretionary bonus with shares instead of cash will not necessarily compromise the corporation's deduction of the bonus. 

The CRA stated that a plan entitling an employee to shares based on measurable performance goals will likely qualify for section 7 treatment. Section 7 will likely also apply where the employee has the choice of receiving shares or cash, but the arrangement constitutes a binding agreement. However, if the employer has the right to choose whether to compensate the employee with shares or cash, it will have no binding commitment to issue shares and section 7 will not apply. This will also be the case for a share appreciation rights plan or a deferred share unit plan, where the corporation is entitled to satisfy commitments with cash or shares at its discretion.

The CRA also addressed stock options with discretionary vesting conditions, where the employer grants employee options subject to allowing employees to exercise only the number specified by the employer in each subsequent year. Such arrangements will not constitute an agreement to issue shares until the time notice is given confirming what may be exercised.

Where shares are instead issued to a trust established by an employer for the benefit of employees, they are generally deemed to be owned by those employees since the time the trust acquired them. The CRA considered a situation in which shares were issued to a trust but no specific employees were allocated shares until later years, and the trustees had full discretion as to which employees received shares or whether any employees received shares at all. Unsurprisingly, the CRA concluded the employees would not be considered to own the shares until they were allocated by the trust. Consequently, employees might not, for example, have held the shares for the two years required to claim the 50 per cent stock option deduction or the capital gains deduction for qualifying small business corporation shares.

The stock option rules are complex, and the Transalta decision, while successful for that particular taxpayer, has made the rules a little tougher to navigate. Careful planning is needed to ensure that employee equity participation plans work as intended. Contact your Collins Barrow advisor for help. 

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Collins Barrow National Incorporated
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Collins Barrow National Incorporated
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions