Subsection 7(1) - Agreement to issue securities to employees
Paragraph 7(1)(a)
Cases
The Queen v. Morin, 2006 DTC 6057, 2006 FCA 25
The taxpayer entered into an arrangement with a consultant ("Bobsan") under which Bobsan would recommend to him firms within the high-tech area to whom the taxpayer might apply for a position, and the taxpayer agreed to pay Bobsan the first $100,000 of any employee stock option benefits realized by him from such an employer, plus 1/3 of the excess over $100,000. In finding that an amount paid by the taxpayer to Bobsan pursuant to this arrangement did not qualify as an "amount ... paid by the employee to acquire the right to acquire ... securities" for purposes of s. 7(1)(a)(iii), so that the amount so paid was not deductible under s. 7(1)(a)(iii), Malone J.A. stated (at p. 6059) that:
"An amount paid to acquire property is an amount paid in exchange for title to the property or in exchange for the incidents of title, and here is apparent that the payments made by the taxpayer to Bobsan were not made to acquire the stock options, which instead were received directly from the employer to whom he had been referred by Bobsan, and he was not required to pay any money to that employer for the options."
Clemiss v. The Queen, 92 DTC 6509 (FCTD)
Reed J. accepted the Crown's submission that the taxpayer's purported acceptance of his employer's offer, set out in an option agreement, to issue "freely trading shares", could not constitute a binding agreement at that time to acquire the shares because the company at that point was not capable of issuing freely tradeable shares. Accordingly, the taxpayer did not acquire the shares until a later date on which the board of directors alloted and issued the shares to him, a share certificate was delivered to him and he waived the requirement for free tradeability.
The Queen v. Gesser Estate, 92 DTC 6273 (FCA)
In 1970 an executive ("Gesser") entered into a letter of agreement with his employer ("Cemp") which confirmed the purchase by Gesser of 8,400 common shares of a related company ("Fairview") for a purchase price payable (with the exception of a small "supposed" initial payment) in ten years' time. Gesser's interest in the shares, and any previous payments made on account of the purchase price, would be forfeited upon failure to pay the purchase price without any further recourse. Gesser had the right to "put" his shares to Cemp commencing in five years' time for their value as determined by the auditors.
In finding that the Minister had correctly assessed on the basis that Gesser had not acquired the shares in 1970, with the result that s. 7(1)(a) applied to the receipt of the shares by Gesser in 1972, Marceau J.A. found that the 1970 agreement probably gave Gesser the right to compel Cemp after five years to pay the difference between the value of the shares of Fairview in 1970 and at the time of payment.
Scott v. The Queen, 91 DTC 5268 (FCTD), varied 94 DTC 6193 (FCA)
The taxpayer, whose services were provided to a corporation ("Nighthawk") by a corporation ("Delsco") owned by his wife and the spouses of members of a law firm, was also a director of Nighthawk. Ss. 7(1)(a) and 7(1.1) governed the benefit which he received on the disposition of shares acquired by him pursuant to stock options which have been granted to him and the other directors of Nighthawk given that the number of stock options granted to him represented the work which he did for Nighthawk (notwithstanding that his regular remuneration was paid by Delsco).
Steen v. The Queen, 86 DTC 6498, [1986] 2 CTC 394 (FCTD), aff'd 88 DTC 6171, [1988] 1 CTC 256 (FCA)
An employee "acquires" shares pursuant to a stock option agreement at the time he exercises his option to purchase shares from his corporate employer, rather than at the time of the granting of the option. The word "value" in s. 7(1)(a) is essentially synonymous to "fair market value" or "market value".
Mansfield v. The Queen, 83 DTC 5136, [1983] CTC 97 (FCTD), aff'd 84 DTC 6535, [1984] CTC 547 (FCA)
In 1972, the taxpayer and other employees of a private company were offered convertible debentures of their employer which, in the case of the taxpayer, had a principal amount of $5,000. When in 1977 the taxpayer exercised the conversion rights under his debenture to acquire shares of his employer with a fair market value of $11,700, he was deemed by s. 7(1)(a) to receive a taxable benefit equal to the difference between such fair market value and the $5,125 price for which his convertible debenture had been issued to him. This benefit was not exempted from taxation by s. 51, which only dealt with the adjusted cost base of the shares and whether there had been a disposition, and did not deem the exchange to be non-taxable.
Mahoney, J. also stated (at p. 5138 DTC) that "'agree' and 'agreement' are not terms of art or technical expressions," so that the acquisition option embedded in the terms of the debenture represented an agreement with the employer.
The Court of Appeal rejected a submission that the $11,700 value of the debenture in 1977 constituted the "amount paid" for purposes of s. 7(1)(a), as this interpretation "would have the effect of rendering that subsection of no effect."
Grant v. The Queen, 74 DTC 6252, [1974] CTC 332 (FCTD)
The effect of two resolutions and applications for shares by the company's employees was to create binding agreements. The taxpayer "acquired" his share for the purposes of s. 85A(1)(a) at the time of the agreement, notwithstanding that he did not fully pay for the share and receive a share certificate until later when the market price of the shares had risen.
See Also
Van de Velde v. The Queen, 2007 DTC 1314, 2007 TCC 533
RSUs (which Miller J. appeared to treat as securities) did not have their value included in his income until the time that his entitlement to them vested.
Williams v. The Queen, 97 DTC 887, Docket: 97-445-IT-I (TCC)
When the taxpayer exercised stock option rights, he did so as nominee for others. Accordingly, he had not "acquired" (i.e., obtained for himself) the shares and, accordingly, was not taxable.
Bertram v. The Queen, 93 DTC 1251 (TCC)
Although the taxpayers purported to exercise employee stock options and assign them for the exercise price to the purchaser of shares of the corporation at a time that the market price was well in excess of the exercise price, in fact, they were doing so as agent for the purchasers. Accordingly, they realized no stock option benefits.
Stafford v. The Queen, 93 DTC 438 (TCC)
In order to evade limitations established by the Vancouver Stock Exchange as to the number of shares a stock promoter was permitted to have the right to acquire under option, a promoter entered into an arrangement with the taxpayer under which the taxpayer was granted employee stock options and agreed to sell a portion of the shares acquired by him under option to the promoter at the taxpayer's cost. Because the agreement with the promoter was separate from the stock options granted to the taxpayer, the taxpayer realized an employment benefit under s. 7(1) when he exercised his options at the request of the promoter.
Ball v. MNR, 92 DTC 2123 (TCC)
The taxpayer was granted an option to purchase 25,000 shares of his employer at a price of $2.05 per share. On July 10, 1985 the taxpayer purported to exercise his option and was issued a share certificate for 25,000 shares. He thereafter sold 9,700 shares and, only at that time, paid the exercise price for those shares. His employer became insolvent before he could sell the balance of the shares purportedly issued to him, and he returned the share certificate for the balance of the shares to his employer.
Because only 9,700 shares had been validly issued to him, he was subject to tax under s. 7(1)(a) only with respect to the exercise of his option with respect to those shares.
Tedmon v. MNR, 91 DTC 962 (TCC)
The taxpayer while a resident of the U.S. and while employed by a U.S. company ("GE") was granted stock options by GE. He subsequently resigned from his position with GE (but without losing his entitlement to his options under the GE stock option plan) and commenced to work for an unrelated Canadian company (Noranda Inc.)
Beaubier, TCJ rejected a submission that s. 7 did not apply to the employee stock options of a Canadian resident where the stock options were granted while the resident had been a non-resident with a non-resident employer. Accordingly, the taxpayer was deemed to realize a benefit from employment when (while still resident in Canada) he exercised his GE stock options.
Ingram v. MNR, 91 DTC 939 (TCC)
The taxpayer was asked by some stock promoters to sit on the board of a junior company listed on the Vancouver stock exchange, to give them the authority to trade in the shares of the company in his name but for their account and to receive stock options in his name but held by him for their benefit and at their direction. This agency arrangement pursuant to which the taxpayer acquired and exercised stock options was void (on the basis of the principle that an agent cannot be authorized to that which it is not legally possible for the principal to do, and the option transactions in question were contrary to securities laws). Nonetheless, the resulting stock option benefits nonetheless were income of the promoters, rather than of the taxpayer, because the economic benefit of the options was that of the promoters.
Administrative Policy
1 June 2015 T.I. 2015-0581311E5 - Application of section 7 to employee share purchase
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.
4 May 2015 T.I. 2013-0502761E5 F - Stock Options and Earnout
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 of disposition of the options…[and] are not a benefit under section 7… .
20 March 2015 T.I. 2014-0526941E5 - RSU Plan-Cash Dividend Equivalents
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).
24 March 2015 T.I. 2012-0432951E5 F - Application of section 7
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).
25 September 2013 T.I. 2011-0428941E5 F - Transfer of Stock Options to Protective Trust
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.
19 July 2013 T.I. 2012-0458961E5 F - Stock option, cashless exercise
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):
…in the context of a short sale, the CRA generally is of the view that an employee has acquired the shares of the employer at the moment that the employer transfers the shares to the employee and they are paid for. When 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.
28 December 2012 Guide T4130
When a corporation agrees to sell or issue its shares to an employee, or when a mutual fund trust grants options to an employee to acquire trust units, the employee may receive a taxable benefit. The taxable benefit is the difference between the fair market value of the shares or units when the employee acquired them and the amount paid, or to be paid, for them, including any amount paid for the rights to acquire the shares or units. Also, a benefit can accrue to the employee if his or her rights under the agreement become vested in another person, or if they transfer or sell the rights.
The shares or trust units are considered to be acquired when legal ownership of the shares has been transferred and the vendor has entitlement to receive payment. In general, this would occur where the shares have been transferred to the employee/broker and paid for.
2004 Ruling 2004-007204 -
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.
18 August 2004 T.I. 2004-0070361E5 -
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.
2002 Ruling 2001-011593
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."
2001 Ruling 2001-008401 -
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"
2001 Ruling 2001-007775 -
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.
1999 APFF Round Table, Q. 1 (No. 9M19190)
Where an American citizen, who received stock options from an American public corporation while working for it and living in the United States, becomes a resident of Canada, s. 7 would apply in the year in which he exercises his right to acquire the shares.
1997 Ruling 1 January 1997 9716083 [ADS]
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).
21 October 1996 T.I. 960437 [partnership employees employed by each partner]
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.
2 June 1995 T.I. 950472 (C.T.O. "Employee Stock Option Plan")
"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."
20 January 1994 T.I. 940074 HAA4735-1 (C.T.O. "Section 7 Employees Profit Sharing Plans")
An employees profit sharing plan can be structured to be an agreement by an employer to sell or issue shares of the employer or a non-arm's length corporation and, in such circumstances, s. 7 would be more specific than s. 144, with the result that s. 7 will apply.
11 June 1993 T.I. (Tax Window, No. 31, p. 10, ¶2519)
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).
Tax Professionals Mini Round Table - Vancouver - Q. 4 (March 1993 Access Letter, p. 102)
Discussion of criteria for determining the "value" of publicly treated shares for purposes of s. 7(1)(a).
5 November 1991 Memorandum (Tax Window, No. 12, p. 8, ¶1561)
In contrast with its approach to dividend reinvestment plans, RC will assess an employee benefit where shares are acquired by an employee at a 5% discount to the market price.
27 March 1990 T.I. (August 1990 Access Letter, ¶1362)
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.
86 C.R. - Q.64
a director is an employee for purposes of s. 7.
IT-113R4 "Benefits to Employees - Stock Options" 7 August 1996
6. ...The word "issue" means to deliver unissued shares of a corporation, including...for no monetary consideration. Therefore, section 7 applies when an employer corporation agrees to sell or issue, to an employee of the corporation or of a corporation with which it does not deal at arm's length, its own shares, or to sell or have issued those of a corporation with which it does not deal at arm's length, at less than fair market value or for no monetary consideration.
IC 89-3 "Policy Statement on Business Equity Valuations", para. 38
The reference to "value" is generally interpreted to mean fair market value.
Articles
Christina Medland, Andrew Stancel, "Tax-effective Risk-adjusted Incentive Arrangements for Public Companies", Taxation of Executive Compensation and Retirement, Vol. 22, No. 9, May 2011
Includes overview of treasurey RSU and PSU plans.
Christina Medland, Jennifer Sandford, "Tax Treatment of Share-Based Compensation", Taxation of Executive Compensation and Retirement, September 2005, p. 583.
Scott Sweatman, Richard Schubert, "Long Term Incentives for Employees of Income Trusts", Taxation of Executive Compensation, Vol. 15, No. 2, September 2003, p. 319.
Michael F.T. Addison, Gil J. Korn, "Employee Stock Options: An Up-Date", Personal Tax Planning, 2000 Canadian Tax Journal, Vol, 48, No. 3, p. 778.
Singer, "Forward Participating Shares - A Question by Revenue Canada", Taxation of Executive Compensation and Retirement, June 1992, p. 622.
Lee, "Stock-Based Compensation: Selected Regulatory and Taxation Issues", 1991 Corporate Management Tax Conference Report, c. 4.
Dunbar, "Time of Acquisition of Restricted Shares May Determine Value of Stock Option Benefit", Taxation of Executive Compensation and Retirement, November 1990, p. 361
Further discussion of 27 March 1990 T.I. (see August 1990 Access Letter, ¶1362).
Paragraph 7(1)(b)
Commentary
Under s. 7(1)(b) an employee will be deemed to receive a taxable benefit equal to the value of any consideration received on the disposition of an employee stock option to a person with whom he or she was dealing at arm's length (minus any amount paid by the employee to acquire those options).
It is clear that s. 7(1)(b) applies when the employee voluntarily surrenders his or her options to the issuer of the options (with whom he or she deals at arm's length) in consideration for a cash payment ([pin type="node_head" href="133-Greiner"]Greiner[/pin], [pin type="node_head" href="133-Harvey"]Harvey[/pin]). In contrast to a voluntary cash surrender payment, a payment of damages for breach of a stock option agreement was not (before the enactment of s. 7(1.7))taxable under s. 7(1)(b) ([pin type="node_head" href="133-Buccini"]Buccini[/pin], [pin type="node_head" href="133-Bernier"]Bernier[/pin], [pin type="node_head" href="133-Huestis"]Huestis[/pin]). However, amounts purported paid as damages which essentially were agreed to in advance of a termination of the stock option agreements may be found in substance to represent cash surrender payments (see [pin type="node_head" href="133-Dundas"]Dundas[/pin]).
S. 7(1.7) now deems damages received as a result of employee stock options ceasing to have become exercisable to be proceeds for the disposition of those options to an arm's length person, so that s. 7(1)(b) (and, where applicable, s. 110(1)(d)) are then engaged.
Prior to the enactment of s. 7(1)(b.1), no provision of s. 7 applied to a disposition of stock options by a taxpayer to a person with whom he or she did not deal at arm's length ([pin type="node_head" href="133-Bowens"]Bowens[/pin]).
Cases
Buccini v. The Queen, 2000 DTC 6685, Docket: A-611-98 (FCA)
Following the amalgamation of the taxpayer's employer with other Canadian subsidiaries of the U.S. parent, the taxpayer executed a settlement agreement with the Canadian employer in which he acknowledged that a payment of $83,900 was in full settlement of all claims arising from his employer's unilateral termination of the employee stock option agreement between the taxpayer and the employer. In finding that this sum was a tax-free receipt, and in reversing a finding of the Tax Court Judge that it represented the value of consideration from a disposition pursuant to s. 7(1)(b), Malone J.A. stated that "a 'disposition' under paragraph 7(1)(b) refers to a transaction in which the taxpayer voluntarily agrees to exchange property rights that have accrued under an employee stock option agreement for some other consideration", and noted here that instead there had been a unilateral repudiation of the taxpayer's rights under the option agreement by the employer, and that such unilateral conduct constituted a fundamental breach of the contract that terminated it as of that date.
Bernier v. The Queen, 2000 DTC 6053 (FCA)
In the course of preparing a response to a proposed acquisition of the employer ("Nordair") by another corporation ("CP Air"), Nordair discovered that options which it had issued to the taxpayer and other employees were null and void because they contravened the requirements of Quebec's securities law. CP Air then stated that it was its "present intention ... to take such steps as may be appropriate and legally permissible to compensate (whether in cash or in some other manner) the relevant directors and officers of Nordair for the loss of benefits which would have accrued to them under the original stock option plan". Ultimately, the taxpayer received a lump sum of $58,000 while still an employee.
The Court of Appeal affirmed the finding that this amount was not taxable under s. 7(1)(b) (a finding which effectively affirmed an assessment of the Minister founded on s. 6(1)(a)). As in the Huestis case, the matter involved "the unilateral cancellation of an option contract which gave rise to the financial compensation received by the appellant and not an assignment of rights set out in a contract" (p. 6054).
Dundas v. The Queen, 95 DTC 5116 (FCA)
After the amalgamation of a Canadian corporation ("Canadian Reserve I") with a wholly-owned subsidiary of the U.S. parent of Canadian Reserve I, the taxpayer, who was the President of Canadian Reserve I, was paid an amount in respect of his stock options equal to the difference between the cash amount received by minority shareholders on the amalgamation and the exercise price. Notwithstanding the purported giving of a release by the taxpayer subsequent to the effective date of the amalgamation releasing any cause of action supposedly arising as a result of the amalgamation, Strayer J.A. adopted the finding of the trial judge that the release was not given in settlement for previous options already cancelled by the amalgamation agreement, but rather represented in effect the confirmation of the compensation to which the taxpayer was already entitled under the amalgamation agreement; and that the release agreement, if anything, was evidence of an arrangement worked out prior to the effective date of the amalgamation contemplating the disposition by the taxpayer of his options in accordance with the amalgamation agreement. Accordingly, the amount so received by the taxpayer represented proceeds of disposition of his employee stock options pursuant to s. 7(1)(b).
Hale v. The Queen, 90 DTC 6481 (FCTD), aff'd 92 DTC 6473 (FCA)
While resident in Canada, the taxpayer was granted rights under the employee stock option plan of his Canadian employer (Alcan) and further "share appreciation rights" to be paid amounts based on the appreciation in the Alcan shares over the strike price in lieu of exercising his stock option rights. Amounts paid to the taxpayer pursuant to his exercise (at a time that he had become a resident of the United Kingdom and had ceased to be an Alcan employee) of the share appreciation rights constituted a benefit received by virtue of his employment as described in s. 7(1)(b) (although they were not "remuneration" for purposes of the Canada-UK Income Tax Convention) given that s. 7(4) deemed him to continue to be an employee at the time of exercise.
Beaumont v. The Queen, 86 DTC 6264, [1986] 1 CTC 507 (FCTD), aff'd 88 DTC 6522, [1988] 2 CTC 365 (FCA)
Since the taxpayer was held to be dealing at arm's length with a corporation ("Clarebeau") 1/2 of whose shares were owned by the taxpayer's family holding company and 1/2 of whose shares were owned by the family holding company of his business associate ("Claridge"), a sale by the taxpayer of share purchase options to Clarebeau for nominal consideration was governed by s. 7(1)(b) rather than s. 7(1)(c). The plaintiff and Claridge believed that they (with their respective wives) enjoyed precisely equal control of Clarebeau (although, as they discovered much later, Claridge as president had the right to cast deciding votes at meetings), they had equal rights to the assets and earnings of Clarebeau, and the share options represented a business opportunity that the plaintiff felt himself obliged to pool with Claridge through the medium of Clarebeau.
Greiner v. The Queen, 84 DTC 6073, [1984] CTC 92 (FCA)
Prior to the effective date of an amalgamation squeeze out, the taxpayer agreed to surrender his unvested stock option rights in consideration for a cash payment from his employer equal to the accrued gain. His entitlement to this payment was found to arise under the stock option agreement rather than being in respect of a (separate) claim for damages in respect of the cancellation of those rights. The words "otherwise disposed of" include the surrender for value by employees of share options at a time when their rights under the stock option agreement are still alive. For the purpose of determining whether the rights were still alive at the time of surrender, it was found that the surrender took place when the taxpayer agreed to surrender his rights upon the occurrence of certain events (including shareholder approval of an amalgamation), rather than the date on which the option rights were actually released. In addition, s. 7(1)(b) was not found to be restricted to amounts received from a person other than the optioner/employer, and the words "otherwise disposed of" are "sufficiently broad as to include an amount received as consideration for the surrender of rights that are thereby extinguished."
The Queen v. Harvey, 83 DTC 5098, [1983] CTC 63 (FCTD)
Prior to the effective date of a merger between a Michigan corporation ("Tranter") and a second American corporation, Tranter approached Harvey who was the chief executive of its Canadian subsidiary, and obtained his agreement to surrender his option to purchase Tranter's shares, which had been granted by Tranter to Harvey in 1976, for $25,500. Because Tranter was not in breach of the option agreement when Harvey agreed to surrender his option, the payment made to him was consideration for the disposition of his option (rather than damages for its breach) and accordingly was taxable.
See Also
Bowens v. The Queen, 94 DTC 1853 (TCC), aff'd 96 DTC 6128 (FCA)
When a corporation ("Trilogy") made an offer to acquire all the shares of a corporation ("DEB"), including any outstanding stock options, the taxpayer, who was the chief financial officer of DEB, incorporated a numbered company, transferred his options to it, sold the shares of the numbered company to Trilogy for shares of Trilogy, and filed a joint election with Trilogy under s. 85. In finding that the taxpayer did not deal at arm's length with Trilogy, so that s. 7(1)(b) could not apply to a transfer of his option rights to Trilogy, Bowman TCJ. noted that the taxpayer was a partner in a partnership which, with other corporations, raised capital and promoted the acquisition by Trilogy of the shares of DEB and that the taxpayer for some time had been an executive vice-president of Trilogy and was instrumental in formulating the exchange offer made by Trilogy for the shares and options. In addition, since it was not suggested that the transaction with the numbered company was a sham or legally ineffective, the taxpayer did not "transfer or otherwise dispose of" the options to Trilogy.
The Queen v. Huestis, 75 DTC 5393, [1975] CTC 560 (FCA), briefly aff'd 77 DTC 5044 (SCC)
After the employer corporation ("Bethel") granted options to purchase its shares to the taxpayer and other employees, it commenced winding-up proceedings and gave the taxpayer shares in the purchaser of the assets of Bethel in settlement of Bethel's liability under the option agreement. It was held that the shares in the purchaser were not received "under" the option agreements, nor could the taxpayer be said to have "transferred or otherwise disposed of rights under" the option agreements. (Ss.85A(1)(a), (b) of pre-1972 Act).
Administrative Policy
7 May 2015 T.I. 2015-0570801E5 - Exchange of Stock Options-7(1)(b) Applies
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.
Income Tax Technical News No. 19, 16 June 2000
Where under a securities option plan "an employee has the right to choose to receive the fair market value of the securities option rights in shares, paragraph 7(1)(b) will apply in respect to the disposition of those rights".
1999 Ruling 990259 [cash surrender of subscription rights for unlisted shares]
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).
22 July 1999 T.I. 983381 [change to employer cash-out right]
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).
21 January 1998 T.I. 973116 [cost of new options acquired on exchange
"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."
IT113R4 "Benefits to Employees - Stock Options" 7 August 1996
7. Section 7 applies where a corporate employer issues shares to an employee as a salary bonus or under a stock bonus plan. ...
11. … Where, under a stock option agreement, an employer elects to pay cash in lieu of issuing shares, subsection 7(1) does not apply and the amount of cash received by the employee is taxable under either subsection 5(1) or paragraph 6(1)(a)… . Where it is the employee who has the right to choose cash instead of shares, paragraph 7(1)(b) will apply, in respect of the cash received by the employee in satisfaction of the employee's rights under the plan. …
Income Tax Technical News, No. 7, 21 February 1996
Where under an employee stock option plan, it is the employee rather than the employer who has the option to choose cash instead of shares, s. 7(1)(b) will apply in respect of the cash that the employee elects to receive in satisfaction of his rights under the plan.
Income Tax Technical News, No. 1, 22 July 1994
If an employee compensation package includes any convertible preferred shares, s. 7(1) will apply when those shares are sold or converted to common shares unless, in the case of the conversion or sale of a convertible preferred share that is a not a forward participating share, the share was issued before December 1, 1994 as part of an employee compensation that was in place on or before August 31, 1994.
17 February 1994 T.I. 5-940137 -
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).
1 May 1991 T.I. (Tax Window, No. 3, p. 28, ¶1224)
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.
Articles
Anna Malazhavaya, "Stock Options and Foreign", Taxation of Executive Compensation and Retirement, Vol. 23, No. 1, July/August 2011, p. 143
Where a foreign corporation repurchases its own shares and then transfers those same shares to an employee under a stock option plan, it would appear that such shares cannot be considered to be "issued" to the employee; but that they may be considered to be "sold."
Jeremy Forgie, Elizabeth H. Boyd, "Tax Issues Relating to Stock Options in the Context of Corporate Mergers, Acquisitions and Reorganizations", Taxation of Executive Compensation and Retirement, Vol. 11, No. 5, December/January 2000, p. 224.
Elizabeth H. Boyd, "Stock Options and Other Executive Compensation Arrangements in a Reorganization, Merger or Acquisition - Tax Issues", Taxation of Executive Compensation and Retirement, Vol. 10, No. 1, July/August 1998, p.3.
Paragraph 7(1)(c)
Administrative Policy
1 December 2009 T.I. 2009-0307821E5
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.
2002 Ruling 2001-010761
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.
31 October 1996 T.I. 963433 (C.T.O. "RRSP Options")
"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."
28 April 1995 T.I. 950344 (C.T.O. "Stock Option in RRSP")
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).
12 December 1989 Memorandum (May 1990 Access Letter, ¶1207)
Where an employee held unexercised employee stock options at the time of his death, no amount will be included in the income of the deceased or the estate in respect of their value, whether under ss.7(1)(c), 70(2), 70(5), or otherwise. S.7(1)(c) does not apply because the employee is deceased at the time the estate exercises the options. The ACB of the options to the estate is fair market value by virtue of s. 69(1)(c).
Paragraph 7(1)(e)
Administrative Policy
16 June 2014 STEP Roundtable Q. , 2014-0523011C6
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.
21 December 2012 Memorandum 2009-0327221I7 - Paragraph 7(1)(e) - Death of a Taxpayer
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.
May 19 1995 Executive Institute Round Table, Q. 24 (C.T.O. "Employee Stock Option")
An employer is required to issue a T4 in the year of death of an employee computing the benefit under s. 7(1)(e).
26 April 1990 Memorandum (September 1990 Access Letter, ¶1442)
Discussion of state of law prior to enactment of s. 7(1)(e).
Subsection 7(1.1) - Employee stock options
Cases
Wiebe v. The Queen, 87 DTC 5068, [1987] 1 CTC 145 (FCA)
A stock option agreement which the trial judge found to have been in place in 1972 or 1973 was held to have been so radically altered in its terms in 1977, that in that year it should be regarded as a new agreement, with the result that the agreement should be regarded as coming into being after 31 March 1977. The changes consisted of requiring the employee, as a condition to acquiring the shares: (1) to guarantee indebtedness of the employer; and (2) to execute a buy-back agreeement.
Administrative Policy
21 October 1996 T.I. 5-963321 -
"Where an employee stock option is transferred by the employee to a non-arm's length person such as an RRSP under which the employee is the annuitant, recognition of any benefit under section 7 of the Act is not made in accordance with paragraph 7(1)(a) of the Act but under 7(1)(c) if the option is exercised by the RRSP. Accordingly, subsection 7(1.1) of the Act can not apply to defer taxation of the amount."
28 July 1992 T.I. (Taxation of Executive Compensation and Retirement, November 1992, pp. 682-683)
The preferential rules for a Canadian-controlled private corporation will be applicable after the corporation becomes a public corporation only in relation to rights under the employee stock option plan that had vested in the employee at the time the corporation became a public corporation.
28 May 1990 T.I. (October 1990 Access Letter, ¶1450)
S.7(1.1) will be available to an employee under a plan who can elect to receive either cash or shares as a year-end bonus, and he elects to receive shares.
Subsection 7(1.3) - Order of disposition of securities
Administrative Policy
Income Tax Technical News No. 19, 16 June 2000
Under "Change of Position in Respect of GAAR - Section 7".
15 October 1997 T.I. 972531
Where an employee/shareholder owns shares of a CCPC which have a nominal adjusted cost base and subsequently acquires shares under a stock option arrangement, subsequent dispositions by the employee of shares will be deemed to come first out of the original shareholding, with the result that the realization of an employment benefit under s. 7(1.1) (and of a corresponding addition to ACB) will be deferred.
25 October 1999 T.I. 990956
Discussion of the order of disposition of identical shares, some acquired under option and some not, for the purposes of s. 7.
Subsection 7(1.4) - Exchange of options
Administrative Policy
7 May 2015 T.I. 2015-0570801E5 - Exchange of Stock Options-7(1)(b) Applies
An exchange of s. 7 stock options of an employee on Target shares for options on Buyer's shares does not qualify under s. 7(1.4). CRA indicated that the exchange gave rise to a s. 7(1)(b) benefit but that the new options had a cost based on the value of the exchanged options - perhaps implying that such cost could be deducted on a subsequent surrender of the new options. See summary under s. 7(1)(b).
2 December 2014 Folio S4-F7-C1
1.81 Subsection 87(5) does not apply where an employee holds rights under an agreement to acquire shares of a predecessor corporation and subsection 7(1) is applicable to such right, because the right will not constitute capital property of the employee. However, by virtue of subsection 7(1.4), no benefit arises under paragraph 7(1)(b) when such a right is exchanged by the employee for a right to acquire a share of the new corporation or of a corporation with which the new corporation does not deal at arm's length provided that the fair market value of the new option does not exceed the fair market value of the old option.
2009 Ruling 2009-0338731R3
underline;">: Overview. Public company spin-off butterfly by DC of Spinco including splitting of stock options..
Option exchange
DC had an option plan under which it had granted stock options some of which included "tandem share appreciation rights" (which permitted the option holder to surrender a vested stock option in exchange for a cash payment equal to the "in the money value" of the option thereby extinguishing the holder's option). Under the butterfly reorganization those options were exchanged for options to acquire shares of Spinco and new options to acquire shares of reorganized DC (a.k.a., New DC), corresponding to the division of assets between the two corporations. In the case of Spinco, its option plan enabled it to issue stock options with "attached tandem share appreciation rights". In the case of New DC, the ruling does not expressly refer to tandem share appreciation rights but the replacement options are issued under DC's existing plan, which includes such rights.
Ruling
The exchange of the existing options for new options of Spinco and New DC would be governed by s. 7(1.4). The ruling was conditioned on the new options of Spinco and New DC being the sole consideration for the disposition of the old options and the old options being cancelled. Although the tandem share appreciation rights are not expressly addressed, the ruling in effect treats the tandem share appreciation right as part of the option itself.
2004 Ruling 2004-005817 -
Ruling that the rules in ss. 7(1.4)(d) to (f) will apply where an Optionee exchanges his or her existing options for a Substituted Right (with further provision that if an Optionee elects to exercise his or her options, the company may, in its discretion, require the Optionee to exchange his or her options for Substituted Rights).
7 October 1997 T.I. 972427
RC followed Amirault v. MNR, 90 DTC 1330 (TCC) in indicating that a reduction in the exercise price for an employee stock option would not represent a disposition.
1997 Ruling 9716083
The addition of dividend equivalent rights to stock options received on a merger would constitute additional rights for purposes of s. 7(1.4).
27 March 1992 T.I. (Tax Window, No. 18, p. 16, ¶1840)
The 1991 amendment to s. 7(1.4) eliminated the requirement that a corporate reorganization take place in order for the subsection to apply.
25 September 1991 Memorandum (Tax Window, No. 9, p. 10, ¶1471)
S.7(1.4) does not apply in a takeover situation where stock options of the target are exchanged for stock options of the acquiring company and the target company is then dissolved, if the acquiring company deals at arm's length with the target immediately after the exchange and the arrangement involves no amalgamation or a merger.
Articles
Eva M. Krasa, "Exchange of Stock Options Under Subsection 7(1.4): Some Unexpected Issues", Taxation of Executive Compensation and Retirement, Vol. 20, No. 6, February 2009
Includes discussion of effect on valuation test of an increase in value of Acquireco shares subsequent to agreement date, earn-out; multiple exchanges of the options in question; and acquisitions by mutual fund trust.
K.A. Siobhan Monaghan, "Reorganization of Stock Options in the Context of a Dividend-in-Kind", Corporate Structures and Groups, Vol. IV, No. 4, 1997, p. 232.
Subsection 7(1.5) - Rules where securities exchanged
Administrative Policy
20 March 2001 T.I. 2001-007144
S.7(1.5) is not available where the proceeds for the exchange of shares include a put right, even if the put right has nominal value. Accordingly, s. 7(1.5) is not available on exchanging shares for exchangeable shares.
23 March 1995 T.I. 5-950040
Where an individual transferred his shares of an CCPC to his holding company, the fact that he elects an amount under s. 85(1) greater that the ACB of the transferred shares does not affect the operation of s. 7(1.5).
13 October 1994 T.I. 5-942547
RC intimated that it would be prepared to apply its position that s. 85.1(1) applies to some transfers where non-share consideration also is received, to s. 7(1.5).
2 December 1993 T.I. 933266 (C.T.O. "Adjustments to ACB of Section 7 Shares")
S.7(1.5) will apply where an employee elects under s. 85(1) to be deemed to receive proceeds of disposition of the share in excess of its ACB.
There will be an increase to cost base under s. 53(1)(j) where new shares acquired as described in s. 7(1.5) are later sold or exchanged.
19 February 1992 T.I. (Tax Window, No. 16, p. 12, ¶1756)
By virtue of s. 7(1.5)(g), the rules in s. 7(1.5) will apply to reorganizations involving more than one exchange of shares.
9 January 1992 T.I. (Tax Window, No. 15, p. 19, ¶1691)
Relief of the type described in s. 7(1.5) is not available to a transfer to which s. 85(1) applies.
21 September 1990 T.I. (Tax Window, Prelim. No. 1, p. 5, ¶1001)
The favourable treatment accorded under s. 7(1.1) will apply if there has been both a share-for-share exchange and an amalgamation.
86 C.R. - Q.65
S.86 was knowingly excluded.
Articles
Firoz Ahmed, "Treatment of Employee Stock Options in Corporate Reorganizations", Canadian Current Tax, Vol. X, No. 3, December 1999, p. 23.
Dunbar, "Draft Tax Amendments Correct Technical Deficiencies in Stock Benefit Provisions", Taxation of Executive Compensation and Retirement, September 1990, p. 330.
Subsection 7(2) - Securities held by trustee
Cases
MNR v. Chrysler Canada Ltd., 92 DTC 6346 (FCTD)
After finding (below) that the Chrysler employee stock ownership plan was both an employee benefit plan and an agreement to issue shares to employees within the meaning of section 7, Strayer J. found that section 7 had "priority" over paragraph 6(1)(g).
Re MNR and Chrysler Canada Ltd., 91 DTC 5526 (FCTD)
Chrysler (U.S.) contributed treasury shares to a trust for the benefit of its employees and those of Chrysler Canada. Chrysler Canada reimbursed Chrysler (U.S.) for the shares contributed for the benefit of Chrysler Canada's employees. The trustee allocated the shares notionally to employees, reinvested dividends and further shares which are similarly allocated and at the termination of the plan (which occurred some seven years later) distributed the shares or cash proceeds thereof.
Subject to any further argument on how to resolve any conflict between the two sets of provisions, this arrangement was held to entail both the issue of shares as described in ss.7(1) and (2), and an employee benefit plan as described in s. 248(1). After noting that Canadian employees agreed to make wage concessions partly in return for right of participation in the plan, Strayer J. stated (p. 5531):
"I can see no reason why the 'agreement' referred to cannot be an oral agreement or an implied agreement - even an implied agreement based on a collective bargaining arrangement ..."
Administrative Policy
3 May 1994 T.I. 940975 (C.T.O. "Tax Adjustment for Forfeiture Under Stock Option")
S.7(2) deems an employee to have acquired a share at the time a trustee commences to hold it for the employee, even if the employee's entitlement is not vested. On the occurrence of forfeiture, the employee will realize a capital loss based on a disposition of the shares for nil proceeds.
Articles
Ian MacDonald, "Trusts Holding Employee Shares - After the Initial Transfer", Taxation of Executive Compensation and Retirement, Vol 22, No.10, June 2011, p. 1415:
There are a number of indicators which suggest that an s. 7(2) trust is not governed by various employee benefit plan rules.
Subsection 7(3) - Special provision
Paragraph 7(3)(a)
See Also
Rogers v. The Queen, 2015 DTC 1029 [at 124], 2014 TCC 348
The taxpayer, who was the CEO of a Canadian corporation ("RCI") whose voting and non-voting shares both traded on the TSX, did not deal at arm's length with RCI as he held over 90% of its voting shares. RCI issued stock options to the taxpayer in 1997 pursuant to the RCI employee stock option plan, and in 2007 attached a share appreciation right ("SAR") to all previously granted options, permitting the holder to cash surrender options for their in-the-money value. The taxpayer exercised the SAR in 2007, and reported a capital gain.
Hogan J found that s. 7(3)(a) applied to preclude a benefit under s. 6 (as assessed by the Minister), stating (at paras. 38-39):
[T]his provision [s. 7] is meant to provide a complete code for the taxing of benefits arising under or because of a stock option agreement. … If the carve‑out in section 7(3)(a) is interpreted in a narrow fashion, as the Respondent argued it should be – that is it only applies if the benefit is subject to tax under subsection 7(1) of the Act – it would mean that a non-arm's length transfer could become immediately taxable notwithstanding the fact that section 7 specifically provided that this should not be the case.
In the result, the taxpayer received the benefit as a capital gain (see summary under s. 39(1)).
Mathieu v. The Queen, 2014 TCC 207
In successive years, the taxpayer cash-surrendered employee stock options to the corporation ("Forages Garant") which had granted the options. Paris J found that the taxpayer was related to his wife from whom he was legally separated but not divorced. Accordingly, he was a member of a related group which controlled Forages Garant, which meant that his stock option surrender benefits were not taxable under s. 7(1)(b).
In rejecting a Crown submission that the option surrender benefits were taxable under s. 6(1)(a), Paris J stated (at para 77, TaxInterpretations translation) that "the principle of generalibus specialia derogant applies and subsection 7(3) deflects the application of the general provision," that the provisions of s. 7(3)(a) "are clear and unequivocal" (para. 79) and that "it is evident that the [subsequent] addition of paragraph 7(1)(b.1) effected a change to section 7 and not a clarification" (para. 85). Accordingly, the benefits were not taxable.
Ward v. The Queen, 98 DTC 2097 (TCC)
Shares issued to the taxpayer were found to be in satisfaction of consulting fees owed to him that had been written off by the corporation in question on its books, rather than being received by him by virtue of his employment with the corporation, based on a finding that the consulting fees would not have been written off had the shares not been issued to him, and given that the records of the corporation did not show him to have become an employee of the corporation until subsequently (although he was a director). Accordingly, the value of the shares received by him was includible in his income under s. 9, or under s. 5(1) by virtue of the application of s. 6(3)(b), and the benefits of the application of s. 7(1.1) were not available to him.
Aylward v. The Queen, 87 DTC 1097 (TCC)
Before concluding that s. 7(1.1) governed the issuance of shares to the taxpayer, Margeson TCJ. found that they were issued to the taxpayer in respect of his former employment with the issuer and that there was no requirement under s. 7 that the taxpayer be an employee of the company at the time of the granting of a stock option or at the time of its exercise.
Although there was no formal agreement for the issuance of the shares, there is nothing in the word "agreed" that suggested that "a formal contract in the sense of an offer and acceptance" is required (p. 1108).
Administrative Policy
2004 Ruling 2004-005692 -
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.
2004 Ruling 2004-005692 -
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.
2002 Ruling 2001-010761
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.
16 February 2001 Memorandum 2000-005365
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."
10 May 2001 T.I. 2001-007568 -
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.
26 June 2000 T.I. 2000-001820
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.
10 August 2000 T.I. 2000-001687 -
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.
18 February 1999 Memorandum 990081
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).
6 December 1995 T.I. 952703 (C.T.O. "Taxation of Benefit of Employee Share Offering")
"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."
Paragraph 7(3)(b)
Cases
The Queen v. Placer Dome Inc., 92 DTC 6402 (FCA)
In finding that an employee stock purchase plan (under which employees contributed up to 6% of their salary and the taxpayer and its affiliated companies then were obligated to contribute an amount equal to 1/2 of each employee's contribution) was governed by s. 7(1)(a), with the result that s. 7(3) applied to deny a deduction to the taxpayer (except to the extent that the taxpayer's contribution to the plan was not returned to it in the form of a share subscription), Marceau J.A. stated (p. 6410):
"Based on the following facts: that the trustee is merely a conduit through which the employer administers the Plan; that the employees never receive money or money's worth until termination or withdrawal and, even then, never from the employer directly; and, that the funds payable by the employer to the trustee each month have a predetermined destination and never fall under any real control or genuine power of the employees or the trustee, it must be concluded that the true benefit the employees acquire by their participation in the Plan is not the entitlement to an additional remuneration but the entitlement to a credit for shares of Placer at two-thirds of their market value."
Kaiser Petroleum Ltd. v. The Queen, 90 DTC 6034 (FCTD), rev'd 90 DTC 6603 (FCA)
In an agreement between the U.S. parent of the taxpayer and Kaiser Resources Ltd. for the sale of shares of the taxpayer to Kaiser Resources Ltd. for $33.50 per share, it was agreed that the U.S. parent would cause the taxpayer to obtain the cancellation of outstanding employee stock options on the shares of the taxpayer on the payment by the taxpayer of the difference between the exercise price per share and $32.50 per share. Before finding that the payment of such amounts by the taxpayer in consideration for the cancellation of the options was deductible notwithstanding s. 18(1)(b) on ordinary principles, Joyal J. implicitly accepted the submission of the taxpayer's counsel that s. 7(3) "has no application as no issue of shares took place" (p. 6036).
See Also
Transalta Corporation v. The Queen, 2012 DTC 1106 [at 3044], 2012 TCC 86
Near the beginning of each year, the taxpayer would notify each of its executives that an award of units (within a specifed range) would be made to the executive in respect of the three-year compensation period commencing with that year, which would then be used to determine, within 120 days after the end of that compensation period, the bonus that would be paid to the executive in respect of the compensation period. Bonuses were paid at the option of the taxpayer in cash or shares with full stated capital.
Margeson J. found that the taxpayer's deduction of the amount of the bonuses which were paid in treasury shares was not barred under s. 7(3)(b) because such shares were not paid or issued pursuant to an "agreement." The word "agreement" in s. 7 refers only to legally binding agreements, meaning contracts. There was no "meeting of the minds" that could have led to the formation of a bilateral contract (para. 71), nor did the employees do or refrain from doing anything specified in an offer for a unilateral contract (para. 86). The implicit notion that the bonuses would be earned through superior work performance was not enough to constitute an offer (para. 85). Even if there had been an agreement to pay bonuses, they could have been paid entirely in cash, so there was no agreement to issue securities.
Administrative Policy
ATR-64
Ruling that s. 7(3)(b) would not apply to an arrangement under which bonuses are paid no later than the end of the third calendar year after the particular year of service through the transfer to the employee of shares of the employer (whose number, before taking into account a notional dividend reinvestment feature, is specified at the time of the grant of the bonus), given that the shares are purchased at the time of payment through broker rather than being issued by the employer.
18 March 2004 Memorandum 2004-005531
S.7(3)(b) will not deny the employer a deduction where under a stock option plan, an employee elects to be paid in cash and uses the cash proceeds to acquire shares namely, flow-through shares) of the employer that are different from the shares that could have been acquired under the stock option.
14 November 2000 T.I. 2000-004835 -
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."
1999 Ruling 990259 [use of employee bond to acquire foreign parent share at initial value]
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 relting to the tax rules in teh 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, put and call agreements with a non-resident corporation ("Putcallco") under which 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.
18 February 1999 Memorandum 990081 [non-deductibility of reimbursements by Cdn employer to US parent]
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).
Income Tax Technical News, No. 7, 21 February 1996
Where under an employee stock option plan, the employee has the option to receive cash instead of shares, s. 7(3)(b) will not deny a deduction by the employer of a resulting cash payment because no shares will have been sold or issued under the plan.
1995 Institute of Chartered Accountants of Alberta Round Table, Q. 9 (9511740)
In RC's view, it is not appropriate for cash that an employee elects to receive in lieu of exercising a stock option to be eligible for the deduction under s. 110(1)(d), with the employer at the same time being entitled to a corresponding deduction. Accordingly, this matter is under study by RC and Finance.
20 January 1994 T.I. 940075 HAA4735-1 [purchase of employer shares under EPSP]
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).
92 C.R. - Q.47
In response to the decision in the Placer Dome case, RC is undertaking a complete review of its practices whereby treasury shares of the employer are acquired by employees or employee stock purchase plans.
92 C.R. - Q.45
A payment by a Canadian subsidiary to its U.S. parent to compensate the U.S. parent for the participation of employees of the Canadian subsidiary in a U.S. stock option plan, would not be deductible on computing the Canadian subsidiary's income.
4 May 1992 Tax Executive's Round Table, Question 10 (December 1992 Access Letter, p. 48)
S.7(3)(b) will not deny a deduction in computing the income of a corporation in respect of a cash payment which an employee elects to receive in lieu of exercising his stock option.
21 November 1991 T.I. (Tax Window, No. 15, p. 16, ¶1672)
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.
Articles
MacKnight, "Pyrrhic Policy: Fixing the Phantom Loophole in Paragraph 7(3)(b)", 1993 Canadian Tax Journal, No. 3, p. 429.
Subsection 7(4) - Application of s. (1)
Cases
Hurd v. The Queen, 81 DTC 5140, [1981] CTC 209 (FCA)
Where an individual was granted a stock option by reason only of his employment by the grantor company, he will realize taxable employment income in the year that the option is exercised notwithstanding that in that year he (1) is no longer an employee of the company (s.7(4)) and (2) is no longer a resident of Canada. Respecting the second point, the reference in S.2(3) to "a previous year" makes it clear that the duties of employment need not be performed in Canada in the year in which the benefit is sought to be taxed.
Administrative Policy
26 November 1992 T.I. 912281 (September 1993 Access Letter, p. 405, ¶C5-213)
A Canadian employee who exercised an employee stock option after becoming a non-resident of Canada would be taxable in Canada on the benefit subject to the provisions of any tax convention.
Articles
Tobias, "Taxing Benefits Realized by Former Canadian Residents", Taxation of Executive Compensation and Retirement, March 1994, p. 889
The author argues that Canada has no right to tax the benefit resulting from the exercise or realization of employee stock options on shares of non-Canadian corporations with no connection to Canada if such options are exercised after the employee has departed Canada and has established residence in a treaty jurisdiction and the individual is present in Canada in the year of exercise or realization for less than 183 days.
Subsection 7(5) - Non-application of this section
Commentary
The provisions of s. 7 do not apply to a benefit conferred by an agreement if it was not "received in respect of, in the course of, or by virtue of" the employment. The quoted phrase has also been interpreted in the context of [pin type="page" href="162"]s. 6(1)(a)[/pin].
Even if an individual is a director or employee of a corporation at the time that it grants stock options to him or her, the resulting benefit may be found not to have been received by virtue of his or her employment. For example, the grant of options to the taxpayer and other individuals may not be correlated in any way with the extent of the individuals' duties (if any) as employees or directors ([pin type="node_head" href="133-Grohne"]Grohne[/pin], [pin type="node_head" href="133-Bernstein"]Bernstein[/pin] cf. [pin type="node_head" href="133-Scott"]Scott[/pin], [pin type="node_head" href="133-DelGrande"]Del Grande[/pin]).
Cases
Scott v. The Queen, 94 DTC 6193 (FCA)
The taxpayer, who was the Director and Secretary-Treasurer of a public corporation ("Night Hawk") and whose work as corporate secretary (for which he received no remuneration) of advising directors of meetings, taking minutes and preparing directors resolutions etc. was usual work of a corporate secretary, was issued stock options by Night Hawk and exercised them at a gain.
The Court affirmed the finding of the Trial Judge that the options were granted to the taxpayer in respect of, in the course of, or by virtue of his "employment" with Night Hawk notwithstanding that the taxpayer was an employee of a corporation ("Delsco") which provided significant managerial services of the taxpayer to the Night Hawk group (who provided such services to the group on close to a full-time basis). The award of stock options to the directors were proportined to the degree of time and effort they devoted to the affairs of Night Hawk, and they received no other direct compensation. Furthermore, and notwithstanding the form of the agreements with Delsco, there was evidence to support the finding of the trial judge that in substance the taxpayer was a Night Hawk employee independently of his position of (an ostensibly unpaid) director and officer of Night Hawk. Accordingly, the taxpayer was taxable under s. 7(1)(a) when he exercised his options.
Grohne v. The Queen, 89 DTC 5220 (FCTD)
The taxpayer, along with other promoters of a company, entered into a "standby agreement" whereby they agreed to purchase shares of the company for 25¢ per share to the extent that shares pursuant to a rights offering by the company were not fully subscribed for. At the time the taxpayer acquired shares pursuant to the standby agreement, the market price was well in excess of the 25¢ per share paid by him.
Strayer J. held that the taxpayer received this advantage by virtue of being a promoter of the company rather than by virtue of being its president and a director, in light of the fact that all five promoters of the company had equal rights and obligations under the standby agreement irrespective of any of their employment duties, and in light of the fact that the taxpayer had no regular duties or remuneration as an employee.
Busby v. The Queen, 86 DTC 6018, [1986] 1 CTC 147 (FCTD)
It was found that the taxpayer received stock options in two mining companies as a result of her close personal relationship with a German businessman and, to a lesser extent, as a result of her agreement to guarantee some loans, and not by reason of her part-time employment at the German businessman's management company.
Bernstein v. MNR, 77 DTC 5187, [1977] CTC 328 (FCA)
The two beneficial shareholders of a company ("Highland") each received an option, and exercised that option, to purchase redeemable preference shares of a subsidiary of Highland for $200, and then received the sum of $100,000 when those shares were redeemed. It was held that they did not receive their options by virtue of their employment with Highland, but rather in their capacities as shareholders, in light of their substantial salaries as officers, the fact that other valuable employees did not receive the stock options and their desire to devise a scheme to extract the earnings of Highland in a fashion that minimized tax. (S.83A(7) of pre-1972 Act.)
See Also
Del Grande v. The Queen, 93 DTC 133 (TCC)
In finding that any benefit received by the taxpayer as a result of the granting or exercise of options would have been received more by virtue of being an officer and director rather than by virtue of being a shareholder, Bowman J. stated (p. 138):
"... the option agreements refer to his contribution to the business and affairs of the companies. The options are exercisable only while he is an officer or director of the companies. In other words the granting and exercise of the options may have been connected with his position as an officer and director but they are in no way connected with his being a shareholder."
Administrative Policy
6 September 1994 T.I. 5-942052 -
Options are received by a director in respect of an employment where the options were granted to the director in consideration for the services to be performed as director.
Subsection 7(6) - Sale to trustee for employees
Administrative Policy
14 November 2013 T.I. 2013-0500641E5 - Subsections 7(6) and 153(1) - Withholding
Under an arrangement described in s. 7(6), does obligation to withhold tax rests with the corporation/employer or the s. 7(6) trust? CRA stated:
[T]he arrangement is deemed to be a section 7 agreement to issue shares. Accordingly…the corporation is paying the section 7 employment benefit as remuneration for purposes of paragraph 153(1)(a) and therefore, the corporation has the obligation to withhold and remit the appropriate amount of tax.
Before so concluding, CRA summarized s. 7(6) as follows:
[S]ubsection 7(6) provides that where a corporation has entered into an arrangement where the corporation's shares are issued or sold to a trustee to be held for sale to the corporation's employees, for purposes of section 7 and paragraphs 110(1)(d) and (d.1), the following apply:
(i) the arrangement is deemed to be a section 7 agreement to issue shares between the corporation and the corporation's employee;
(ii) shares acquired under the arrangement are deemed to be acquired under the section 7 agreement, and
(iii) amounts paid to the trustee under the arrangement by the employee are deemed to be paid to the corporation under the section 7 agreement.
Subsection 7(9)
Articles
K.A. Siobhan Monaghan, "Amendments to Stock Option Rules - The New Deferral of Section 7 Benefits", Corporate Structures and Groups, Vol. VI, No. 4, p. 336.
Subsection 7(11)
Administrative Policy
21 February 2002 T.I. 2001-010965
Given that the 13 July 2001 comfort letter of Finance dealing with a reduction in the option price of employee options discusses only the application of s. 110(1)(d) and not s. 7(11), in the repricing situation the specified value for purposes of s. 7(11) is based on the fair market value of the security at the time the option was granted to the employee and not the fair market value at the time the option was repriced.
Commentary
Ss. 7(1)(a) to (e) stipulate various rules that apply where a corporation has agreed to issue shares to an employee of it or another corporation with which it does not deal at arm's length (an "option agreement"). Similar rules apply to mutual fund trusts (see s. 7(7)).
Under s. 7(1)(a), the employee is deemed to have received a benefit from his or her employment at the time that he or she acquires shares under the option agreement (unless, in the case of the exercise of an option agreement by an arm's length employee to acquire shares of a Canadian-controlled private corporation, the recognition of this benefit is deferred until the time that the employee disposes of the shares). The amount of the benefit is equal to the "value" of the shares at the time of their acquisition by the employee minus the exercise price, i.e., the amount paid by by employee under the option agreement to acquire the shares. (In the unusual circumstance where the employee has paid an amount to acquire the option agreement, the amount of the computed benefit is correspondingly reduced.) The amount of the computed benefit then is included in the employee's income under s. [pin type="page" href="162"]6(1)(a)[/pin].
These rules apply in the same manner to options of an employee to acquire shares of a non-resident corporation, even if the employee was not resident in Canada and was employed outside Canada at the time he or she received the stock options in respect of his or her employment ([pin type="node_head" href="133-Tedmon"]Tedmon[/pin]).
The word "value" in s. 7(1)(a) is essentially synonymous with "fair market value" ([pin type="node_head" href="133-Steen"]Steen, IC 89-3[/pin]).
Although we utilize the term "option agreement" to reference the agreement of the employer to issue shares, it has been stated that the terms "agree" and "agreement" are not technical expressions (but cf. Statutory Interpretation, "[pin type="page" href="1868"]Ordinary meaning[/pin]"), so that, for example, an option embedded in the terms of a convertible debenture issued by the employer also would be sufficient to engage the application of s. 7 ([pin type="node_head" href="133-Mansfield"]Mansfield[/pin]). Similarly, it has been stated that no formal contract is required in order to engage the application of s. 7 ([pin type="node_head" href="133-Aylward"]Aylward[/pin]).
For the purposes of s. 7(1)(a), the time at which the employee acquired shares under an option agreement has been determined as being the time at which the shares which he contracted to acquire were validly issued to him. Accordingly, the employee has been found not to have acquired shares where his option was to acquire "freely trading shares" and at the time in question the employer was not yet capable of issuing freely tradeable shares ([pin type="node_head" href="133-Clemiss"]Clemiss[/pin]), where the shares supposedly acquired by him would be forfeited upon failure to pay the exercise price ([pin type="node_head" href="133-Gesser"]Gesser[/pin]), or where the taxpayer had not yet paid the exercise price for shares purportedly issued to him ([pin type="node_head" href="133-Ball"]Ball[/pin]) . Although under most or all corporate statutes, shares are not validly issued until they are fully paid for, in one case it was found that an employee had acquired shares of a trust company when there was a binding agreement for him to acquire them, notwithstanding that he did not fully pay for them at that time ([pin type="node_head" href="133-Grant"]Grant[/pin]).
The acquisition of shares by a nominee will not give rise to a taxable benefit to the nominee ([pin type="node_head" href="133-Williams"]Williams[/pin], [pin type="node_head" href="133-Bertram"]Bertram[/pin] cf. [pin type="node_head" href="133-Stafford"]Stafford[/pin]).