In Transalta v. The Queen (2012 DTC 1106) ("Transalta"), the Tax Court of Canada concluded that for the stock option rules in section 7 of the Income Tax Act (the "ITA") to apply there must be a "legally binding agreement" by the corporate employer to issue shares to the employee. Following the decision in Transalta, the Canada Revenue Agency (the "CRA") received inquiries from its auditors on the meaning of "agreement" for purposes of section 7 and paragraph 110(1)(d). In CRA technical interpretation 2016-0641841I7, September 19, 2016, the CRA addresses those inquiries.
Discretionary Share Bonus Plan
The CRA states that a discretionary share bonus plan is not considered a legally binding agreement for purposes of the stock option rules because the employer corporation's commitment is fully discretionary. The CRA describes a discretionary share bonus plan similar to the plan considered in Transalta. Under that plan, at the beginning of a three-year period, a participating employee is advised by the corporate employer of the maximum number of shares that can be earned as a bonus for the period. The employee does not have to meet any performance conditions to be entitled to the bonus. At the end of the period, the corporation has discretion regarding the amount of the bonus and the form of payment: whether to issue shares from treasury or pay a cash bonus. The CRA states that because the employer corporation's commitment is fully discretionary, the arrangement does not give rise to a legally binding agreement for the purposes of section 7 of the ITA.
The CRA similarly states that a fully discretionary stock bonus plan without a cash option will also fall outside of section 7 where the grant of the options and issuance of the shares is made concurrently. The CRA, however, states that if the grant of the options occurs at a different time from the eventual issuance of the shares and the issuance of the shares is subject to time or "other objective vesting conditions", section 7 would apply. In other words, although the initial decision of the employer corporation to grant the options is fully discretionary, once the options are granted, the employee would have a legally enforceable right to acquire the shares at a future date conditional on satisfying the vesting conditions.
Employee Stock Options and Notice
The CRA states that where a corporation grants an employee options to acquire shares that are exercisable only when the employee receive notice from the corporation, a legally binding agreement arises only after the corporation sends the employee such notice specifying the number of shares he/she may exercise.
The CRA explains that before receiving the notice, the employee has no enforceable right to acquire the shares and the corporation has no obligation to issue the shares. As a result, the employee would not be entitled to a deduction under paragraph 110(1)(d) if the share price increases between the date of the grant of the options and the date of the notice.
Lesson to be learned
Careful consideration and detail by must be given by tax advisors and counsel to structuring and documenting their clients' stock bonus/option plans in order to ensure such plans fall within Section 7 of the ITA.
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.
