Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Non-Arm’s Length Stock Options Transfers Marie-Emmanuelle Vaillancourt and Alan Shragie “Non-Arm’s Length Stock Options Transfers” by Marie-Emmanuelle Vaillancourt and Alan Shragie Davies Ward Phillips & Vineberg, LLP The tax treatment of employee stock options is principally governed by section 7 of the Income Tax Act (Canada) (the “Act”), which sets out the timing of when the employment benefit should be realized in various scenarios.1 For example, the assignment of an option to an arm’s length third-party results in an immediate income inclusion for the employee.2 Furthermore, it is generally understood that a transfer to a person with whom the employee is not dealing at arm’s length is taxable only at the time of the exercise of the options (or the transfer of same to a thirdparty) by the non-arm’s length transferee.3 It appears, however, that certain taxpayers were filing their tax returns on the basis that section 7 did not apply in two different cash-out scenarios, which prompted confusing statements from the Minister of Finance in the last Budget (as discussed in more detail below). The first situation involves the cash-out of options by an employee who does not deal at arm’s length with the employer at the time of the cash-out. In the second scenario, the options are first transferred by the employee to a non-arm’s length person and the transfer is followed by a cash-out of the options by the transferee. Employee and Employer Not Dealing at Arm’s Length Paragraph 7(1)(b) determines the tax treatment of cash-outs where the employee and the employer deal at arm’s length and requires the amount to be included in the employee’s income at the time of the cash-out. As for paragraph 7(1)(c), which applies to transfers between nonarm’s length persons, it requires that the rights of the employee under the stock option agreement be “vested in a person who has acquired securities under the agreement”. On the cash-out of options by a non-arm’s length employer, the options are cancelled and it could be argued, therefore, that the options do not “vest in a person who has acquired securities under the agreement”. If section 7 does not apply to a cash-out between an employee and an employer not dealing with each other at arm’s length, the question is whether any benefit arising from the cash-out is taxable under another provision of the Act, for example paragraph 6(1)(a). Pursuant to subsection 7(3), an employee is deemed not to have received or enjoyed a benefit under or because of a stock option agreement, except as provided for in section 7. The wording of subsection 7(3) appears to be broad enough to argue that if section 7 does not apply, any benefit arising from a stock option is exempt from tax. 1 All statutory references herein are to the Act. 2 Paragraph 7(1)(b) of the Act. 3 Paragraphs 7(1)(c) and 7(1)(d) of the Act. It should be noted, however, that if the employee has passed away at the time of exercise, the transferee is taxed on the employment benefit, not the estate. Mtl#: 1766420.3 -2Cash-out By Non-Arm’s Length Transferee As explained above, an employee who has transferred his or her options to a non-arm’s length person is generally taxable on any benefit arising therefrom at the time of the exercise of the options by the transferee (or transfer of the options by the transferee) under paragraph 7(1)(c) or (d), as the case may be. However, for paragraph 7(1)(c) to apply, the transferee must acquire “securities”, which is not the case where the transferee cashes-out the options. As for paragraph 7(1)(d), it applies where the non-arm’s length transferee “disposed of rights under an agreement to another person […]” (emphasis added). Even if one views the options as being disposed of upon the cancellation of the options, it is arguable that the options have not been disposed of to a person and thus, paragraph 7(1)(d) does not apply to the cash-out because the options are not being acquired by anyone.4 If neither paragraph 7(1)(c) nor paragraph 7(1)(d) applies, the employee can again rely on subsection 7(3) to argue that any benefit arising from the cash-out is not taxable under the Act as a whole. Budget 2010 The tax measure section of the 2010 federal Budget indicates that the Act will be amended “to clarify that the disposition of rights under a stock option agreement to a non-arm’s length person results in an employment benefit at the time of disposition (including cash-out)”. Clause 24 of The Notice of Ways and Means Motion provides that subsection 7(1) of the Act shall be clarified to ensure that it applies “in circumstances in which an employee […] disposes of rights […] to a person with whom the employee does not deal at arm’s length”. Although meant as a “clarification”, these broad statements create ambiguity. A plain reading could lead to the conclusion that the transfer of an option by an employee to his personal holding company, for example, would be subject to tax at the time of the transfer rather than at the time of exercise. Yet, the current wording of paragraph 7(1)(c) of the Act is clear: the transfer of options to a non-arm’s length person does not trigger immediate taxation. Is this a policy change or an overly broad statement? Discussions with representatives of the Minister of Finance indicate that the intention is not to tax the employee on the transfer of his or her options to a non-arm’s length person and that the Budget statements were meant for cash-out situations only. Proposed legislation confirming this position should be released this summer. Based on the foregoing comments from the Department of Finance, it appears that the uncertainties created by the Budget in respect of the taxation of stock options are benign but such lapses highlight that statements contained in a budget must be handled with care. 4 This argument is supported by the fact that there is no equivalent to subsection 7(1.7) that would deem such a disposition to be in favour of another person. Subsection 7(1.7) provides that even if there is no disposition at law, the cancellation of a stock option agreement is deemed to result in a disposition of the employee’s rights under the agreement to an arm’s length person for purposes of paragraph 7(1)(b) (overruling Buccini v. The Queen, 2000 DTC 6685 (FCA)). See also, a contrario, subsection 84(9), which specifies that a shareholder is deemed to have disposed of shares redeemed or cancelled to the corporation proceeding to the redemption or cancellation. Mtl#: 1766420.3