Principal Issues: [TaxInterpretations translation] (1) Did the taxpayer receive only shares as consideration for certain shares held by the taxpayer under a stock option plan? (2) Is the ACB calculation on the certificate of compliance by virtue of section 116 properly determined?
Position: (1) Yes (2) Yes
Reasons: (1) The contract for the sale of the shares is sufficiently explicit to conclude that certain shares were sold solely in exchange for other shares. (2) Consideration must be given to all shares disposed of and the ACB must be determined taking into account the benefits taxable under section 7, whether the benefit is realized or deferred under paragraph 7(1.1).
February 9, 2010
Laval Tax Services Office Headquarters Specialized Audit Income Tax Rulings Directorate Attention: Mr. Richard Martel Michel Lambert,CA, M.Fisc. (613) 957-8968
2009-033357
XXXXXXXXXX
Tax treatment of a disposition of shares
This is further to your memorandum of July 16, 2009, regarding the application of subsection 7(1.5) in the specific situation described below.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
Names of the parties
XXXXXXXXXX Corporation A
XXXXXXXXXX Corporation B
XXXXXXXXXX Corporation C
XXXXXXXXXX Corporation A
Corporation C is the parent company of Corporation B.
Statement of Facts
1. Prior to the commencement of the transactions that are the subject of your request, Corporation A established two stock option plans for its employees. Since Corporation A is a Canadian-controlled private corporation, the provisions of subsection 7(1.1) apply when a plan participant exercises his or her options.
As part of the first plan that was implemented, employees received options to purchase Class A shares of Corporation A.
Under the second plan, Corporation A issued XXXXXXXXXX Class C shares to Trust A for an amount of $XXXXXXXXXX per share. Trust A is a trust of which all of the trustees are residents of Canada. Section XXXXXXXXXX of the trust indenture provides that the shares will subsequently be sold to employees of Corporation A pursuant to a stock option plan established by Corporation A. We understand from documents provided to us that the provisions of subsection 7(6) apply.
2. On XXXXXXXXXX, all employees exercised their options and acquired the Class A shares from Corporation A and the Class C shares from Trust A that they were permitted to acquire under their stock options. Following the acquisition, Corporation A issued to each employee a single share certificate for all Class A shares issued to the employee. It did the same with respect to the Class C shares.
3. On XXXXXXXXXX, after the employees acquired their shares, Corporation A reduced the paid-up capital of its Class A and Class C shares and paid an aggregate amount of $XXXXXXXXXX to all of its Class A and Class C shareholders. Each shareholder received a pro rata amount corresponding to the shareholder’s shareholding.
4. On the same day, after the paid-up capital reduction, the employees sold their Class A and Class C shares of Corporation A to Corporation B for an aggregate amount of U.S.$XXXXXXXXXX. According to clause XXXXXXXXXX of the Share Purchase Agreement (the "Agreement"), the purchase price of the shares was as follows:
An amount of U.S.$XXXXXXXXXX was paid in Corporation C shares in consideration for a number of Corporation A shares determined in accordance with the Agreement.
An amount of U.S.XXXXXXXXXX was paid in cash in consideration for a number of shares of Corporation A also determined in accordance with the Agreement.
5. Article XXXXXXXXXX of the Agreement reads in part as follows:
XXXXXXXXXX
Columns XXXXXXXXXX indicate for each employee the number of shares sold in consideration for Corporation C shares and columns XXXXXXXXXX indicate for each employee the number of shares sold for cash consideration.
6. With respect to the stock option plans under consideration, Corporation A intends to include on each employee's T4 slip, for the XXXXXXXXXX year, employment income equal to the amount required to be added to the employee's income under section 7 for shares that were sold for cash consideration, i.e., XXXXXXXXXX% of the shares held by each employee. However, no amount will be added to an employee's income in respect of the disposition of the shares that were sold in consideration for Corporation C shares.
Company A withheld Part I tax as salary, wages or other remuneration for the consideration paid in cash but did not withhold in respect of the consideration paid in shares.
7. Employees who participated in the stock option plans include XXXXXXXXXX individuals who are residents of the United States and one who is a resident of XXXXXXXXXX. The representative of these individuals filed Form T2062 - Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property.
For each of these individuals, the documentation accompanying this form indicates that the individual has no taxable capital gain from the disposition of all of the Corporation A shares acquired by the individual under the two stock option plans. To arrive at this conclusion, we are advised that the adjusted cost base (ACB) of the shares is determined by including the cost of the shares and the amount of the section 7 taxable benefit and deducting the amount of the paid-up capital reduction applicable to those same shares.
For purposes of determining the ACB of the Corporation A shares that were disposed of, the taxable benefit was calculated as if the individual had been taxed on a benefit arising from the sale of the shares for which the individual received cash and for which the individual received Corporation C shares.
Your Questions
8. You are asking whether the situation under review meets the requirements of paragraph 7(1.5)(b) and paragraph 17 of Interpretation Bulletin IT-113R4 (endnote 2) because the employees received both shares and cash on the disposition of the shares of Corporation A to Corporation B.
9. With reference to Technical Interpretation 2003-0003645 (endnote 3), you also wish to know whether the shares exchanged for the new shares of Corporation C can be clearly identified.
10. In addition, you asked whether the amount each employee received when the paid-up capital of the shares was reduced has the effect of making the shares sold ineligible under the rules in subsection 7(1.5).
Your Opinion
11. You did not express an opinion on the questions you asked us.
Vendor's Opinion
12. According to representatives of Corporation A, employees of Corporation A can avail themselves of the provisions of subsection 7(1.5) in respect of the exchanged shares for which the consideration is in shares and no withholding tax was required to be withheld under paragraph 153(1)(a) in respect of that consideration.
Our Opinion
Application of subsection 7(1.5)
13. Paragraph 17 of Interpretation Bulletin IT-113R4 (endnote 4) is substantially similar to subsection 7(1.5) and reads as follows:
“Subsection 7(1.5) provides that the provisions of paragraph 7(1)(a) and 110(1)(d) will not apply to the disposition of shares of a CCPC to which the provisions of subsection 7(1.1) apply where the shares are exchanged for new shares. Subsection 7(1.5) applies when the following conditions are met:
(a) the taxpayer disposes of or exchanges shares of a Canadian corporation that were acquired under a stock option agreement described in subsection 7(1.1);
(b) the taxpayer receives no consideration for the disposition or exchange of the old shares other than new shares from:
(i) the employer corporation,
(ii) a corporation with which the employer corporation does not deal at arm's length immediately after the disposition or exchange of the old shares,
(iii) the newly amalgamated or merged corporation, or
(iv) a corporation with which the newly amalgamated or merged corporation does not deal at arm's length immediately after the disposition or exchange of the old shares; and
(c) the fair market value of the new shares immediately after the disposition or exchange is not more than the fair market value of the old shares immediately before the disposition or exchange.
If the conditions described above are met:
- the taxpayer is deemed not to have disposed of or exchanged the old shares and not to have acquired the new shares;
- the new shares are deemed to be the same as and a continuation of the old shares, and the new shares are deemed to have been issued under the same stock option agreement, if any, as the old shares; and
- the corporation that issued the new shares is deemed to be the same corporation as and a continuation of the corporation that issued the old shares.”
Subsection 7(1.5) applies only for the purposes of section 7 and paragraphs 110(1)(d) to (d.1).
14. The first issue to be resolved is whether the employees received shares of a corporation referred to in subsection 7(1.5) as consideration for their Corporation A shares. Our understanding of the facts is that the employees received shares of Corporation C, which is the parent corporation of Corporation B. Since Corporation A, which is the employer, becomes a subsidiary of Corporation B, which in turn becomes a subsidiary of Corporation C, the shares obtained on the sale of Corporation A shares are shares of a corporation with which the employer does not deal at arm's length immediately after the disposition of the Corporation A shares. In our view, therefore, the Corporation C shares received by the employees are shares described in subsection 7(1.5).
15. The second issue is whether the employees only received shares as part of the series of transactions described in the statement of facts. The transactions were structured so that the employees disposed of XXXXXXXXXX% of their shares for Corporation C shares and XXXXXXXXXX% for cash consideration. In our view, section XXXXXXXXXX of the Agreement is explicit in this regard.
16. Referring to the provisions of paragraph 7 of Interpretation Bulletin IT-450 (endnote 5) and Technical Interpretation 2003-0003645 (endnote 6), you question whether the Corporation A shares being exchanged can be clearly identified.
Paragraph 7 of the Bulletin reads as follows:
“A vendor may receive shares of the purchaser for some of the exchanged shares and cash or other consideration for other exchanged shares. In these cases, subsection 85.1(1) may be utilized for the exchanged shares for which shares of the purchaser were received, as long as the vendor can clearly identify which shares were exchanged for cash or other consideration and which were exchanged for shares of the purchaser. Where the vendor receives shares and cash or other consideration for each exchanged share, subsection 85.1(1) may be utilized for the fraction of each exchanged share for which only share consideration was received, provided that the purchaser's offer clearly indicates that the share consideration will be exchanged for a specified fraction of each share tendered and the non-share consideration will be given for the remaining fraction. In these situations, the cash or other non-share consideration received represents proceeds of disposition of shares or fractions of shares of the acquired corporation as a consequence of the sale of those shares or fractions of shares by the vendor to the purchaser.” (endnote 7)
17. In Technical Interpretation 2003-0003645 (endnote 8) , to which you referred, we indicated that the provisions of paragraph 7 of IT-450 could apply to an exchange of shares to which subsection 7(1.5) applies depending on the facts of the particular case.
"We have previously stated that we may be prepared to extend the very limited exceptions in paragraphs 6 and 7 of Interpretation Bulletin IT-450R entitled Share for Share Exchange (section 85.1 of the Act) to rollovers under subsection 7(1.5) of the Act where the specific proposed transaction is submitted in the form of a request for an advance income tax ruling. This would give us the opportunity to review the pertinent facts and proposed transactions to determine whether the limited exceptions should apply to the particular situation."
18. In our view, Article XXXXXXXXXX of the Agreement, quoted in the Statement of Facts above, is sufficiently explicit to conclude that each employee can clearly identify which shares were exchanged for cash and which were exchanged for shares of Corporation C. The fact that each employee holds only one certificate, for all of the shares owned by the employee, is not a determinative factor in determining whether the employee has clearly identified which shares the employee exchanged for shares and which ones the employee exchanged for cash.
19. Finally, you wish to know whether the reduction in the paid-up capital of the Corporation A shares may result in the provisions of subsection 7(1.5) not applying to the Corporation A shares that were exchanged for Corporation C shares. In our view, having regard to the Agreement, the reduction in paid-up capital cannot be considered to be an amount received as consideration for the disposition of the Corporation A shares even though that transaction was part of the series of transactions involving the sale of those shares.
20. We are of the view that for the purposes of paragraph 7(1.5)(b), the employees received "no consideration …other than securities" as consideration for the Corporation A shares exchanged pursuant to Part I of the Agreement.
21. Since the Corporation A shares that were exchanged for the Corporation C shares were shares that were issued in circumstances described in paragraph 7(1.1), the taxpayer will realize a taxable benefit under section 7 when the taxpayer disposes of the Corporation C shares.
Section 116 Certificate of Compliance
22. The representative for employees who are non-residents of Canada filed a Form T2062 for each employee. This form indicated that these employees did not realize a capital gain on the disposition of the shares of Corporation A whether the shares were paid in cash or in shares of Corporation C.
23. All of the shares disposed of are the subject of the request, which in our view is correct. Subsection 7(1.5), which provides that there is no disposition of the shares when all its conditions are satisfied, applies only for the purposes of section 7 and paragraphs 110(1)(d) to (d.1). Thus, for the purposes of section 116, all shares disposed of must be considered, not just those disposed of for cash consideration.
24. The taxpayer's representative determined the ACB of the shares by adding to the amount otherwise determined the value of the taxable benefit determined under section 7 in respect of the shares disposed of for cash consideration. The taxpayer's representative also added the value of the deferred taxable benefit resulting from the application of subsection 7(1.1) in respect of the shares disposed of in consideration for the Corporation C shares, even though the benefit from the disposition of those shares has not yet been included in the taxpayer's income.
In our view, this ACB calculation is consistent with paragraph 53(1)(j). Paragraph 53(1)(j) adds to the ACB of the shares that each employee acquired under a stock option the amount of the benefit that the employee is deemed by subsection 7(1) to have received in respect of the acquisition of the shares. In addition, in the case of a security issued after February 27, 2000, paragraph 53(1)(j) allows the amount of the benefit that is deferred from being recognized in the employee's income under subsection 7(1.1) to be added to the ACB.
Subsequent disposition of Corporation C shares
25. In this case, subsection 7(1.1) applies to defer recognition of the benefit determined under subsection 7(1) until the taxation year in which the employee disposes of the Corporation C shares. For greater certainty, subsection 7(4) provides that subsection 7(1) will then apply to the employee who has benefited from the provisions of subsection 7(1.1) even though the employee is no longer employed by Corporation A.
26. In the case of each non-resident, it is our view that the benefit determined under subsection 7(1) will be required to be added to the non-resident's employment income earned in Canada in the taxation year of the disposition of the Corporation C shares by virtue of subsections 7(1) and (1.1) and subparagraph 115(1)(a)(i).
27. The Canada-U.S. tax treaty and that of Canada and XXXXXXXXXX, as applicable, should also be considered. Generally, in both cases, employment income of a resident of the United States or of XXXXXXXXXX, as the case may be, may be taxed in Canada on income relating to employment in Canada. However, we are not making a final determination as to the application of the tax treaties since we do not know all the relevant facts and you have not asked us specific questions about their application.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance.
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
ENDNOTES
1 For the purposes hereof, we refer to this part of Article XXXXXXXXXX of the Agreement as the First Part of the Agreement.
2 CANADA REVENUE AGENCY, Interpretation Bulletin IT-113R4 Benefits to Employees - Stock Options, August 7, 1996.
3 CANADA REVENUE AGENCY, Technical Interpretation 2003-000364, April 1, 2003.
4 Supra, note 2.
5 CANADA REVENUE AGENCY, Interpretation Bulletin IT-450 Share for Share Exchange, April 8, 1993.
6 Supra, note 3.
7 Supra note 5, para. 7.
8 Supra, note 3.