N.R. Mitchell Tel. (613) 957-2134
JUN 2 1988
Dear Sirs:
Re: Employee Stock Purchase Plan
This is in reply to your letter of March 29, 19R8 concerning the application of the Income Tax Act (the "Act") to the following situation.
In June 1973 it public corporation established a stock purchase plan with a trustee by way of an agreement entitled "Key Employee Stock Purchase XXXX (herein referred to as the "Plan"). The Plan relates to the common shares of the corporation which are listed for trading on the Toronto Stock Exchange.
Pursuant to the Plan, B committee of outside directors of the corporation determines from time to time which individual employees of the corporation will be offered participation in the Plan. All employees are eligible under the Plan, although the committee generally offers participation in the Plan only to employees considered to be "key" employees (i.e., middle and senior management). There is no requirement that an employee be or not be a shareholder in order to be offered participation in the Plan. There is, however, a provision that a director of the corporation who does not hold a salaried employment or office in the corporation is not eligible for participation in the Plan.
Shares to be acquired under the Plan are acquired from the corporation as newly issued shares from treasury or are purchased on the Toronto Stock Exchange at current market prices. The purchase price pan' for newly issued shares is equal to the Toronto Stock Exchange market price on the date the shares are issued.
Under the terms of an agreement between the trustee and the employee, the employee becomes directly indebted to the trustee (and indirectly to the corporation) in the amount of the total purchase price for the shares acquired by the employee under the Plan. The employee is not required to make any payment for the shares at the time of acquisition; instead, the unpaid purchase price is due and payable, without interest thereon, on the tenth anniversary of the acquisition, although the employee is entitled to make certain prepayments. The shares are held by the trustee for the benefit of the employee and are also held by the trustee as security for the unpaid purchase price. The trustee is required to pay to the corporation the proceeds of any payments made by the employee in respect of the purchase price.
Certain employees of the corporation who had participated in the Plan still have amounts outstanding on the unpaid balance of the purchase price of their shares acquired pursuant to the Plan. These employees cquired their shares at various times from 1973 to 1976. Of the member of this group of employees, the president would own the largest number shares, not all of which could have been acquired pursuant to the Plan. The total number of shares owned by the president or over which he has voting control would represent approximately 6.59% of all the common shares of the corporation issued and outstanding. The percentage shareholdings of the other members of this group of employees would be relatively insignificant.
In 1982 at the annual shareholders' meeting of the corporation, the shareholders approved a resolution to extend to June 1988 the time within which the amounts outstanding on the unpaid balance of the purchase price of shares acquired by these employees pursuant to the Plan had to be paid. The time within which the payments had to be made was accordingly extended by mutual agreement between the corporation, the trustee and the employees.
Since the introduction of section 80.4 of the Act and prior to 1982, the employees have not included in their income a benefit in respect of the fact that the unpaid amounts do not bear interest because the amounts qualified as an "excluded loan" within the meaning of paragraph 80.4(2)(a) of the Act as it then read. After 1981, the employees have included in their income an amount as a benefit pursuant to subsection 80.4(1) but have claimed an offsetting deduction pursuant to section 80.5 of the Act on the basis that the benefit is deemed to be interest paid or payable, as the case may be, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from property.
The corporation ant these employees propose to enter into an agreement whereby the corporation would make a new loan to each of these employees equal in amount to the balance outstanding on the purchase price of their shares acquired pursuant to the Plan. These new loans would not bear interest and would be repayable on the fifth anniversary of the date the new loans are made. It would be a condition of the new loans that the proceeds be used to pay the balance owing to the trustee on the purchase price of the shares acquired pursuant to the Plan. The trustee will then pay the amounts received to the corporation.
You have asked us to confirm your understanding of the consequences under the Act of the transaction described above, which is as follows:
(a) Subsection 15(2) of the Act would not apply to the new loans because the loans would be made to the relevant employees in their capacity as employees and not in their capacity as shareholders.
(b) The amount of the new loans would not be included in the income of the new employees pursuant to paragraph 6(1)(a) or any other provision of the Act, other than section 80.4 in the manner described in (c).
(c) Each of the relevant employees would be required to include in his income pursuant to subsections 6(9) and 80.4(1) a benefit due to the fact that the new loans would not bear interest. Each such employee would be entitled to an equivalent deduction pursuant to or is a result of section 80.5, subsection 20(3) and paragraph 20(1)(c) on the basis that the new loans would be used to pay an amount that was payable for property acquired for the purpose of gaining or producing income therefrom.
Inquiries involving a specific proposed transaction are generally responded to by way of an advance income tax ruling. Nonetheless, we are prepared to offer the following general comments with respect to the issues raised in your letter.
Subsection 15(2) of the Act is not applicable to a shareholder/employee unless, at the time of the transaction, the loan is received or indebtedness is incurred by the individual in his capacity as a shareholder. The issue of the capacity in which an individual receives a loan or incurs indebtedness is a question of fact which can only be resolved on a case-by-case basis having regard to all of the surrounding circumstances.
Subject to the above, we would agree that the benefit to the employees as a consequence of their receipt of no-interest loans from their employer would be calculated in accordance with subsection 80.4(1) and included in income under subsection 6(9) of the Act. We would add that the very specific provisions in subsections 80.4(1) and 6(9) of the Act dealing with the calculation and inclusion in income of the benefit deemed to be received from low-interest loans apply to the exclusion of more general benefit provisions, such as paragraph 6(1)(a) of the Act. Section 80.5 of the Act provides that the amount of a benefit deemed by section 80.4 to have been received in a taxation year by an individual shall for the purposes of paragraph 20(1)(c) of the Act, be deemed to be interest paid in, and payable in respect of, the year by the debtor pursuant to a legal obligation to pay interest on borrowed money. Where a loan or indebtedness received by virtue of employment was originally used by an individual to acquire shares, and a subsequent loan or indebtedness is used to repay the funds previously borrowed, subsection 20(3) of the Act would permit the deduction under paragraph 20(1)(c) of the interest deemed to have been paid on the new loan by virtue of section 80.5 of the Act.
In our opinion, if the original loans described in your letter were granted to the individuals in question in their capacity as employees, the proposed new loans would retain the same character and receive the same tax treatment as the old loans. This is subject to the proviso that there has been no material change in the relationship of any of the individuals with the corporation since the time of the original loan.
We trust these comments will be of assistance, but we would reiterate that this is not a ruling and is not binding upon the Department.
Yours truly,
ORIGINAL SIGNED BY P.D. FUOCO for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch