In a recent technical interpretation, the CRA considered the applicability of a subsections 7(1) or (1.1), dealing with employment income inclusions, to an employment bonus paid via the issuance of shares.
Subsection 7(1) of the Income Tax Act (“ITA”) deems an employment income inclusion where an employer agrees to sell or issue securities to an employee. This benefit is equal to the difference between the fair market value of the securities at the time they are acquired by the employee and the actual amount paid by the employee, that is, the difference between their fair market value and their strike or exercise price. Under subsection 7(1), this benefit is included in the employee’s income in the year that the employee acquires the securities. However, it is possible to defer the employment benefit until the securities are disposed of by the employee pursuant to subsection 7(1.1) if the securities acquired were those of a Canadian – Controlled Private Corporation (“CCPC”). In addition, subsection 110(1)(d.1) can provide for a deduction of 50% of this employment benefit where the shares acquired by an employee were those of a CCPC and certain other criteria is met.
If a CCPC employer were to provide an employment bonus that is paid via the issuance of its shares, the question posed to the CRA was whether subsection 7(1.1) would apply so that no taxable income will be included in the employee’s income until the year of disposition of the securities by the employee.
The response from the CRA outlined that whether either subsection 7(1) or 7(1.1) would apply to such an issuance depended on whether there was a legally binding agreement for the corporation to issue the shares. If an arrangement for such an issuance is expressly discretionary and no legal rights or obligations are created, it will not fall within Section 7. Whether or not an arrangement is legally binding is a question of fact; however, the CRA stated that if the decision to issue the shares is placed in the hands of the employer, the conditions of a legally enforceable commitment have not been met and therefore the issuance would not be subject to the provisions of Section 7. On the other hand, if an employer puts in place an arrangement whereby the employer agrees to award a bonus on the condition that the employee achieves certain measurable performance objectives and the employer agrees to pay the bonus in shares, then such arrangement could be an agreement contemplated by Section 7.
The CRA went on to comment that subsection 7(1.1) changes the time at which an employee is deemed to have received a benefit in respect of shares of a corporation, one of the conditions of which is that the corporation is a CCPC. Where an agreement gives an employee the choice between a stock bonus or a cash bonus and the employee elects payment in shares, the time at which the employee is deemed to have received a benefit is the taxation year in which the employee disposed of the shares or exchanged the shares instead of the taxation year in which the shares were acquired.
It should be noted that if Section 7 does not apply, the full value of the shares will be considered employment income, with no 50% deduction available. As well, the benefit will arise at the time of issuance of the shares, rather than being deferred until their sale. However, the impact on the employer also varies. Where Section 7 applies, the employer receives no deduction in respect of the shares issued to the employee. Where it does not, the employer is able to deduct the value of the shares in its corporate income tax return. For these reasons, employment contracts where the issuance of shares are considered should be carefully reviewed for income tax obligations to both the employee and the corporation prior to execution.
Winter 2017 DFK Newsletter Article
Other articles in this issue: Potential GST/HST Surprise for Medical Practitioners | More Fallout from the Graduated Rate Estate (“GRE”) Tax Rules | Will the 2017 Federal Budget Increase the Capital Gains Tax?
Author: Christie Hoem-McNall, CPA, CA – KRP, Kingston Ross Pasnak, LLP