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Share options What are the most common types of share option plan in your jurisdiction? Please outline the rules relating to each scheme.
Share option or stock option plans are one of the most common forms of executive compensation. The features of such plans vary between employers – the characteristics of a particular stock option plan is often dependent on:
- the size of the issuer;
- the employer’s overall compensation strategy;
- market trends; and
- tax planning concerns of employees.
What are the tax considerations for share option plans?
There are no tax consequences to an employee on grant of a stock option. However, an employee may be subject to an income inclusion, under Section 7 of the Income Tax Act, on exercising the option; that income inclusion is an amount equal to the excess of the fair market value of the stock at the time the employee acquires the stock over the price, if any, that the employee paid to acquire the stock. The timing of such income inclusion and availability of any deductions against the income inclusion differs between options offered by Canadian-controlled private corporations (CCPC) and those offered by other issuers. A CCPC is a private corporation that is not generally controlled directly or indirectly by non-resident persons or public corporations.
If the shares in question are not CCPC shares, the taxable benefit described above is included in the employee’s income when the employee acquires the shares. However, under the Income Tax Act, a deduction (the 110(1)(d) deduction) is available to the employee if certain conditions are met, including:
- the exercise price is fixed at a price not less than the fair market value of the share at the time the option was granted; and
- the employee is at arm’s length with the corporation granting the option (and the employer, if the employer and the issuing corporation are different entities) and the share is a prescribed share, as defined in the Regulations to the Income Tax Act (Canada).
If the employee qualifies for a deduction under Section 110(1)(d), only half of the option benefit received by the employee is taxable.
If the shares in question are CCPC shares, the benefit to the employee is not subject to tax until the year in which the employee disposes of the shares. In addition, provided that the employee has not disposed of the shares within two years of acquiring them, the amount of taxable benefit may be reduced by 50% (the 110(1)(d.1) deduction).
Share acquisition and purchase plans What are the most common types of share acquisition and purchase plan in your jurisdiction? Please outline the rules relating to each scheme.
Stock purchase plans are often made available to employees in order to encourage employee savings and performance. Shares may be made available at fair market value or at a discounted price.
What are the tax considerations for share acquisition and purchase plans?
If shares are made available to employees for purchase at the fair market value, there is no taxable benefit to the employee and the employee pays the full value of the shares. However, if shares are made available to employees at less than fair market value, the difference between the fair market value and the price paid by the employee will be a taxable benefit to the employee.
Phantom (ie, cash-settled) share plans What are the most common types of phantom share plan used in your jurisdiction? Please outline the rules relating to each scheme.
Phantom share plans are typically offered to employees when, for various reasons, actual shares are not available to be issued or the employer does not wish to issue actual shares. A phantom stock plan is essentially a cash-only bonus plan pursuant to which the amount of cash bonus payable is based on the value of the corporation’s shares at the date the bonus is payable or on the increase in the value of the corporation’s share during a defined period.
There are a number of different types of phantom share plans, including:
- share appreciation rights (SARs);
- restricted share units (RSUs);
- performance share units (PSUs); and
- deferred share units (DSUs).
SARs are designed to provide an employee with a bonus equal to the increase in value of shares over a defined period whereas RSUs, PSUs and DSUs typically involve the granting of notional units equal in value to a defined number of shares and are subject to conditions which must be met before the bonus payment is made. For example, RSUs are typically subject to vesting and continued employment conditions whereas PSUs are typically subject to performance based objectives. Under a DSU, as the name suggests, payment or settlement is generally deferred until certain events, such as death, termination or retirement.
What are the tax considerations for phantom share plans?
A key consideration when designing a phantom stock plan is to avoid the application of the salary deferral rules (SDA) under the Income Tax Act.
Under the Income Tax Act, employment income is generally taxed on receipt. However, there is an exception if an employee is entitled to an amount in the future under an SDA. An SDA is a plan or arrangement, funded or not, under which a person has a right in a taxation year to receive an amount after the year where it is reasonable to conclude that one of the main purposes for the creation or existence of the right is to postpone tax payable by the taxpayer in respect of salary or wages rendered by the taxpayer in the year or preceding years.
There are defined exceptions to the SDA rules under the Regulations to the Income Tax Act; the most commonly used exceptions are the exceptions for three-year deferred bonus plans and DSUs.
Under the three-year deferred bonus plan exception, a plan or arrangement under which a taxpayer has a right to receive a bonus or similar payment in respect of services rendered by the taxpayer in a taxation year will not be considered an SDA if the plan provides for payment of the deferred amount by the end of the third calendar year following the year in respect of which the bonus is earned. RSUs are often structured to have vesting within three years in order to avoid application of the SDA rules.
There is also an express exception under the SDA rules for DSUs, provided that certain conditions are met. Under Income Tax Act Regulation 6801(d), an arrangement will be exempt from the application of the SDA rules if it meets the prescribed conditions, including that:
- payments may only be received after retirement, termination of employment or death (ie, a triggering event);
- payments must be made before the end of the calendar year following the calendar year in which any of the triggering events occurred;
- the payment amount must be determined on the basis of the fair market value of the shares of the employer corporation at a time within a period that begins one year before the triggering event and ends at the time the amount is received; and
- there can be no guaranteed minimum payment under the plan.
Consultation Are companies required to consult with employee unions or representative bodies before launching an employee share plan?
No, unless the terms of the applicable collective agreement require such consultation.
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