CRA Approves Employer Deduction for Certain Stock-Based Compensation Plans

In TI 2015-0600941I7 (July 29, 2016), the CRA confirmed its acceptance of the decision in Transalta Corporation v. The Queen (2012 TCC 86), which allows a corporate tax deduction for the cost of shares issued under a stock-based compensation plan when the share issuance is a discretionary choice of the employer (that is, the employer was not legally obliged to issue shares). However, the attractiveness of this compensation choice may be limited because employees will lose the paragraph 110(1)(d) deduction of one-half of the employment income amount: for the deduction to be allowed, the income must be taxed under section 7.

In the TI, employees of a Canadian subsidiary (Canco) participated in various share-based compensation plans provided by the US parent company (USco). The CRA concluded that section 7 of the Act will apply to any share-based compensation plan that creates a legally binding obligation on the employer to issue shares to its employees upon settlement. This obligation will preclude the employer from claiming a corporate tax deduction for the cost of the issued shares (paragraph 7(3)(b)).

The CRA opined that no such legally binding agreement exists with respect to a stock appreciation rights (SAR) arrangement that provided for settlement in either cash or shares at the discretion of the employer's committee. In the situation described in the TI, USco did not have a legally binding obligation to issue shares, and a Canco employee did not have a legally enforceable right to require USco to issue shares. Thus, section 7 would not apply to the SAR arrangement, and a corporate tax deduction would be available. This interpretation follows Transalta, in which the court concluded that if an employer issues shares under an equity plan that does not meet the criteria of section 7, the employer should be entitled to claim a corporate tax deduction (assuming that the other conditions for a deduction are met).

With respect to the other plans reviewed by the CRA (deferred stock, restricted stock, performance shares, and stock options), the CRA concluded that a legally binding obligation to issue shares was created under each arrangement; therefore, section 7 applied to the plans, and a corporate deduction was not available to the employer.

The planning implication of this TI is clear: companies that want to structure share-based compensation plans around the availability of the corporate tax deduction should ensure that the plan allows the flexibility to the employer to decide, until the settlement, to settle obligations in cash or shares (and thus ensure that the employee was not previously provided with the right to request shares). Care must be taken to ensure that the salary deferral arrangement rules do not apply, since they would trigger immediate taxation to the employee upon grant and then annually on the increase in value of the award.

One interesting issue not addressed in the TI is whether section 7 would still apply if the discretionary choice of the employer were different—if, instead of a choice between cash and newly issued shares, the choice was between newly issued shares and shares purchased in the market. The accounting issues related to such a choice should also be considered.

Huoy Theam
Deloitte LLP, Montreal

Canadian Tax Focus
Volume 7, Number 3, August 2017
©2017, Canadian Tax Foundation