With the increased amount of transaction activity taking place globally in 2021, there are some key points to consider in the context of equity-based plans for Canadian tax purposes.
Many Canadian-based equity plans are structured using traditional stock options, in order to benefit from a 50% deduction on the taxable income that arises upon the exercise of an option (if certain conditions are met).
One of the conditions for the 50% deduction to be available is that the underlying share has to be a “prescribed” share, which means that the shares themselves need to meet a number of criteria to qualify. One of the criteria is that the employer, or a specified person that does not deal at arm’s length with the employer, cannot reasonably be expected to acquire the share within two years from the date of exercise.
In a transaction setting, the expectation is that the shares would be acquired within a two year period. There are specific exceptions in certain situations, such as in the case of a purchase of all or substantially all of the shares of the corporation, however it is key to review the terms of the transaction to ensure that the underlying shares qualify as “prescribed shares” for this purpose.
An exchange of one stock option for another would generally be regarded as a disposition of rights under the original agreement – this could result in a taxable income inclusion at the time of exchange.
However, where certain conditions are met it is possible for the exchange of an option to be disregarded for Canadian tax purposes. This would mean that the new option is considered to be the same as the original option and would defer taxation until the exercise of the new option. The terms and economic value of the exchange should be looked at in detail to ensure that these rollover provisions are met.
Similarly, a deferral of taxation may be available where shares held by an individual are exchanged for shares in another company in a transaction. There are a number of conditions that would need to be considered to determine if this deferral opportunity is available.
Under Canadian rules, a corporate tax deduction is not generally available where shares are issued from treasury in settlement of equity award. However, a cash settlement made to employees equal to the in-the-money benefit of the award would generally be deductible for corporate tax purposes.
Care should, however, be taken when a cashout payment is made to employees in connection with a corporate transaction. There have been several court cases where such payments were held to be a capital expense and were not deductible to the corporation, and others where the deduction was allowed. It is therefore key to understand the specific nature of the payments being made to the employees to determine if a corporate deduction is available.
In any corporate reorganization or acquisition there are a number of considerations relating to the treatment of equity-based awards and the terms of the transaction should be reviewed carefully to ensure that all relevant items have been addressed.