Canada: Stock option benefit not taxable
26 November 2014
Posted by: Author: Georgina Tollstam
Author: Georgina Tollstam (KPMG LLP, Toronto)
In Mathieu (2014 CCI 207), the TCC concluded that because
the taxpayer was not dealing at arm’s length with his employer, his stock
option benefit should not be included in his income under section 7. The TCC
also found that the taxpayer’s stock option benefit—in excess of $4 million—was
not taxable under paragraph 6(1)(a), which deals with the value of benefits to
be included in income from an office or employment. The stock option benefit
arose on the taxpayer’s dispositions of stock option rights to his employer in
2004 to 2006. A key criterion for determining whether the taxpayer was at arm’s
length with his employer was whether he was still connected by marriage to his
estranged spouse, an indirect shareholder.
The result is surprising, and would not occur under current
law: paragraph 7(1)(b.1), enacted in 2010, includes similar benefits in income
if an employer and employee do not deal at arm’s length. Furthermore, a
taxpayer can no longer claim a 50 percent paragraph 110(1)(d) deduction unless
the employer elects under subsection 110(1.1) to forgo the payment’s deduction
In Mathieu, the taxpayer (Mr. A) was legally separated from
his spouse (Ms. A) in the taxation years in dispute. Mr. A, Ms. A, and their
son held significant indirect shareholdings in Mr. A’s employer, Employerco;
the remaining shares were held indirectly by unrelated persons.
Mr. A received stock option rights from Employerco. Mr. A
did not exercise the options, but he surrendered them to Employerco over 2004
to 2006 for more than $4 million. Mr. A included in income the consideration
received (paragraph 7(1)(b)), and he claimed a 50 percent deduction (paragraph
110(1)(d)). The CRA disallowed the deduction, saying that Mr. A was not at
arm’s length with Employerco because he was still married to Ms. A.
Generally, related persons are deemed not to deal at arm’s
length with each other (subsection 251(1)). Related persons include individuals
connected by marriage or blood and corporations and persons that meet specific
control tests (subsection 251(2)).
If an employee disposes of rights under a stock option
agreement to an arm’s-length person, he is deemed to have received a stock
option benefit equal to the value of the consideration received net of any
amount paid to acquire the rights (paragraph 7(1)(b)). The employee may also be
entitled to a 50 percent deduction from that benefit (paragraph 110(1)(d)) if
he was at arm’s length with the employer immediately after they entered into
the stock option agreement. If the employee receives a right under a stock
option plan, he is deemed not to have received a benefit under the plan unless
section 7 applies (paragraph 7(3)(a)).
In Mathieu, the TCC concluded that Mr. A was not at arm’s
length with Employerco. The TCC said that if Mr. A and Ms. A were related, they
and their son constituted a related group that controlled Employerco. As a
member of that related group, Mr. A would be related to and not at arm’s length
with Employerco. The TCC said that Mr. A and Ms. A were connected by marriage
even though they were legally separated: a marriage is dissolved only by death
or divorce (section 14 of the federal Divorce Act and article 507 of Civil Code
of Québec). Even if a separation is recognized by an order, it does not
dissolve the marriage; thus, Mr. A and Ms. A were related to each other in the
years in dispute. Because Mr. A was not at arm’s length with Employerco, he was
not allowed the 50 percent deduction (paragraph 110(1)(d)), and the benefit was
not included in his income under paragraph 7(1)(b). In the result, the
non-arm’s-length relationship between Mr. A and Employerco allowed the stock
option benefit to escape income tax altogether under section 7. Moreover, the
TCC agreed that paragraph 7(3)(a) at the time overrode the more general
paragraph 6(1)(a), and the benefit was not included in income at all.
The Mathieu case is a good reminder that the precise reading
of a provision may sometimes lead to unexpected results, despite what many may
believe to be the provision’s intended purpose.
This article first appeared on ctf.ca.