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OPTIONS AND OTHER
EQUITY-BASED INCENTIVES FOR
EMPLOYEES AND
OTHER SERVICE PROVIDERS:
Tax, Corporate and Securities Issues
Jay A. Lefton
Senior Partner
[email protected]
416.216.4018
Presentation at the
Sault Ste. Marie Innovation Centre
September 15, 2009
Tax Framework:
Taxation of Employment Income

Fundamental principle of the Income Tax Act
(Canada) (“ITA”):


Remuneration and benefits generally taxed in
year received
Exceptions:
 Plans for employees governed by section 7 of
the ITA

“employee” includes an officer and may also include a
director where the agreement is entered in
consideration for the individual's services as director.

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“phantom” stock plans
Section 7 Based Plans
 Common plans eligible for exemptions
under Section 7 of ITA:
 Stock option plans
 A right, subject to certain conditions, to
acquire:
 A specified number of shares
 At a specified price
 For a specified period of time
 Share appreciation rights (SARs)
 Entitles the holder to take specified value
(FMV – exercise price) either in cash or
shares
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Section 7 Based Plans (cont’d)
 Common plans eligible for exemptions
under Section 7 of ITA:
 Stock Bonus Plans
 A bonus payable in shares
 Could be a one-time incentive or an ongoing
program
 Stock Purchase Plans
 If sold at FMV, no taxable benefit
 If sold at a discount to FMV, s. 7 benefit equal
to FMV of share at purchase date less price
paid
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Section 7 Based Plans:
General Rules
 Three distinct times are relevant:
 When the right is granted
 When the right is exercised
 When the shares received under the right are
disposed of (usually sold)
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Section 7 Based Plans:
General Rules (cont’d)
 No tax on entering into agreement
 Employee generally taxed either:
 When share acquired (subject to deferral
discussed later), or
 Disposition of share or rights under agreement
 Employee generally taxed on difference between
 FMV of shares at time acquired and
 Option exercise price
 Value of s. 7 benefit added to employee’s cost of
share (to avoid double taxation)
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Section 7 Based Plans:
General Rules (cont’d)
 Deduction for employee
 Employee may be entitled to a 50% deduction from
income if (i) employee is dealing at arm’s length
with the corporation and (ii) certain requirements
are met
 General Requirements
 Amount payable to acquire the security (i.e. exercise
price) is not less than FMV at date of agreement, and
 Underlying security is a “prescribed share”
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Section 7 Based Plans:
General Rules (cont’d)
 Deduction for employee
 Employee may be entitled to a 50% deduction from
income if certain requirements are met
 Alternative Basis for Claiming Deduction
 Share acquired is of a “Canadian controlled private
corporation (“CCPC”) (being a private corporation
incorporated in Canada which is not controlled directly
or indirectly by one or more non-resident persons,
public corporations or any combination of these
entities), and
 Employee holds the shares for at least 2 years before
disposing of them
 Result 
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s. 7 benefit taxed at
capital gains rates
Section 7 Based Plans:
General Rules (cont’d)
 Deferral of s. 7 benefit for CCPCs
 s. 7 benefit not taxed until employee disposes of
shares
 Deferral opportunity for public company (nonCCPC) plans
 If agreement to acquire certain publicly-listed
shares, s. 7 benefit may be deferred until earliest of
 Year shares are sold
 Year employee dies
 Year employee ceases to be resident in Canada
 Availability of deferral subject to certain
conditions and monetary limits
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Section 7 Based Plans:
Other Tax Issues
 Federal Source Deductions
 Generally, employers are obligated to withhold and
remit income tax and CPP contributions (but not EI
premiums) on s. 7 benefit
 No withholding on non-CCPC options where election
to defer
 However, CRA generally does not require income tax
withholding:
 Where there is no cash payment at same time,
 Section 7 benefit is large in relation to cash remuneration,
or
 Withholding would cause undue hardship.
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Phantom Stock Plans
 No shares are acquired under these plans,
but payment is based upon value of a specified
number of company shares
 Phantom stock “awards” or “units” may be linked
to performance targets set by employer
 Can avoid the “Salary Deferral Arrangement” by
fitting into one of two exceptions
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Phantom Stock Plans (cont’d)
 Exceptions to “Salary Deferral Arrangement”
rules
 Bonus payable within 3 years from date services
rendered, or
 “prescribed plan”:
 Written agreement to receive cash amounts attributable to
employment
 Amounts receivable only following retirement, death or
termination of employment, and no later than year
following this triggering event
 Amounts based on FMV of shares of employer (or related
corporation) determined in the period between
1 year before termination date and the payment date
 No downside protection (if a decrease in value)
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Stock Options
and Consultants
 General rules:
 A consultant is not an “employee”
 Income inclusion in year of grant
 Additional inclusion when exercised, either:
 Business income, or
 Capital gain
 Exercise price and cost of option added to cost of
share
 Issuer not entitled to deduction for value of option
 Issuer generally entitled to deduction for issuing or
selling share, but amount of deduction is reduced
by that amount FMV of share exceeds
exercise price
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Corporate Considerations:
Stock Option Plans
 A stand-alone grant or a “plan”
 Considerations:
 Maximum number of shares eligible
 Exercise price
 Permit cashless exercise?
 Categories of recipients
 Employees
 Directors
 Consultants
 Ability to transfer to RRSPs of the foregoing?
 “Vesting” conditions
 Restrictions/Conditions of exercise, if any
 Term (“expiration date”) of the entitlement
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Corporate Considerations:
Stock Option Plans (cont’d)
 Considerations (cont’d):
 Effect of a sale of the company (change of
control) or amalgamation/merger
 Automatic vesting?
 Mandatory exercise of “in the money” options?
 Effect on “under water” options?
 Exchange of options for options of the acquiror?
 Do option holders need to become parties to the
acquisition agreement for the purposes of giving
representations, or do they get to “play for free”?
 “Jail time” considerations for options and
underlying shares
 A “reverse retention bonus”
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Corporate Considerations:
Stock Option Plans (cont’d)
 Considerations (cont’d):
 What happens if the recipient ceases to be
involved with the company?
 Effect on vested vs. unvested options
 Terminated by the company “for cause”
 Terminated by the company not “for cause”
 Voluntary resignation by individual
 Death or disability
 Ability of the company to repurchase options and
underlying shares?
 At what price?
 “Valuation” vs. formula vs. Board determination
 Minority discount vs. proportion of overall value?
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Corporate Considerations:
Stock Option Plans (cont’d)
 Considerations (cont’d):
 Consider that shareholders have rights!
 Waive rights to financial statements?
 Non-voting convertible shares?
 Need to become party to a unanimous
shareholders’ agreement?
 Consider “drag-along” provisions
 Voting rights?
 Voting trust agreement?
 Power of attorney?
 Family Law considerations
 Modification of the plan in the future
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 Method of approval
 Effect on prior grants
Securities Law Issues
 The grant or issuance of these rights
(options/shares) are “securities” for the
purposes of the Securities Act (Ontario)
 Under National Instrument Rule 45-106, there are
conditional exemptions available for trades to
employees, executives, directors and consultants
of issuer and affiliates
 Participation must be voluntary
 “Consultant” provides services under a written
contract and “spends a significant amount of time
and attention on the business of the issuer or a
related entity”
 Consider National Instrument 45-102
 Resale of Securities
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Jay A. Lefton
Ogilvy Renault LLP
Suite 3800 – 200 Bay Street
Royal Bank Plaza, South Tower
Toronto, Ontario, Canada M5J 2Z4
416.216.4018 (o)
416.998.1818 (c)
[email protected]
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