Equity-Based Compensation Plans: DSUs, SARs, RSUs, PSUs, Options Fred Purkey John J. Lennard September 9, 2015
Ordre de la présentation 1. Aperçu 2. Droits à la plus-value d actions (DPVA) 3. L alinéa 6801d) du Règlement et les unités d actions différées (UAD) 4. Les unités d actions incessibles (UAI) et les unités d actions liées au rendement (UAR) 5. Faits nouveaux Options d achat d actions 2
1. Aperçu
1. Considérations juridiques Primes en argent Régime structuré de primes ou primes discrétionnaires Primes annuelles ou primes différées Considérations de cessation d emploi Régimes fondés sur des titres de capitaux propres Options d achat d actions Régimes d actions fictives Imposables en vertu de l art. 5, 6 ou 7 de la LIR? Règles applicables aux ententes d échelonnement du traitement (EET) 4
1. Entente d échelonnement du traitement De façon générale, une EET est un régime ou un mécanisme qui donne à une personne : au cours d une année d imposition, le droit de recevoir un montant après l année droit dont il est raisonnable de considérer que l existence ou la création a, entre autres principaux objets, celui de reporter l impôt payable en vertu de la LIR par le contribuable 5
1. Entente d échelonnement du traitement (suite) sur un montant lui revenant au titre d un salaire ou traitement pour des services qu il a rendus au cours de l année ou d une année d imposition antérieure l alinéa l) de la définition d EET exclut «les régimes ou mécanismes visés par règlement» (c.-à-d. de nombreux types de ce qu on appelle les «régimes d actions fictives») 6
1. Régimes d actions fictives Régimes qui attribuent des actions ou unités théoriques. Paiements en espèces qui constituent des paiements incitatifs à long terme liés à la valeur de l action de la société. Paiements qui visent à harmoniser l intérêt de l employé et celui de la société et de ses actionnaires. 7
1. Formes de régimes d actions fictives Comprennent : les droits à la plus-value d actions (DPVA) les unités d actions différées (UAD) les unités d actions incessibles (UAI) les unités d actions liées au rendement (UAR) 8
2. Share Appreciation Rights
2. Share Appreciation Rights SAR = good, deferred income Salary deferral arrangement (SDA) = bad, income inclusion, unless one of the exceptions apply SAR is not defined in the ITA A SAR is a right with no current value granted to a participant and may increase in value in the future A SAR could, for example, grant an executive 10% of the retained earnings of the corporation after grant date, payable at a certain point in the future 10
2. Share Appreciation Rights (cont'd) Why a SAR instead of a stock option? If you do not want the participant to have shares but still participate in the growth of the business In Technical Interpretation 1999-0007315, May 24, 2000, the CRA indicated that it has accepted that certain SAR incentive plans are not SDAs. These plans are future oriented with a nil payout value to a participant at inception and with no rights to cash out until a fixed date 11
2. Share Appreciation Rights (cont'd) Technical Interpretation 9307455, June 1, 1993: a SAR plan will generally not be considered to be an SDA since a SAR is normally granted for the employee s future services, rather than for the employee s current or past services. This is true even though a SAR might be exercisable at some indefinite future time while the holder is still employed. Thus, in a normal SAR plan, only in the year that the SAR is exercisable can the plan become an SDA This deferral likely would end when the SAR plan member has a right to receive amounts, even if the member chooses not to In Technical Interpretation 9422835, September 14, 1994, the CRA explained that the SDA rules could apply to a SAR if the beneficiary under a SAR arrangement chose to defer receipt of an amount payable under the plan in a year 12
2. SAR Conversion into Options SAR benefits are fully included in income, but stock option benefits may be available for a 50% deduction at the federal level or a 25% deduction at the Québec level So it may be advantageous to convert a SAR plan into a stock option plan as long as the conversion itself does not trigger an income inclusion The ITA does not provide for a tax-deferred exchange of a SAR plan (as it does for options under s. 7(1.4)), so the plan member might realize an income inclusion at that time 13
2. SAR Conversion into Options (cont'd) In Technical Interpretation 2001-0067027, February 16, 2001, the CRA stated that if the SAR would only vest in the future, but now is converted into a pure stock option plan, there would be no current benefit unless there were an accelerated right to receive cash as a result of the exchange. If there is only an accelerated right to receive shares, s. 7 would apply to the issuance of those shares, with an income inclusion equal to the benefit when the shares are acquired 14
2. SAR Conversion: 2003-0043361 Model SAR conversion ruling: 2003-0043361R3 Will the termination of a SAR and its replacement with an agreement to issue shares result in any immediate taxation? No Will the new options be treated as SDAs? No REASONS: The transaction is in accordance with our established position on the application of s. 7(3)(a) Since the number of shares to be provided may not be determined until the option is exercised, there was a concern that the arrangement was in effect an SDA and not a true stock option plan as contemplated by s. 7 of the ITA. However, the proposal provides for the exercise of the options as soon as practical after their grant. Hence it was concluded that the SDA provisions would not be applicable in the circumstances 15
2. SAR Conversion: 2003-0043361 (cont'd) A. Section 7(3)(a) of the ITA will apply in respect of an employee where, as described in 8 above, the employee is granted rights under the option plan so that, except as provided in s. 7, as ruled on in C below, the employee shall not be considered to have received or enjoyed any benefit to which s. 5(1), 6(1)(a) or (i) or s. 15 would otherwise apply, as a result of the grants or from the acquisition of shares under the option plan B. Section 39(1) shall not apply in respect of an employee as a result of the termination of the phantom plans as described in 10 above C. Provided that an employee continues to deal at arm's length with the corporation immediately after the corporation grants rights as described in 8 above, s. 7(1.1) and s. 7(1)(a) will apply to deem the employee to have received a benefit calculated in accordance with those provisions in the year the employee disposes of or exchanges a share acquired under the option plan D. Provided that the conditions in s.110(1)(d.1) are met, an employee may deduct an amount, as calculated under that provision, in the year in which the employee disposes of or exchanges a share acquired under the option plan as described in C above 16
2. SAR Conversion: 2003-0043361 (cont'd) The steps in the conversion described in this ruling were as follows: Corporation is a Canadian controlled private corporation (CCPC) SAR plan with an accrued value of $1 million, for example SAR plan rights cancelled for no consideration New stock option granted to the employee, where she has the right to acquire for $1 in the aggregate preferred shares with a redemption price of $1 million Employee immediately exercises the right, acquires the shares and holds them for at least two years Employee sells shares to a third party, triggering stock option benefit, claims federal deduction of 50% and Québec deduction of 25% 17
2. SAR Conversion: 2003-0043361 (cont'd) The key to the conversion is ITA s. 7(3)(a): if a corporation has agreed to issue its securities to an employee, then except as provided by s. 7, the employee is deemed to have neither received nor enjoyed any benefit "under or because of" the agreement limits tax treatment to what s. 7 triggers, not ss. 6, 5 or any other provision In-the-money stock options of a CCPC exercised = no immediate income inclusion, only upon disposition/death, and get deduction if held for two or more years If the corporation repurchases the shares, there would be a deemed dividend, so shares must be sold to another person (perhaps another shareholder) No capital gain, this is a stock option benefit, with the normal withholding rules applying 18
3. Regulation 6801(d) and Deferred Share Units (DSUs)
3. Why a 6801(d) Plan? Means of compensating directors and employees without issuing shares Often seen in public corporations No limit on amounts that can be awarded, as long as the awards are reasonably attributable to employment duties Immediate value at grant time, payout only later Deferral of income inclusion Based on the value of the corporation's shares, so an extra incentive to maximize shareholder value (and the beneficiary's wealth!) Payouts can be made in cash or shares of the corporation Usually the 6801(d) rights are expressed as "units", with one unit having the value of one common share 20
3. How It Works Generally income from an office or employment is taxed when received by a taxpayer (i.e., on receipt of employment income or benefits) ITA s. 5(1) includes in a taxpayer's income any salary, wages or other remuneration received by the taxpayer from an office or employment ITA s. 6(1)(a) includes in a taxpayer's income from an office or employment the value of any benefit received or enjoyed by the taxpayer in the taxation year The position of a director of a corporation is specifically included in the definition of "office" provided in ITA s. 248(1) 21
3. Salary Deferral Arrangement Exceptions exist to this general rule, notably where there is an SDA, as defined in ITA s. 248(1) Under ITA s. 6(11), a right to receive a "deferred amount" (as defined in s. 248(1)) under an SDA by a taxpayer is deemed to have been received by the taxpayer as a benefit for the purposes of s. 6(1)(a) in that taxation year, provided that amount has not already been included in the taxpayer's income in a previous year 22
3. 6801(d) Text 6801. For the purposes of paragraph (l) of the definition salary deferral arrangement in ITA s. 248(1), a prescribed plan or arrangement is an arrangement in writing (d) between a corporation and an employee of the corporation or a corporation related thereto under which the employee (or, after the employee's death, a dependant or relation of the employee or the legal representative of the employee) may or shall receive an amount that may reasonably be attributable to duties of an office or employment performed by the employee on behalf of the corporation or a corporation related thereto where (i) all amounts that may be received under the arrangement shall be received after the time of the employee's death or retirement from, or loss of, the office or employment and no later than the end of the first calendar year commencing thereafter, and 23
3. 6801(d) Text (ii) the aggregate of all amounts each of which may be received under the arrangement depends on the fair market value of shares of the capital stock of the corporation or a corporation related thereto at a time within the period that commences one year before the time of the employee's death or retirement from, or loss of, the office or employment and ends at the time the amount is received, unless, by reason of the arrangement or a series of transactions that includes the arrangement, the employee or a person with whom the employee does not deal at arm's length is entitled, either immediately or in the future, either absolutely or contingently, to receive or obtain any amount or benefit granted or to be granted for the purpose of reducing the impact, in whole or in part, of any reduction in the fair market value of the shares of the corporation or a corporation related thereto 24
3. Writing, Employee, Attributable An arrangement in writing: no verbal 6801(d) plans Between a corporation and an employee, including directors The position of a director of a corporation is included in the definition of "office" provided in ITA s. 248(1), and a director of a corporation is an "officer" by virtue of that same definition 248(1): office includes the position of a corporation director, and officer means a person holding such an office "Employee" is also defined in s. 248(1) to include "officer" This is supported by various rulings: 2008-026892, 2006-016886, 2008-026563, 2004-007204, and 2004-006477 Attributable to the duties performed usually not an issue for a public corporation 25
3. Timing of Receipt The payout timing element is crucial Must be after death/retirement/loss of office or employment, but before the end of the following calendar year For example, if board member resigns on September 9, 2015, payout can be no earlier than September 10, 2015, and no later than December 31, 2016 No specific concept of constructive loss of employment, but may be risky, for example, to make a payout when an employee has gone from 40 hours per week to only 17 hours, and then to take the position that for the purposes of 6801(d) there has been a loss of employment To be safe, make the payout possible only after the person is gone Transferring between affiliates is not enough to have a termination/loss Remember, the wording in 6801(d) is "may or shall receive", so if it is possible for someone to receive an amount under the plan before she should under the rules, the plan may be broken even if she does not receive the amount at the wrong time 26
3. Fair Market Value Depends on the fair market value of shares of the capital stock of the corporation The CRA used to rule whether a given methodology to determine FMV was valid or not, but no longer does so What is FMV? In general: "An open and unrestricted market in which the price is hammered out between willing and informed buyers and sellers on the anvil of supply and demand" Henderson Estate v. M.N.R., [1973] C.T.C. 636 at 644 (FCTD) The FMV of a public corporation's shares is normally the trading price of the share on the date of the transfer. However, when there is no open market for the particular share or there are no trades for a significant period before and after that date, the FMV can be determined only after a review of all the relevant trading information available at that time Technical Interpretation 2004-010741. 27
3. Fair Market Value: 6801(d) Closing Price: the CRA has accepted the closing price of publicly traded shares as a methodology for determining fair market value Rulings 2007-025937, 2006-021017 Greatest Volume: The CRA has accepted "the closing price on the stock exchange on which the Common Shares are then listed that had the greatest volume of trading on that particular day" Rulings 2002-0123153, 9931613 Weighted Average: A 30-day weighted average was approved by the CRA in the past (Ruling 2001-0101301) and on the basis of discussions with the CRA, even a one-year weighted average share price might be acceptable Not Publicly Traded: If the shares are no longer publicly traded, the CRA in previous rulings has permitted some flexibility in determining fair market value 28
3. Fair Market Value: 6801(d) (cont'd) Not Publicly Traded: The CRA has approved a look-back to the most recent trading price if the shares are no longer listed (of up to 365 days in one ruling), and the use of a third party to advise on the valuation. See: "if the Participant's Termination Date is after the last Trading Day before the Cease Trade Date, the value of such DSUs on the Participant's Redemption Date will be based on the fair market value of a share of the Corporation as determined on a reasonable and equitable basis by the Board after obtaining the advice of one or more reputable, independent investment banks" Ruling 2002-0167253 "if the Director's Termination Date is more than 365 days after the Cease Trade Date, the value of such DSUs on the Director's Redemption Date will be based on the value of a share of the Corporation as determined on a reasonable and equitable basis by the Board after obtaining the advice of one or more reputable, independent investment banks " Ruling 2001-0101633 29
3. Fair Market Value: 6801(d) (cont'd) Not Publicly Traded: The CRA has even approved the determination of fair market value without specifically identified outside assistance: "If, at any time, the Shares are no longer listed on the XXXXXXXXXX, the Market Value shall be calculated in such manner as may be determined by the Committee from time to time. The Market Value shall always be established in relation to the fair market value of a common share of the Corporation or of a corporation related thereto" Rulings 2000-0011903 and 9807853 "Market Value will mean fair market value as determined by the Board of Directors of the Corporation on a reasonable and equitable basis, taking into account any financial statement, report or other data, which the Board may consider reliable" Ruling 2004-006752 Or with the assistance of a valuator: "The Market Value of a Common Share at any time on or after the first anniversary date of delisting will be determined by a Valuator that is an internationally recognized firm of public chartered accountants The Valuator's determination will not be subject to review, but will be final and binding on the Corporation " Ruling 2004-006752 30
3. Value Within Date Range Depends on the fair market value within the period that commences one year before the time of the employee's death or retirement and ends at the time the amount is received So the specific wording of Income Tax Regulations paragraph 6801(d) permits the valuation of the shares to be performed during the range of one year before termination until the time of receipt 31
3. Value Within Date Range (cont'd) The CRA has specifically approved in previous rulings the ability to select a specific date for valuation of the shares within this time range (and as early as one year before termination): "The Date of Valuation specified shall be a Trading Day that next follows the date of the Determination which falls within the period that commences one year before the Date of Payment and ends on the date the payment is received by the Member Ruling 2001-011271 Valuation Date with respect to a Member means such date as elected by the Member and comprised within the period beginning one year before the Member's Termination Date and ending on XXXXXXXXXX of the first calendar year after the Member's Termination Date" Ruling 991942 32
3. Value Within Date Range (cont'd) For example, a director resigns on January 1, 2016. The director can pick a valuation date any time from January 1, 2015, until the payout date, which could be as late as December 31, 2017, essentially giving a three-year range in this example 33
3. No Benefit to Reduce Loss of Value There can be no amount or benefit granted or to be granted for the purpose of reducing the impact, in whole or in part, of any reduction in the fair market value of the shares of the corporation So a participant cannot be granted any 6801(d) benefits or receive any other compensation under the plan or otherwise to reduce the impact of any decline in value of the corporation's shares 34
3. 6801(d) Cross-Border Issues No deemed disposition on emigration for 6801(d) rights as per ITA s. 128.1(10)(c)(vii) Rough equivalent of 6801(d) in the United States is Internal Revenue Code (IRC) section 409A "separation from service" rules more complex; there are rules to deal with an employee with substantially reduced hours, for example Less flexibility on the timing of valuation and payout; may need to determine in advance how many days after separation from service the payout will occur for a given year's award of benefits The plan will have different election dates and payout rules for Canadian and U.S. participants In general, possible to have a common plan for U.S. and Canadian participants, but much more complicated May want to consider having two separate plans, if possible 35
3. 6801(d) General Will an amendment consolidating two 6801(d) plans, of two related corporations, into one 6801(d) plan, be acceptable? Yes Ruling 2002-0123153 Can a signing bonus be deferred into a plan governed by 6801(d)? Yes Ruling 2007-0259371R3 Can participation under a DSU plan be terminated and effectively converted into participation under an employee stock option plan on a tax-deferred basis? No REASONS: The granting of rights under the employee stock option plan in satisfaction of the amount the employee would be entitled to on termination of participation under the DSU plan (the value of DSUs credited to the employee at that time) would cause the DSU plan to fail to comply with s. 6801(d)(i) of the regulations. As a result, the DSU plan would be a salary deferral arrangement and taxed accordingly Ruling 2006-0178881E5 36
3. 6801(d) CRA Rulings At one time, it was standard procedure to obtain a ruling from the CRA on a 6801(d) plan, especially for a public corporation No rulings were issued for four years after 2010, when three 6801(d) rulings were issued (two of those rulings were released to the public in severed form in 2012) CRA only recently began issuing 6801(d) rulings again In the absence of a ruling, an opinion might be required by the client The policy of the IRS is not to issue IRC section 409A rulings 37
4. Restricted Share Units (RSUs) and Performance Share Units (PSUs)
4. What Are RSUs? A form of phantom shares Can be granted on the basis of a formula determined by the employer (set out in an RSU plan document or agreement with the employee) Typically granted with vesting conditions (e.g., on the basis of service and/or the attainment of corporate/personal performance objectives) 39
4. What Are RSUs? (cont'd) During the vesting period, employees may receive additional RSUs or cash based on dividends declared on the shares of the company Upon satisfying vesting conditions, the employee is eligible to exchange RSUs for shares of the employer or for the equivalent value in cash 40
4. Tax Considerations If settled with cash, or cash or shares at the grantor s option, very high risk of being an SDA because RSU units are allocated at the outset and cash payment can be received before retirement, termination or death To avoid SDA issue, RSU rights are typically settled by the end of the third year following the year of grant 41
4. Tax Considerations for Employer Employer not entitled to a deduction in respect of the expense associated with the grant or settlement of the RSUs if they are settled through newly issued shares If settled in cash, employer will be entitled to a deduction for the amount of the RSU cash payment in the year the payment is made 42
4. Tax Considerations for Employee Employee taxed in the year in which the shares are acquired under the RSUs and the taxable benefit is the fair market value of the share at the time of its issuance RSUs that are required to be settled in shares issued by the employer or an affiliate from treasury are taxed under ITA, s. 7 43
4. Section 7 and RSUs ITA s. 7(3)(a) provides that when an arrangement falls within s. 7, an employee is deemed not to have received or enjoyed any benefit under or because of the arrangement except as provided by s. 7 Effectively excludes the application of the SDA rules to arrangements governed by s. 7 In practice, this means that RSUs settled in shares issued from treasury can provide for vesting/deferral that extends past three years without creating an SDA 44
4. RSUs: Other Tax Considerations RSUs settled through the issuance of shares do not qualify for the 50% deduction under s. 110(1)(d) because employee does not pay any amount for the shares However, if the corporation is a CCPC, employee may still qualify for the 50% deduction under s. 110(1)(d.1) provided that the employee holds the shares for at least two years 45
4. PSUs PSU usually refers to an RSU that is subject to performance-based vesting Accordingly, income tax issues for the employer and the employee are essentially the same as those that exist for regular RSUs Principal issue: Avoiding the SDA rules 46
5. Faits nouveaux Options d achat d actions
5. Attribution d options d achat d actions aux employés travaillant au Canada et à l étranger (document de l ARC 2012-0459411C6) Rappel du changement de politique de l ARC en matière de détermination de la partie d un avantage tiré d une option d achat d actions qui est attribuable au Canada lorsque l employé non résident a travaillé au Canada et à l étranger. Plutôt que d établir une répartition en fonction du nombre relatif de jours de service au Canada lors de l année d attribution, l ARC utilisera la méthodologie qui figure dans les Commentaires de l OCDE, méthodologie qui fait plutôt référence au nombre relatif de jours de service au Canada pendant la période d acquisition (de l attribution à l acquisition). 48
5. Attribution d options d achat d actions aux employés travaillant au Canada et à l étranger (document de l ARC 2012-0459411C6) (suite) Le changement de politique s applique aux options d achat d actions exercées après 2012 (sous réserve des dispositions particulières d une convention fiscale) par exemple, l annexe B du cinquième protocole de la Convention fiscale Canada-États-Unis en fonction du nombre relatif de jours de service entre l attribution et l exercice, plutôt que seulement la période d acquisition. 49
5. Réduction du prix d une option d achat d actions Nouveau paragraphe 110(1.7) la réduction du prix d exercice de l option d achat d actions de l employé n empêche pas la déduction de 50 % prévue à l alinéa 110d) dans la mesure où la réduction aurait pu être effectuée au moyen d un échange par exemple, une option comporte un prix d exercice de 10 dollars, lorsque la JVM des actions est de 10 dollars. Si la JVM des actions baisse à 8 dollars, le prix d exercice peut être réduit à 8 dollars. Le paragraphe 110(1.7) prévoit que la réduction est réputée effectuée au moyen d un échange. 50
5. Réduction du prix d une option d achat d actions (suite) Le paragraphe 110(1.8) établit des conditions : on ne peut se prévaloir de l alinéa 110(1)d) après la réduction (compte non tenu du paragraphe 110(1.7)) on pourrait se prévaloir de l alinéa 110(1)d) si l échange et l exercice subséquents ont eu lieu. Rétroactivité aux réductions du prix d exercice survenues après 1998. 51
Questions?
Merci! Thank you! Fred Purkey 514 841-6458 fpurkey@dwpv.com John J. Lennard 514 841-6517 jlennard@dwpv.com