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Imperial Tobacco Redux – Unwelcome Revisit to Deductibility of Payments to Option Holders Surrendering Stock Options

1 Mar 2011

The Canada Revenue Agency ("CRA") generally permits the deduction of payments made by an employer to employees who surrender their options under an employee stock option plan ("ESOP") in the ordinary course of business. Nonetheless, in the context of corporate reorganisations or acquisitions, CRA has characterised such payments as being on account of capital within the Income Tax Act. As a consequence, any payment cannot be deducted against income. While the common law on this issue generally favours CRA, it has been shifting in favour of taxpayers until the latest Tax Court of Canada ("TCC") decision in Imperial Tobacco Canada Limited v. The Queen1 ("Imperial Tobacco"). Taxand Canada provides a summary of the common law and analyse the impact of Imperial Tobacco.

Taxand's Take

The judgment in Imperial Tobacco means that Shoppers should be interpreted as a narrow exception to Kaiser. The approach adopted and reasoning used by Bowie J. in Imperial Tobacco leaves taxpayers with few less than ideal tax planning options. For example, in crafting an ESOP, a corporation may include provisions to automatically accelerate the vesting of options in the event of an acquisition or reorganisation and allow option holders to surrender their unexercised options for a cash payout at their discretion. However, these provisions have their disadvantages as they attenuate the ability of a corporation to manage its ESOP and control the number of shares issued and outstanding. This may be problematic if the corporation is the target of an unwanted corporate takeover. In addition, allowing option holders the ability to seek a cash payout at their discretion can disrupt a corporation's cash flow management. Hopefully, given the proliferation of ESOP as a means of compensation since Kaiser, the FCA will be presented with an opportunity to revisit its decision from Kaiser.

Read the full article from Taxand Canada here

Your Taxand contact for further queries is:
Eric Koh
T. +613 786 0121

Taxand's Take Author