20 March 2002 Internal T.I. 2002-0126537 - Article XV(2); Employee Stock Options

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: 1. Is a stock option benefit to be included in income in the year the stock option was granted for purposes of determining the application of subparagraph 2(a) of Article XV of the U.S. Tax Convention?

2. Where the individual has regular employment income in the year that the stock option benefit was granted, and this income is borne by a Canadian employer (or a PE), is this sufficient to make the whole of the remuneration for the year, including the stock option benefit, taxable in Canada, notwithstanding that the stock option benefit is not borne by a Canadian employer (or a PE) and would ordinarily be exempt under subparagraph 2(b) of the U.S. Tax Convention (where the individual is not in Canada for more than 183 days)?

Position: 1. Yes. 2. No.

Reasons: 1. We have consistently taken the position that a stock option benefit is to be included in "remuneration" for purposes of subparagraph 2(a) of Article XV in the year that the stock option was granted. Thus, even if regular employment income is less than $10,000, a stock option benefit that is attributable to the same year may bring the employee's total remuneration for year above $10,000 such that the exemption in subparagraph 2(a) of Article XV does not apply.

2. Although we could try to read "remuneration" as a collective whole for purposes of subparagraph 2(b), as we do for subparagraph 2(a), the emphasis on the amount being "borne by" the Canadian employer (or PE) strongly suggests that the intention was that any income not borne by a Canadian employer (or PE) should not be taxable in Canada where the employee was not in Canada for more than 183 days.

Ms. Thea Kreuger

International Tax Directorate
Canada Building 2002-012653
344 Slater Street, 5th Floor Eliza Erskine
Ottawa ON K1A 0L5

March 26, 2002

Dear Ms. Kreuger:

Re: Application of Paragraph 2 of Article XV of the Canada-United States Income Tax Convention (the "Convention") to an Employee Stock Option Benefit

This is in reply to your email letter to us of March 4, 2002 (the "Email Letter"), in which you asked us to consider the application of paragraph 2 of Article XV of the Convention to the following situation:

? The taxpayer was not a resident of Canada for purposes of either the Income Tax Act (the "Act") or the Convention. The taxpayer was a resident of the United States for purposes of the Convention.

? The taxpayer was employed by a Canadian corporation ("Canco") and was paid a salary of $7,000 by Canco in respect of his employment exercised in Canada in the particular taxation year.

? In the same taxation year, Canco granted stock options to the taxpayer in connection with his employment exercised in Canada.

? The taxpayer was not present in Canada for more than 183 days.

? The taxpayer exercised the stock options at a time after the particular taxation year and obtained a benefit of $543,500.

We also acknowledge your request for a copy of the example that was originally attached to our file #933330 dated December 2, 1993 (the "1993 Memo"). We enclose a photocopy of the example requested with this letter.

Unless otherwise stated, every reference in this letter to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act, except in the case of references to Article XV, which are references to the Convention.

Issues

1. Should the stock option benefit described above be included in "remuneration" in the year the stock option was granted for purposes of determining the application of subparagraph 2(a) of Article XV?

2. Should the fact that the taxpayer earned regular employment income in the year that the stock option benefit was granted, which was income "borne by" a Canadian employer for purposes of subparagraph 2(b) of Article XV, be sufficient to make the whole of the remuneration for the year, including the stock option benefit, taxable in Canada, even though the stock option benefit itself was not "borne by" a Canadian employer for purposes of subparagraph 2(b) of Article XV due to the application of subsection 7(3)?

Our Comments

Issue 1: Application of subparagraph 2(a) of Article XV.

Our position continues to be the same as that set out in the 1993 Memo. This means that we consider the full amount of an employee stock option benefit to be earned in the year that the stock option was granted, regardless of when the stock option is actually exercised. In the situation set out above, we would consider that the employee stock option benefit of $543,500 was derived by the taxpayer in respect of an employment exercised in Canada in the year that the stock option was granted (which we understand to be the same year in which the salary of $7,000 was earned). We also take the position that "remuneration", for purposes of subparagraph 2(a) of Article XV, is a collective term that means the total of all compensation earned by the taxpayer in the year in respect of an employment exercised in Canada.

Thus, the taxpayer in the situation set out above is not exempt from Canadian tax on either the $7,000 salary or the $543,500 stock option benefit on the basis of subparagraph 2(a) of Article XV, as his total remuneration for the year from his employment exercised in Canada was in excess of $10,000.

Issue 2: Application of subparagraph 2(b) of Article XV.

There are two conditions that must be met in order for a taxpayer who is resident in the United States for purposes of the Convention to be exempt from Canadian tax pursuant to subparagraph 2(b) of Article XV with respect to remuneration derived from employment exercised in Canada. First, the taxpayer cannot have been present in Canada for more than 183 days in the taxation year, and second, the remuneration must not be "borne by" either a Canadian employer or the permanent establishment of a non-resident employer. For purposes of the Convention, "borne by" means that the amount in question is available to the employer as a deduction in computing taxable income.

In the situation described above, the taxpayer meets the first condition for the application of subparagraph 2(b) of Article XV, as he was not present in Canada for more than 183 days in the taxation year. He clearly does not meet the second condition with respect to the $7,000 of regular employment income, as that is an amount that could be deducted by the Canadian employer in computing its taxable income and is, therefore, remuneration borne by the Canadian employer. On the other hand, the stock option benefit is not considered to be an amount "borne by" the Canadian employer, because subsection 7(3) prevents the Canadian employer from deducting the amount of the stock option benefit in computing its taxable income. The issue that arises is whether the two types of remuneration, one borne by the Canadian employer and the other not, must be considered together in applying subparagraph 2(b) of Article XV. If the two types of compensation are considered as together comprising the "remuneration" contemplated by subparagraph 2(b) of Article XV, then the fact that some of the remuneration is borne by the Canadian employer in the situation described above could be enough to conclude that the exemption from Canadian tax under that provision does not apply. In our opinion, however, the better view is that subparagraph 2(b) of Article XV was intended to exempt from Canadian tax any Canadian employment income of a United States resident that is not deductible by the Canadian employer (for purposes of the Act), as long as the United States resident is not present in Canada for more than 183 days. In other words, in the context of subparagraph 2(b) of Article XV, it is reasonable to consider each item of employment income individually in order to determine what is, and what is not, borne by a Canadian employer and consequently what is not, and what is, potentially exempt from Canadian tax.

With respect to the situation described above, it is our opinion that the $7,000 of regular employment income is taxable in Canada because neither subparagraph 2(a) nor subparagraph 2(b) of Article XV apply. However, the stock option benefit of $543,500 is exempt from tax in Canada by virtue of subparagraph 2(b) of Article XV, because the taxpayer was not present in Canada for more than 183 days and that amount was not borne by the Canadian employer due to subsection 7(3).

We trust that these comments will be helpful to you.

Yours truly,

Jim Wilson
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

Enclosure