Jay A. LeftonJay A. LeftonSenior PartnerSenior Partner

jlefton@ogilvyrenault.comjlefton@ogilvyrenault.com

416.216.4018416.216.4018

OPTIONS AND OTHER OPTIONS AND OTHER EQUITY-BASED INCENTIVES FOR EQUITY-BASED INCENTIVES FOR

EMPLOYEES AND EMPLOYEES AND

OTHER SERVICE PROVIDERS:OTHER SERVICE PROVIDERS: Tax, Corporate and Securities IssuesTax, Corporate and Securities Issues

Presentation at the Sault Ste. Marie Innovation Centre

September 15, 2009

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Tax Framework:Tax Framework:Taxation of Taxation of EmploymentEmployment Income 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.

“phantom” stock plans

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Section 7 Based PlansSection 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 Section 7 Based Plans (cont’d)(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: Section 7 Based Plans: General RulesGeneral 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: Section 7 Based Plans: General Rules General Rules (cont’d)(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: Section 7 Based Plans: General Rules General Rules (cont’d)(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: Section 7 Based Plans: General Rules General Rules (cont’d)(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 s. 7 benefit taxed at

capital gains rates

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Section 7 Based Plans: Section 7 Based Plans: General Rules General Rules (cont’d)(cont’d)

Deferral of s. 7 benefit for CCPCs s. 7 benefit not taxed until employee disposes of shares

Deferral opportunity for public company (non-CCPC) 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: Section 7 Based Plans: Other Tax IssuesOther 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 PlansPhantom 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 Phantom Stock Plans (cont’d)(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 Stock Options and Consultantsand 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:Corporate Considerations:Stock Option PlansStock Option Plans A stand-alone grant or a “plan” Considerations:

Maximum number of shares eligible Exercise price

Permit cashless exercise? Categories of recipients

EmployeesDirectorsConsultants 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:Corporate Considerations:Stock Option Plans Stock Option Plans (cont’d)(cont’d)

Considerations (cont’d): Effect of a sale of the company (change of control) or

amalgamation/mergerAutomatic 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:Corporate Considerations:Stock Option Plans Stock Option Plans (cont’d)(cont’d)

Considerations (cont’d):

What happens if the recipient ceases to be involved with the company?Effect on vested vs. unvested optionsTerminated by the company “for cause”Terminated by the company not “for cause”Voluntary resignation by individualDeath 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:Corporate Considerations:Stock Option Plans Stock Option Plans (cont’d)(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

Method of approvalEffect on prior grants

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Securities Law IssuesSecurities 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. LeftonJay A. LeftonOgilvy Renault LLPOgilvy Renault LLP

Suite 3800 – 200 Bay StreetSuite 3800 – 200 Bay Street

Royal Bank Plaza, South TowerRoyal Bank Plaza, South Tower

Toronto, Ontario, Canada M5J 2Z4Toronto, Ontario, Canada M5J 2Z4

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jlefton@ogilvyrenault.com