Commentary on October 24, 2012 Notice of Ways and Means Motion Relating to Tax Matters - Shares Issued as Consideration for Property or Services (proposed section 143.3)

Nov 1, 2012

The Tax Court of Canada held in Alcatel Canada Inc. v. The Queen, [2005] 2 C.T.C. 2001 (TCC), that the taxpayer was entitled to an investment tax credit in respect of the value of stock option benefits granted to its employees because the stock option benefits constituted “expenditures” made in respect of an expense for salary and wages – notwithstanding that the taxpayer made no cash outlay in respect of the stock option benefits.  Proposed section 143.3, the legislative response to Alcatel was introduced in a Notice of Ways and Means Motion tabled on November 17, 2005 to “clarify that the amount of an expenditure allowable to a taxpayer, and upon which a tax credit or deduction may be claimed, is limited to the amount actually disbursed by the taxpayer” (see Department of Finance press release 2005-080, dated November 17, 2005). Proposed section 143.3 contains rules that determine the amount of an expenditure that is considered to be made by a taxpayer on the issuance of an interest in the taxpayer or the issuance or exercise of an option to acquire an interest in the taxpayer.  Proposed section 143.3 was revised in 2006 and again in 2010 (see the Notice of Ways and Means Motion tabled on November 9, 2006 and the draft legislative proposals released by the Department of Finance on July 16, 2010; the latter is referred to herein as the “2010 Proposals”).

The 2010 Proposals provided that where a share or interest in the taxpayer is issued as payment for property or services received by the taxpayer, the amount of the taxpayer’s expenditure is generally reduced by the excess of the fair market value of the issued share or interest over the fair market value of the “property transferred to” or the services provided to the taxpayer.  The 2010 Proposals provided that an issuance of a share to a taxpayer is deemed to be a transfer of property for this purpose (proposed paragraph 143.3(5)(e)).  The 2010 Proposals did not provide a similar rule for the issuance of interests by non-corporate entities, such a partnerships and trusts or the issuance of a promissory note other promise to pay.  Nor did the 2010 Proposals address the issuance of promissory notes or other promises to pay by corporate or non-corporate entities.  These omissions have been addressed in the Notice of Ways and Means Motion (the Notice of Ways and Means Motion removes proposed paragraph 143.3(5)(e) and revises proposed subparagraphs 143.3(3)(a)(ii) and 143.3(4)(a)(ii) to include “property transferred or issued to” the taxpayer).

Previous versions of proposed section 143.3 provided that the portion of an expenditure that arises as a result of a taxpayer granting or issuing an option in itself or in another taxpayer with whom the taxpayer does not deal at arm’s length is generally not considered to be an expenditure of the taxpayer.  This rule has been criticized on the basis that it results in the taxpayer not having a cost in a property that it receives as consideration for the granting of an option to acquire shares or other interests in the taxpayer (see letter from The Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants to the Department of Finance dated September 17, 2010.).  This issue has not been addressed in the Notice of Ways and Means Motion.

Finally, the Notice of Ways and Means Motion broadens the scope of options that are addressed by proposed section 143.3 to include “a security that is issued or sold by a taxpayer under an agreement referred to in subsection 7(1) [of the Act]” (these are, generally speaking, shares issued or sold pursuant to employee stock options).

If enacted, proposed section 143.3 will come into force on November 17, 2005, except that for securities issued or sold before October 24, 2012, the definition of “option” is to be read without regard to the revision referred to in the immediately preceding paragraph.

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