February 20, 2018
Emerging and high growth companies must face a wide range of complicated executive compensation issues as they scale. When structuring compensation awards, your business must not only navigate employment law but also complex tax law and many other matters.
In addition, you might also encounter cross-border compensation issues if your business has operations in the U.S., for example, or if you have employees in Canada who are U.S. taxpayers. Understanding and preparing for these issues is key to mitigating risk and minimizing associated expenses. This presentation by Lynne Lacoursière, Co-Chair of Osler’s Executive Compensation Group, explains executive compensation matters your business will have to contend with. Available in both webinar and PowerPoint format, the goal of this presentation is to help you navigate the following issues:
- commonly used equity awards
- principal terms of equity incentive plan
- considerations on a change of control or IPO
- taxation of employment income in Canada
- deferred compensation — Section 409A of the Code
- taxation of commonly used equity awards
- stock options
- restricted shares
For more information, contact Lynne Lacoursière, Co-Chair of Osler’s Executive Compensation Group, at firstname.lastname@example.org, or 416.862.4719
This presentation is part of Osler’s Emerging and High Growth Companies 101 series, designed to help emerging ventures navigate through the various issues and legal requirements they will encounter throughout their growth cycle.
SIMON LEITH: All right. We're going to get started here. So hopefully everyone's had a chance to grab some lunch. I'm Simon Leith. I'm an associate here at Osler. And I wanted to welcome everyone to our Lunch and Learn series. I know many of you have been to previous series before. So today we're fortunate to have Lynne Lacoursiere speaking about executive compensation for emerging companies and startups 101.
So this is a topic that we see many of our startup clients struggle with. It's a topic that I guess overlaps with employment law, with tax law, and then when you add in US employees, you've got cross-border issues as well. So it's something that we find sometimes comes up in a financing or in an acquisition where stock options haven't been documented properly or tax issues haven't been dealt with. And so we always find it's better to address them at the outset rather than wait for a financing or an acquisition to clean things up. It's a lot cheaper that way as well.
And so I think the takeaway from today will just be it's a complicated topic. And so if you can leave here with just a high level understanding of some of the issues to look out for to know and to give us a call when you're either granting stock options to employees or consultants or directors or dealing with cross-border type compensation issues as well so that we can kind of help you through those issues.
So I think Lynne is going to get into the details here, and hopefully we don't lose you all in some of the rules, because they are complicated. But I think if you just kind of take a step back and think about the high level issues and know to give us a call when you're doing those types of stock issuances, I think that'll be a good take away for everyone. So without further ado, I'll turn it over to Lynne.
LYNNE LACOURSIERE: Sure. Thank you, Simon. So welcome, everyone. If you have any questions as I'm going along, please feel free to interrupt. I'd like it to be as interactive as possible. And again, to the extent that there's something that I'm talking about that you want to explore a little bit further, it's better to do it at that point.
So just what we're going to cover today. First commonly used equity awards. So the types of equity awards you'll see, what they're called, and what they cover. The principal terms of an equity incentive plan. Things to consider on a change of control or IPO. So when you have an exit event. And then as Simon alluded, it's hard to talk about equity compensation awards without getting into a bit of basics about the tax consequences, because these equity awards are structured with tax in mind.
And so if you don't understand the tax, then it's hard to understand what you can and can't do with these awards. And you certainly want to create that there's a match between when the employee has tax and when they're either receiving cash or they're receiving the shares so that they aren't being taxed before they actually get a benefit. So we'll cover both the tax consequences in Canada and the US.
And so, again, the reason why we would cover the US is, one, you could have operations in the US. So you have employees who are based there. But even if you don't have operations in the US, if you have employees in Canada who are US taxpayers, so they're a US citizen or US permanent resident, they are subject to US tax on their worldwide income. So the US tax rules matter for them as well when you're structuring the awards.
So just first on the commonly used equity awards. So stock options are the most commonly used. And a stock option is a right to purchase a share at a specified price. So that's what we typically refer to as the exercise price. It can be fair market value at the time of grant so that the employee or the recipient is only participating in the growth from the time of the grant. It could be at a discount. And then the option also typically specifies a period during which the option can be exercised after it's vested. Option terms typically no more than 10 years, but that's specified in the plan.
Another type of award are restricted share units and performance share units. And so an option an employee or the recipient is only participating in the growth from the exercise price to the time that they acquire the share. In a restricted share unit or performance share unit, it's a contractual right to receive a share or cash payment equal to the value of the share. So this is what's referred to as a full value award.
So even if there isn't any appreciation in the share price from the time that they're granted the award, unless a company goes bankrupt, there'll be some value that's ascribed to this award. So for a restricted share unit and performance share unit, they're not a shareholder at the time the award is granted, because it's just a contractual right to get a share or cash payment in the future. So they would only become a shareholder if the award is subsequently settled in shares.
Another type of full value award is a deferred share unit. And this is a right to receive a cash payment equal to the value of the share. And it's typically only paid out at the time that an individual ceases to be an employee or ceases to be a director. Deferred share units are more commonly used for deferral of director fees. Or you may see them for senior executives deferring a portion of their annual bonus. But because of the restriction on when the deferred share unit is paid out, you wouldn't typically use it for broad based employee grants.
And then another type of grant is restricted shares. And so this is an actual outright grant of shares. So they become shareholders at the time that the award is made. And it's typically subject to vesting and transfer restrictions. So if an employee ceases to remain employed through the vesting period, they would forfeit the share when they leave. And so restricted shares can be a good tool for founders when there's little initial value. And there might be a payment, a nominal payment, for the shares equal to the fair market value at that time.
OK. So just then switching into the principal terms of an equity incentive plan. So one of the first things is determining what is the share reserve. So how many shares are going to be made available for issuance under the plan? So you might see a reserve of between 10% and 20%. And it will also depend on the stage of the company. So at an earlier stage, you may see a larger pool.
And as the company grows in value in its later stage, the pool is smaller and would tend to approach more than 10%. And then you often see replenishment with each round outside investment. So the number of shares that are available for issuance under the plan will often be amended with each series of financing.
The next thing to consider is what type of shares will be subject to the awards. So you could use a series of voting common shares for the founders and then another series of common non-voting shares for equity awards. So when you're granting awards to your employees below the founder level, you probably don't want them to be having voting shares, but they could get the same economics through the use of non-voting shares. And then they would still be subject to shareholders agreements and voting agreements under the plan. But using the non-voting shares facilitates if there's any shareholder approval that's needed for share issuance to subsequent investors.
Then what type of plan would you be using? Just a simple option plan so that the plan only permits the grant of stock options? Or there's also omnibus plans. And so these are plans that contemplate that you can grant a number of different types of awards, such as the options, the restricted share units, restricted shares, deferred share units. So it gives the company the flexibility to choose the type of award. But they've all set it up under one plan.
Then who's going to be eligible to receive awards? So employees. That would be the most common. Directors. So if you have non-employee directors, would they be participating? And also if you have consultants.
So then if you have stock options, how are you going to determine the exercise price of the option? So typically an option is granted with an exercise price equal to fair market value on the date of grant. But it doesn't necessarily have to be a fair market value option. So if the company is a CCPC, there is more flexibility. And we'll get into that a little bit later in the tax piece.
So if you are granting the options at fair market value, one thing to consider then is how are you determining what that fair market value is. So you can obtain a valuation to determine that. And so scalar, which is a company based in Utah, typically charges about $3,000 for a valuation. Valuation is important if you have US taxpayers who are participating in the plan because of the potential adverse tax consequences to them if the option doesn't have an exercise price equal to fair market value.
But it also gives the directors comfort in knowing that there's a basis for the fair market value that's used for the exercise price for the options. But also if there are any repurchase rights that are exercised if an employee is a shareholder and subsequently leaves and the shareholders agreement may provide for the company's ability to repurchase the shares of the individual who's no longer an employee.
So then the awards are typically subject to vesting conditions. So for options and restricted shares for employees, it's pretty typical that they would vest 25% after one year and then 148 each month thereafter. And then for advisors or directors, there's typically a shorter vesting schedule. And so you might see perhaps a three month cliff and 1/24 each month thereafter. And so the awards are not-- an option can be exercised until the vesting condition has been met. And then if you have restricted shares as well, if an individual left before the vesting conditions were met, then the award would be forfeited.
So then if your plan contemplates either cash settled restricted share units or performance share units, those would typically vest within a three year deferral period. And this is to satisfy Canadian tax limitations. And then if you have performance share units, you would want to consider what are the applicable performance metrics. So are they financial performance measures such as EBITDA? Is it achieving a particular return on capital? So there's a lot of flexibility then in setting what the performance metrics would be for a PSU.
Then another typical provision is what is the term of the option? So how long does an individual have from the time the option is granted before it needs to be exercised? At which point the option would just expire if it was not exercised at that point. So 10 years is most common, but you may see something as low as five to seven years. So when you're setting what that option period is, you should consider when you think individuals would be exercising the options and whether you've given yourself enough flexibility.
So if you have US taxpayers, for example, and you had options with a five year term and the five year term was coming close to expiring, you would have a lot of difficulty in increasing the period of time in which they could exercise, so extending it to seven years or 10 years, for example, without triggering adverse tax consequences to them. So again, having a longer period at the beginning gives them more flexibility.
Then you also need to consider, well, what happens to these awards when an individual terminates employment? And so in the option context, how long do they have following a termination of employment to exercise their vested options? And so that can vary depending on the reason for the termination. So if an individual is terminated for cause, for example, you typically have all the options, whether they're vested or invested, immediately forfeited at the time of termination. But then if the termination is due to death or disability, you might have a longer period of time. If they're terminated without cause or that's a voluntary resignation or in some cases plans will provide a longer period of time for retirement. So again it's just thinking about how long do you want after an individual is no longer associated with the company to be able to exercise their awards? Yeah?
AUDIENCE: What's the typical length you're seeing for an exit that's not for cause, then, in the market?
LYNNE LACOURSIERE: So you might see something as short as 30 days. I think that is pretty short certainly in a private company context. You might see something as long as one year. There is a lot of variation on how that's structured. But you typically have a shorter window if it's a, say, voluntary resignation versus death or disability you might have a longer period or if somebody is terminated without cause. Or retirement you might see a longer window.
But typically, the vesting will cease when the individual is no longer performing services for the company. If someone is terminated without cause, it may be that the vesting-- the plan may provide that the vesting would continue during the statutory notice period. So that could be up to an additional eight weeks depending on the individual's length of service. But a plan needs to be very clear about when the vesting will cease in a termination. If the idea is that it should terminate on the last day of active employment, then the documents need to be very clear on that. Because otherwise it would otherwise continue during their notice period, because during the notice period, you're deemed to be made whole for the compensation that you would have had during that period.
And so then the other piece after you've determined, well, what are the restrictions on when the option can be exercised post termination? Well, what happens once they acquire the shares? So the individual exercises the option because they're in the money, and now they're a shareholder. So are there any repurchase rights that come into play following their termination of employment? And so perhaps there's a delay. If they're subject to non-competes, perhaps you want to have a longer period in which the company can exercise that repurchase right so you can see if they've violated any non-compete.
Shares are typically repurchased at fair market value. But if there's a termination for cause, so say for example somebody was terminated for cause but they had previously exercised the option, so they were already a shareholder, you may find that those are repurchased for the lesser of the cost. So what the individual paid to acquire the shares and the fair market value at the time. So the idea being that if somebody is a bad leaver that they shouldn't be participating in the growth.
So then another typical term is restrictions on transferability. So these awards are granted to incentivize the recipients and to make sure that their interests are aligned with those of the shareholders of the company. And so if an individual could just freely transfer those awards, it can undermine that incentive. And so typically the awards are not transferable other than on death there may be some ability, some limited ability to transfer them in connection with estate planning purposes. So if it's transferring to a trust that's controlled by the individual, for example. But often there isn't the ability to transfer that.
Then another thing is if you have full value awards such as your restricted share units, your PSUs, or your DSUs and the company is paying dividends on its common shares, often dividend equivalent rights are granted. And so this means that additional units of RSUs, PSUs, or DSUs are granted to those holders to make them whole for the dividends as though they were shareholders. And again, it could be done on a contractual basis. So you may have some awards that provide for the dividend equivalents and some that don't.
Then there are also what type of adjustments would be made to the awards in connection with a corporate event. So if you had a stock split or a share consolidation, for example, you would typically make an appropriate adjustment to the exercise price and the outstanding award so that you preserve the economic value of the awards. Also if you had a stock dividend, for example, that may necessitate an adjustment to the awards. But typically the plans don't provide for dilution protection.
So as additional common shares are issued, as you have subsequent investors coming in, there isn't this automatic right to get additional options or awards so that you maintain the same percentage. So employees who receive the grants earlier on will have low-- assuming the trajectory of growth will have a lower exercise price, perhaps greater value, but they'll have greater potential for dilution as time goes on.
Then what type of amendments can be made to the plan? Do any amendments need shareholder approval or is it just board approval? So that's where you look into your shareholders agreements and then perhaps as you've had subsequent outside investors, some investors may have some rights vis-a-vis what type of amendments are needed. If you have a plan that has incentive stock options, which are a special type of US stock options, then you need to be aware of the certain rules under the US for incentive stock options that require certain amendments to be approved by shareholders.
The big one would be if you had an increase in the share reserve. Unless the plan specifically set out, said the share reserve is x but the number of options that can be granted under incentive stock options is y and we weren't changing the y number, there's some thinking more in the terms of if you had an increase in the share reserve because you had an additional round of investment, that's just something to be aware of on whether any of the amendments need shareholder approval.
And then because these individuals once they receive either exercise of stock option or if they get restricted shares or they have their RSUs, PSUs settled in shares, they need to become party to any of the shareholders agreements, voting agreements, any rights with respect to drag along. So you want to make sure that they're becoming party to all of those agreements as a condition of the shares being issued to them.
Then in the context of stock options where an employee or the recipient would need to pay the exercise price to then receive the shares, some plans may provide for a net settlement or cashless exercise feature. And that helps the employees exercise without having to come up with the cash for the exercise price. So you would look at what's the in the money value of the options, and they would just receive the net number of shares. And so there is an impact if those are CCPC options, which we'll talk about a little bit later, or incentive stock options.
The other thing to keep in mind, it's one thing to allow the employees to cover their exercise price by net settlement. But then they'll also be withholding taxes that are triggered on the net settlement cashless exercise. And so that's a real cash outlay on the part of the company if it allows the employees to cover their taxes by the net settlement. So it could be that you allow employees to cover the exercise price by the net settlement but that they have to pay the company the amount of the withholdings so that the company can remit on their behalf. So again, that's just something to be aware because that has a real cash outlay.
AUDIENCE: If the employee can demonstrate that they have [INAUDIBLE]
LYNNE LACOURSIERE: So just repeating the question. So if the employee hasn't used its lifetime capital gains exemption, does the company still have to withhold? Yes, because the stock options, while they may get capital gains like treatment, and we'll talk about that a little bit later, it's employment income. So it doesn't count. Until they exercise and acquire the shares, that's employment income. So it's not going to count towards their lifetime capital gains exemption.
And so it's more of a concern on the net settlement. So for CCPC, just jumping ahead a little bit, if the individual paid the exercise price and acquired all the shares, you calculate what the amount of the employment benefit is. But they're not subject to tax until they dispose of the underlying share. So it's in recognition that they're acquiring an illiquid security and that they don't otherwise have the cash to meet the withholding. So the taxes are deferred until they sell the underlying share.
But if you do a net settlement or cashless exercise, what you're doing is you're disposing of your rights to acquire the share. And so you're triggering the tax on the disposition of those rights. So we don't have the deferral, and it's employment income. So we can't offset it with other of the lifetime capital gains exemption.
And then the other thing, our change of control provision. So plan will also address what happens to the awards on the change of control. So it could be a single trigger change of control provision, which means that all the awards would accelerate and be exercised or cashed out in a transaction. And that could be automatic. So the award agreement and the plan provides it automatically on a change of control. Everything will be accelerated and settled or cashed out. Or it could be discretionary. So the board, it's one of the things that the board can determine at the time whether they'll be cashed out or not.
Then you can also have double trigger awards. So this requires that the buyer would assume or substitute the award so that they could continue to remain outstanding following the change of control. And they would only vest, the acceleration would only occur if the individual was terminated without cause or constructively dismissed within a period following change of control, which is typically 12 to 24 months. And so again, if the awards are structured as double trigger, then it does give more flexibility for the company to be determining what's appropriate based on the nature of the transaction how to treat the awards. And so certainly in the public company context, double trigger is viewed as a best practice, because there isn't this automatic windfall that's occurring on a transaction.
So just very briefly on golden parachutes. So if there's a change of control and you have US taxpayers who are participating in your plan and their awards will accelerate in connection with the change of control so that there's value. They were otherwise not fully vested, for example, and they're going to accelerate in connection with the change of control. Then one thing you just need to be aware of is 280G. And so 280G was enacted to discourage companies from making large payments to executives in connection with the change of control. So it results if there's a US corporation, they lose the deduction on anything that's viewed as an excessive parachute payment. And then separately, individuals are subject to a 20% excise tax.
So there isn't an equivalent rule in Canada, but they're enforced independently. So if you have a Canadian company that undergoes a change of control but you have a US executive who is getting [INAUDIBLE] load of options that are accelerating, the exercise price was pretty low when they were granted, so there's a lot of value there, they could be subject to this. But there's an important shareholder approval exception for private companies.
And so if disclosure of the payments is provided to the shareholders, then you can effectively cleanse this excess parachute payment and there isn't the loss of deduction. And the individual doesn't have an excise tax. And this is where it's also important now you've considered on the front end that you're going to grant non-voting or you're going to use non-voting shares to your employees so that you have a smaller base of employees who are voting shareholders.
Because this rule requires you to be disclosing to all your voting shareholders what the payments that they're getting on a change of control, and that can be quite sensitive information. So again, this is where having on the front end when you've thought about what types of shares you're using, this also helps you on the back end.
Then if an exit is an IPO, then the plans are typically-- new plans are typically put in place following an IPO, because they're subject to different rules that apply to public companies. So for example, if you're TSX listed or TSXV listed debate, each of those exchanges have their own rules that apply to stock options.
Then another thing to just be aware of. So if you granted stock options within three months of filing a preliminary prospectus to be listed on the TSX, you would want to make sure that those stock options don't have an exercise price that's less than your IPO price. Because the TSX as a condition of your listing can require you to increase the exercise price of those options. So it's, again, being wary of how the valuation is being determined if you have an IPO that's on the horizon.
But typically, you would just-- an IPO is not usually viewed as a change of control. And so the plan would just usually continue to run its course. And so you would keep the old plans in place, and they would govern the awards under the old plans and then new plans that are subject to the TSX rules would be adopted. And then there are also other considerations. So institutional shareholders, proxy advisors such as ISS Glass Lewis. There's also corporate governance practices. So these things that come into play in the public company context that aren't relevant in the private company context. So any questions here before I move on to the tax piece? OK.
So just the general principle about taxation of employment income in Canada is that you're generally taxed when you receive the amount. So you either receive a cash or you receive a benefit such as a share. There's an exception to the general rule that's called salary deferral arrangement. This is a very technical rule. I won't get into what that is. But if you have an amount that's an SDA, then you would have income inclusion in an earlier year.
So before an individual receives the cash payment or they receive the share. So equity awards are designed to avoid the application of being an SDA. So stock options. Those have their own provisions in the Tax Act. So they're not subject to the SDA. Then deferred share units. Again, they have their own regime. And then as well, a cash bonus is paid within three years. So again, that's just where the idea of the tax rules driving how the awards are structured.
AUDIENCE: Are there any circumstances in which you would want an [INAUDIBLE]?
LYNNE LACOURSIERE: No, because you would have-- so say I granted-- the question was, any instance where you'd want an SDA? So say you granted restricted share units that were going to be paid in cash and you said they're going to be paid in cash in a four year vesting schedule. So that would fall outside of the rule, and they were worth on their face $10,000 on the date of grant.
Then the individual should have included $10,000 in their income for the year in which it was granted even though they're not subsequently getting paid. There is an adjustment if they're forfeited. They get to then subsequently sort of remove it. But you've paid tax before you even know that you're getting anything. And then that would be subject to withholding. So then there's a real cash outlay on the part of the employee to cover that.
So then from a US perspective, section 409A of the code is something that comes up often in these equity compensation plans. So it imposes a comprehensive set of rules on the taxation of nonqualified deferred comp. And it's a very broadly defined term. And so 409A was enacted following the collapse of Enron. So back in 2004 where there were a bunch of executives that had all these unfunded deferred compensation arrangements, and they were able to pull out their money from the company as the company is tanking. And so these rules were enacted in response to that.
And so there are significant penalties that are imposed on the individual. So not the company if they're not met. But again, we typically design plans that comply with 409A because this results in a penalty. So 20% additional tax. And then there is earlier income inclusion, and then there's interest penalties. And so employees are certainly not happy if they're subject to these types of penalties. And again, if you have anybody, a US citizen who's in Canada, for example, because they're subject to the US tax rules on their worldwide income, they'll be subject to this as well.
So stock options. So stock options in Canada, they're governed by Section 7 of the Income Tax Act. And it's an agreement to sell or issue shares. So there's no tax that occurs on the grant and there's no tax that occurs on the vesting. So what the individual is taxed on is referred to as the stock option benefit. So this is the difference between the fair market value of the shares when they acquire them and the exercise price. So in the money amount. And then the corporation is not entitled to deduction in respect to the stock option. So the company or the employee will have employment income inclusion, but the company will not get a deduction for the expense associated with issuing the shares.
So if the company is a CCPC, so Canadian Controlled Private Corporation, when the stock option is granted, you would calculate what the benefit is at the time they exercise. So say in the money amount is $20,000 when they exercise it. So that we fixed that amount. But they're not going to include that in income until the underlying shares are sold. And so again, that's in recognition of these being illiquid shares. And then if the shares acquired on exercise are held for two years, then only 50% of that, $20,000 in the example, is subject to tax.
So that's where they would get capital gains like treatment. But it is employment income. And so that's where it doesn't kick in yet vis-a-vis their lifetime capital gains exemption. Separately, the gain on the difference between-- so if the shares increase-- the value of the shares increased from the time that they exercised and so that they sold-- there was an additional 10,000 gain on the shares when they sold them, then that they could apply against their lifetime capital gains exemption but not the full amount.
And then say if the share price declines, for example. So they bought the shares when they were $20, but when they subsequently sell the shares when they're $15, it doesn't reduce what their stock option benefit was. So they still have to include that amount as employment income. It's just been a deferral. But then they would have a capital loss on the option. And so the 50% deduction is available even if the exercise price is less than fair market value. So this would apply if you had even a restricted stock unit that settled in shares, for example. As long as they hold the shares for two years, they have the deferral of the income tax and they could potentially have the 50% income inclusion.
So if the corporation is not a CCPC at the time the stock option is granted or it's a CCPC but you haven't met the two year hold period, there may be a separate 50% deduction available if the exercise price can't be less than fair market value on the date of grant. So you've granted them fair market value options and they acquire proscribed shares. And these are essentially plain vanilla common shares.
But there are certain share terms or repurchase rights that can impact the prescribed share status, such as if on a termination without cause or, say, for example, an individual exercise of stock option but under the shareholders agreement and they've terminated employment under the shareholders agreement, the company can repurchase the shares within six months following the termination. That could impact the prescribed share status of it.
And so generally, I think our form of documents are designed to ensure that they would be proscribed shares. But it's not something that you can guarantee at the outset of the grant, because the determination of whether something is a prescribed share is done at the time that the shares is acquired and not the time that you receive the option grant. So if there was some change in the company or a change in the share terms that could impact the prescribed share status, you can't guarantee that at the time of grant.
So then stock options for the US, again, is consider whether any of your option holders are US taxpayers. And there's two types of options for US taxpayers. There's incentive stock options and non-qualified stock options. And then also consider if there's any US securities laws issues. So if you're granting options to US residents, there are securities laws exemptions that need to be complied with. And so at both the federal and state level.
So if you have employees in California, for example, there are very specific rules as to the terms that need to be in an option plan for employees in California. And the plan is also subject to shareholder approval. So again, just something to keep in mind when you're adopting these plans is where are your employees located. Are there any rules in the local jurisdictions that need to be reflected in the option plan or the option grants agreements?
So an incentive stock option is similar to a CCPC option in that the employee is not taxed until they sell the underlying shares. And as long as a hold period is met, then the employee gets capital gains treatment. But there are a number of very technical requirements to meet an ISO. And so again, just the one that I mentioned before is just being aware of the shareholder approval requirement. So every time you increase the number of shares that are available under an ISO, you need new shareholder approval. And then you also need to just be aware that certain changes to the terms of the option can result in the loss of the ISO status. And then it would become non-qualified options.
So a non-qualified option is any option that doesn't meet the requirements of incentive stock options. And so instead of being taxed when the underlying shares are disposed of, it's taxed at the time of exercise. And there is no favorable capital gains rate. So it's just full employment income. And this is where Section 409A comes into play. And so you just want to make sure that they are being granted options to acquire common stock and that they're either employed by the corporation granting the stock or they're employed by an entity below. And this is, again, just to meet the technical requirements 409A and that the exercise price is not less than fair market value.
So if you grant options at a discount to a US person, we can do that without triggering adverse tax consequences. But you have to hardwire in when the option would be exercised at the time of grant. And so that's not a very desirable feature to be determining at the time that you grant the option when it will be exercised. And there are very limited instances in which you can grant those.
OK, so since we're getting short on time, I'm just going to skip over the RSUs and PSUs and DSUs and just talk very quickly about restricted shares. So they're not as commonly used in Canada unless it's a CCPC than in the US because of the different tax treatment. So if you grant restricted shares, so again, that's an outright grant of shares that are subject to vesting conditions, if it's a CCPC, then you have the deferral of the tax until they subsequently dispose of the share. But if it's not a CCPC, then they've received a taxable benefit. And so while they can't do anything with the shares and they may forfeit the shares, they have immediate income inclusion.
So unless the shares have little value at that time, those aren't as desirable. In the US, a grant of restricted shares, they're not taxed until the vesting. And so only when the vesting conditions are met would an employee be taxed on it. Except an employee can make an election, it's a Section 83(b) election, so that they get taxed at the time of grant and then they got all future appreciation as taxed as capital gains. So again, if the value of the share is relatively low, that may make sense. Oh, so is my battery here. That may make sense to be granting or to be making the Section 83 election, because you're including the amount in income when it's low, and then you get the capital gains rate.
So and then just one last final thing. So as part of the tax reform, there's a new Section 83(i) of the code. And it provides for subsequent deferral for certain private company awards. And so if you have broad based plans, it would allow individuals to defer the tax on the exercise of a non-qualified option or if they get a share on the settlement of RSUs.
I'm not sure at this point how widely this will be used, because it needs to be a broad based plan. So there certainly needs to be a lot of participation of US employees, and we don't have any regulations or guidance on how this would be implemented. But again, this would be-- once we have a little bit more information and you have US folks in there and if you're making broad based grants, it's another potential vehicle that allows for a bit of a deferral for that.
Any questions? I know that was a lot to throw at you, but I'm around if you have any questions. Happy to answer any follow up. And then I think Simon said the slide materials will be sent around too. Yeah, distributed.
LYNNE LACOURSIERE: Sorry, the companies are--
AUDIENCE: The companies that I've been involved with in the past have used RSUs [INAUDIBLE]. So the question is, if you're using those without a [INAUDIBLE], do you actually either pay a set sum of actual shares in the corporation that are used for that, or does the corporation have a treasury that can buy or somehow acquire shares on the [INAUDIBLE] I'm thinking of those restricted shares versus options.
LYNNE LACOURSIERE: Sure. So the question is, if you're granting the restricted shares or you have restricted share units that are going to be settled in treasury shares, do you have a reserve for that? And the answer is yes. So if you had an omnibus plan that allowed for multiple grants, your share of reserve would cover any shares that you issue on exercise of option, any shares that you grant as restricted shares, or if you settle those RSUs and treasury shares. So those would be covered.
So you would typically have just one pool that would cover all of them. In the public company context, the pools usually have subpools that would say x percent are available for options versus full value awards. And that's because a full value award is more dilutive to the shareholders.
SIMON LEITH: Thank you very much, Lynne.
Lynne mentioned she's going to stick around. So if anyone has any.