9 December 2008 Roundtable, 2008-0300631C6 - Allocation of Stock Option Benefit

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.

Principal Issues: What is the CRA's interpretation of the phrase "principal place of employment", that is found in Paragraph 6 of the Diplomatic Note, Annex B to the Fifth Protocol?

Position: Based on physical presence

Reasons: Consistent with existing sourcing rules.

2008 TEI-CRA Liaison Meeting
December 9, 2008

Question 3(B) - Allocation of Stock Option Employment Income

The Fifth Protocol amending the Convention Between Canada and the United States With Respect to Taxes on Income and on Capital (the "Convention") was released on September 21, 2007. Paragraph 6 of the Diplomatic Note, Annex B to the Fifth Protocol provides a specific rule for the allocation of taxing rights under Articles XV (Income from Employment) and XXIV (Elimination of Double Taxation) of the Convention where an employee is granted stock options and his principal place of employment is in both the United States and Canada. What is CRA's interpretation of the phrase "principal place of employment"?

Answer:

Paragraph 6 of the Diplomatic Note, Annex B reads as follows:

For purposes of applying Article XV (Income from Employment) and Article XXIV (Elimination of Double Taxation) of the Convention to income of an individual in connection with the exercise or other disposal (including a deemed exercise or disposal) of an option that was granted to the individual as an employee of a corporation or mutual fund trust to acquire shares or units ("securities") of the employer (which is considered, for the purposes of this Note, to include any related entity) in respect of services rendered or to be rendered by such individual, or in connection with the disposal (including a deemed disposal) of a security acquired under such an option, the following principles shall apply:

(a) Subject to subparagraph 6(b) of this Note, the individual shall be deemed to have derived, in respect of employment exercised in a Contracting State, the same proportion of such income that the number of days in the period that begins on he day the option was granted, and that ends on the day the option was exercised or disposed of, on which the individual's principal place of employment for the mployer was situated in that Contracting State is of the total number of days in the period on which the individual was employed by the employer; and

(b) Notwithstanding subparagraph 6(a) of this Note, if the competent authorities of both Contracting States agree that the terms of the option were such that the grant of the option will be appropriately treated as transfer of ownership of the securities (e.g., because the options were in-the-money or not subject to a substantial vesting period), then they may agree to attribute income accordingly.

Paragraph 6 of the Diplomatic Note, Annex B enters into force on the date of the entry into force of the Fifth Protocol. If the Fifth Protocol enters into force in 2008, Paragraph 6 of the Diplomatic Note, Annex B will have effect on January 1, 2009.

In our view, the phrase "principal place of employment" means the Contracting State in which the employee was physically present while exercising the employment on a particular day. When applying the Fifth Protocol to employee stock option benefits, we generally will apportion the stock option benefit over the period between the grant and exercise of the option using the following fraction:

Number of days on which an employee is physically present in a
Contracting State while exercising the employment in the period
Total number of days exercising the employment in the period

If the employee was present in two countries on one day, rendering services in each country, we would look to the country in which the employee "principally" (i.e. more than 50%) rendered services on that day.

For example, assume that on January 1, 2009, an employee is granted an option to acquire 1,000 shares of the capital stock of his employer. On December 31, 2009, the employee exercises the option, and realizes a benefit of $100,000. During the year, the employee worked 100 days in Canada and 150 days in the United States for the employer, and paragraph 6(b) of the Diplomatic Note, Annex B does not apply. The employee was present in the United States for more than 183 days during the year. Both the employee and the employer are resident in Canada throughout the year for purposes of the Convention.

In this situation, we will consider that $40,000 (i.e. 100/250 x $100,000) of the stock option benefit is derived from employment exercised in Canada, and $60,000 (i.e. 150/250 x $100,000) of the benefit is derived from employment exercised in the United States. The entire benefit of $100,000 is taxable in Canada by virtue of paragraph 7(1)(a) and subsection 2(1) of the Income Tax Act. The United States is entitled to tax $60,000 of the benefit as the country of source, by virtue of paragraph 1 of Article XV of the Convention, and paragraph 2 of Article XV does not apply. The employee will be entitled to a foreign tax credit in Canada in accordance with Article XXIV of the Convention in respect of the U.S. income taxes paid on the portion of the benefit that has been sourced to the United States.

Prepared by:

Sherry Thomson
International & Trusts Division
Income Tax Rulings Directorate
December 4, 2008