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: Sourcing of RSU benefits when employment is exercised within and outside of Canada.
Position: General guidance provided.
Reasons: The OECD Commentary on sourcing cross-border employee stock options is instructive.
Author: Koh, Kah Foo
Section: 7(1)(a); 110(1); 126(1)
January 20, 2021
Jennifer Kiervin HEADQUARTERS
Business Call Centre Support Division Income Tax Rulings Directorate
Call Centre Services Directorate
Kah Foo Koh
Re: Cross-border Restricted Share Units
Dear Ms. Kiervin:
You have asked for our assistance in determining the Canadian taxation of cross-border restricted share units (footnote 1) (“RSUs”) granted to employees who perform portions of their employment duties during the vesting period of the RSUs in Canada and a foreign jurisdiction.
In general, the Canadian taxation of RSUs is a question of fact, and will depend on the particular facts and circumstances in each case. Where the employment duties underlying an award of RSUs are performed both within and outside of Canada, the resulting benefits arising from the RSUs (“RSU Benefits”) may be taxable in both Canada and the foreign jurisdiction. In order to prevent or minimize double taxation, such benefits need to be properly sourced between Canada and the foreign jurisdiction. In particular, the sourcing of RSU Benefits is relevant for the rules for determining taxable income earned in Canada under subsection 115(1) (footnote 2) , the foreign tax credit rules in subsection 126(1), and the employment article in Canada’s income tax treaties.
This memorandum sets out general guidance on the manner in which benefits arising from RSUs (footnote 3) should be sourced between Canada and a foreign jurisdiction. The guidance is subject to any relevant provisions in an income tax treaty between Canada and the foreign jurisdiction. The guidance is not applicable if the RSU plan is a salary deferral arrangement (as defined in subsection 248(1)).
The guidance applies to RSU benefits received after 2020.
Guidance for Sourcing of RSU Benefits
As RSUs and employee stock options are both forms of equity-based employee compensation that are typically subject to a vesting period, we refer, in part, to the Organization for Economic Cooperation and Development’s (“OECD”) guidance on the taxation of employment income arising from cross-border employee stock options (the “OECD Guidance”) to inform our views on the taxation of RSUs.
1) OECD Guidance for Sourcing Cross-Border Employee Stock Options
The CRA has been applying the OECD Guidance to resolve double taxation under its income tax treaties with respect to employee stock options since it was first issued in 2005. In 2012, the CRA extended the application of the OECD Guidance to address double taxation between Canada and countries with which Canada do not have income tax treaties (see 2012-0459411C6).
In general, the CRA applies the principles outlined in paragraphs 12 to 12.15 of the Commentary on Article 15 [Income from Employment] of the OECD Model Tax Convention on Income and on Capital when allocating cross-border employee stock options, unless the provisions of a bilateral income tax treaty provide otherwise (footnote 4) .
Paragraph 12.6 of the OECD Commentary says that determining how much of a benefit is derived from employment exercised in the source state is to be done by examining all the facts and circumstances, including any relevant contracts, and by applying the general principles in paragraphs 12.7 to 12.14.
Paragraphs 12.7 to 12.10 of the OECD Commentary contain the first principle. Paragraph 12.7 says that generally the stock option benefit should not relate to the period of employment after the period that is required as a condition for the employee to acquire the right to exercise the option (i.e., the “vesting period”). Paragraph 12.10 gives examples of situations where the first principle may not apply. That is, the option may clearly relate to some period other than the vesting period.
Paragraphs 12.11 to 12.13 contain the second principle. Paragraph 12.11 says that the employee stock option benefit would generally not relate to past services, unless there was evidence to indicate that past services were relevant. Whether an employee stock option benefit pertains to past services is a question of fact. The OECD appears to have adopted the rebuttable presumption that an employee stock option benefit pertains to services rendered after the date on which the employee stock option was granted. The OECD did not explicitly address the manner in which an employee stock option benefit relating to past services should be sourced.
Paragraph 12.14 says that the employee stock option benefit should be apportioned based on the number of days of employment exercised in each country over the total number of days in the period during which the employment services from which the stock option benefit is derived have been exercised.
2) Hybrid Methodology for Sourcing RSU Benefits
Determining whether RSU Benefits relate to employment exercised inside or outside Canada should be done by examining all of the relevant facts, including the RSU plan documents and the individual award agreements, and by applying the methodology below.
The following methodology generally applies in sourcing RSU Benefits between Canada and foreign jurisdictions (the “Hybrid Methodology”):
i. Separate the “in the money” portion of RSU Benefits at the date of grant (the “ITM Portion”) (footnote 5) and the portion of RSU Benefits relating to the increase in fair market value of the underlying shares from date of grant to date of vesting (the “FMV Portion”).
ii. The ITM Portion at the date of grant generally pertains to past services, and is sourced to the jurisdiction in which the employment services were rendered in the year in which the RSUs were granted (if multiple jurisdictions, in proportion to the employment period exercised in each jurisdiction in that year).
iii. The FMV Portion generally pertains to services rendered during the vesting period, and is sourced according to the OECD Guidance (that is, in proportion to the employment period exercised in each jurisdiction from date of grant to date of vesting).
The Hybrid Methodology may be applied regardless of whether:
* the relevant employee was a resident of Canada or a foreign jurisdiction at the time the relevant RSUs were granted;
* the RSUs all vest on a single day or vest over a period of time;
* the RSUs are settled in cash or through the issuance of shares of the capital stock of the corporate employer; or
* the RSUs are subject to section 7.
It is important and necessary to determine where the employment giving rise to RSU Benefits was exercised. In addition to being necessary for the application of the Hybrid Methodology, under the employment article of Canada’s income tax treaties, Canada may relinquish taxing rights that it may otherwise have under its domestic tax laws if it determines that the benefit is not in respect of employment exercised in Canada, or certain thresholds are not met.
It should be noted that whether a taxpayer is, or is not, a resident of Canada at any time during the vesting period of the relevant RSUs should not have any impact on the manner in which the Hybrid Methodology is applied or the results of the Hybrid Methodology, since the Hybrid Methodology simply looks to the jurisdictions in which the employee's duties were performed (rather than residency) during the vesting period and sources any RSU Benefits accordingly. In contrast, the residency of an employee may have a significant impact on whether, and how much, RSU Benefits are taxed in Canada, and the availability and quantum of foreign tax credits the employee may claim under subsection 126(1). Thus, the amount of RSU Benefits that is sourced to Canada using the Hybrid Methodology may not necessarily be the same as the actual amount of RSU Benefits that are taxable in Canada under the Act.
The following example illustrates the application of the guidance for a typical RSU plan.
Mr. X works as an employee for Company A, a corporation resident in a foreign country (“FC”). Canada and FC do not have a bilateral income tax treaty.
On December 31, 2020, Mr. X was granted 300 RSUs under an RSU agreement between himself and Company A. For each RSU, Company A is legally bound to issue, and Mr. X has an enforceable right to receive, one Company A share issued from treasury on the condition that Mr. X is an employee of Company A on the vesting date. The RSUs vest 1/3 each on December 31st of 2021, 2022, and 2023. On the date of the grant, the shares of Company A were trading at $10 each.
Mr. X satisfies the vesting conditions and receives the following:
* 100 shares of Company A on December 31, 2021 when the shares are trading at $20 each;
* 100 shares on December 31, 2022 when the shares are trading at $24 each; and
* 100 shares on December 31, 2023 when the shares are trading at $34 each.
For years prior to 2022, Mr. X was a resident of FC, and exercised his employment for Company A entirely in FC. On January 1, 2022, Mr. X moves to Canada and becomes resident in Canada for income tax purposes. He continues to exercise his employment for Company A in Canada for all of 2022 and 2023.
Canadian Taxation of Mr. X’s RSUs
Under the hypothetical facts of this example, section 7 will apply because Company A’s RSU plan is an agreement to issue Company A shares to its employees. By virtue of paragraph 7(3)(a), Mr. X is deemed not to have received or enjoyed any benefit under the RSU agreement at the time of grant.
Mr. X does not include any amount relating to the RSUs in his Canadian income in 2021 under subparagraph 115(1)(a)(i) or paragraph 7(1)(a), since he is not a resident of Canada on December 31, 2021 when the relevant RSUs vest and shares are issued, and the benefit relates entirely to duties of employment performed in FC.
As mentioned, Mr. X becomes a resident of Canada on January 1, 2022.
The ITM Portion of the RSUs that vest on December 31, 2022 is $1,000 (footnote 6) . Since it relates entirely to employment services rendered in FC, it is sourced to FC. In addition, the FMV Portion of the benefit is $1,400 (footnote 7) . It is sourced one-half to FC and one-half to Canada reflecting the fact that Mr. X’s employment during the vesting period was split evenly between FC and Canada.
The resulting issuance of 100 shares to Mr. X gives rise to an employment benefit of $2,400 (footnote 8) in 2022, pursuant to paragraph 7(1)(a). Since there is no income tax treaty between Canada and FC, all of the benefit will be taxed in Canada to Mr. X (including the ITM and the FMV Portions that are sourced to FC). However, Mr. X is entitled to claim a foreign tax credit in Canada under subsection 126(1) for any income tax paid to FC on the portion of the employment benefit that is sourced to FC (that is, $1,700 (footnote 9) ).
The ITM Portion of the RSUs that vest on December 31, 2023 is $1,000 (footnote 10) . As noted above, it relates entirely to services rendered in FC and is sourced to FC. In addition, the FMV Portion of the benefit is $2,400 (footnote 11) . It is sourced one-third to FC and two-thirds to Canada in proportion to the period of employment exercised by Mr. X in each jurisdiction during the vesting period (that is, from December 31, 2020 to December 31, 2023).
The resulting issuance of 100 shares to Mr. X gives rise to an employment benefit of $3,400 (footnote 12) in 2023, pursuant to paragraph 7(1)(a). Since there is no income tax treaty between Canada and FC, all of the benefit will be taxed in Canada (including the ITM and the FMV Portions that are sourced to FC). However, Mr. X is entitled to claim a foreign tax credit in Canada under subsection 126(1) for any income tax paid to FC on the portion of the employment benefit that is sourced to FC (that is, $1,800 (footnote 13) ).
We trust our comments will be of assistance. Please contact Kah Foo Koh at Kahfoo.Koh@cra-arc.gc.ca if you have any questions.
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Generally, a RSU acts as a proxy for a share of the capital stock of a corporate employer, and entitles the employee to which the RSU was granted to obtain an actual share, or the fair market value of a share, of the corporate employer at the date of vesting. A RSU typically has intrinsic value at the date of grant equal to the value of the underlying share at that date.
2 Unless otherwise stated, all legislative references in this document are to the Income Tax Act (the “Act”).
3 The guidance may also be applied to source benefits from deferred share units (i.e., an RSU that is structured to conform with the requirements of paragraph 6801(d) of the Income Tax Regulations) and share appreciation rights.
4 For example, the Canada-United States Income Tax Convention contains specific provisions governing the allocation of employee stock option benefits. Generally, under the Canada-United States tax treaty, employee stock option benefits will be allocated to the place of employment during the period between the grant and the exercise of the stock option.
5 The ITM Portion is typically equal to the fair market value of the underlying shares at the date of grant.
6 $1,000 = 100 RSUs x $10 share value at date of grant
7 $1,400 = 100 RSUs x ($24 share value at second vesting date - $10 share value at date of grant)
8 $2,400 = 100 RSUs x $24 share value at second vesting date
9 $1,700 = $1,000 ITM Portion + 50% of $1,400 FMV Portion
10 $1,000 = 100 RSUs x $10 share value at date of grant
11 $2,400 = 100 RSUs x ($34 share value at third vesting date - $10 share value at date of grant)
12 $3,400 = 100 RSUs x $34 share value at third vesting date
13 $1,800 = $1,000 ITM Portion + 33.33% of $2,400 FMV Portion
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