This presentation offers an overview of types, formation, implementation and administration of ESPPs.

1. Converting Employees to Owners:
Employee Share Purchase Plans
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2. Types, Formation, Implementation and
Administration of ESPPs
Presenters: Leah Tolton and Leanne Krawchuk
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3. Four Common Types of ESPPs
• Stock Option Plans
• Share Purchase Plans
• Phantom Stock Plans
• Stock Bonus Plans
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4. Stock Option Plans
• Right to purchase specified number of shares at a specific price
at a specified date
• Timing – usually granted at commencement of employment
• Theory – employee will exercise option when share value is
greater than “strike price”
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5. Share Purchase Plans
• Right to purchase specified number of shares at specific price
at a specific date
• Timing – usually granted to incent employees, often on an
annual basis
• Theory – employees will be motivated to improve productivity
and profitability
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6. Phantom Stock Plans
• Shares are “allocated” but not acquired
• Timing – usually granted to incent employees, often on an
annual basis
• Theory – employee participates in growth of corporation as if
he or she had an ownership interest
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7. Stock Bonus Plans
• Bonus awarded to employees as shares instead of cash
• Timing – usually granted to reward employees, often annually
• Theory – Employee receives an asset that may appreciate and
employer does not deplete cash reserves
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8. Choosing a Form of Plan
• Goals to be achieved by each type
• Manner of determining value of shares
– Fair market determination
– By agreement
• Most commonly used types
• We’ll focus on stock option plans and share purchase plans
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9. Consideration of Policies and
Documentation
• Helps determine legal obligations and rights of the employer
and employees
• Manages expectations
• Need to decide on discretionary, automatic entitlement or
targets
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10. Objective to be Achieved by an ESPP
• To attract and/or incent employees
• To assist in retention efforts
• To enhance employee compensation packages
• To implement succession planning
• To finance the existing business or its growth
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11. Preliminary Issues and Roles of Advisors
• What is the employer trying to achieve?
– Keep the employer’s objective in mind during the planning process
• Consider involving employees in discussions
• Prepare to spend considerable time answering these questions
and preparing the plan before presenting it to employees
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12. Lawyers
• Review existing and future commitments to employees
• Prepare key agreements:
– Participation criteria
– Number and type of shares to be issued
– Value of shares
– Ongoing management of shareholder relationship
– Entry to and exit from the structure
– Liquidity events
– How employees will pay for shares
– Tax implications to employees
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13. Accountants
• Input into value of shares
– Review historical financial performance
– Consider values of underlying assets
• Input into tax implications
– Existing shareholders
– New shareholders
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14. Business Valuators
• May prepare a formal valuation of the corporation’s shares to
use as benchmark when first employees become shareholders
• Work with the accountant to set share value
• Work with the lawyers to set a formula to calculate value on
entries and exits
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15. Other Preparation
• If employees are to participate in discrete parts of business,
may need to reorganize assets before introducing employees
• Example: if employees are to share in business operations but
not real estate value, may need to move real estate
• If employees are to participate in larger group, may need to
reorganize shareholdings
• Example: move shares of operating corporations to a holding
corporation and issue holding corporation shares to
employees
• Consider introducing employees at a separate holding
corporation to simplify entries and exits and ongoing
governance.
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16. Overview of Share Structure
• Consider the type of security to be issued
• Are articles of amendment required to be filed to effect a change in
existing share capital? (i.e. to accommodate a share split or share exchange
or to create new classes of shares or series of shares)
• Prepare dilution calculations
• Is an estate freeze necessary?
• Example: value existing common shares; create a new class of redeemable
preferred (non‐voting) shares having a redemption value equal to the value
of the common shares; exchange common shares for new preferred
shares; common shares are left with nominal value to allow buy in by
employees at low cost
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17. Specifics of the Plan or Policy
• Establish parameters on eligibility of employees to participate
• Should deal with allocations, vesting periods, exercise price,
purchase price, or conversion price, expiry date, and/or
termination date
• How and when is value to be determined?
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18. Unanimous Shareholder Agreement
(“USA”)
• Governs the rights and obligations of shareholders and the
corporation and the ability of shareholders to sell and transfer
shares
• USA can be enforced by the courts
• There are numerous tax considerations involved in the drafting
of the USA
• Employees should obtain independent legal and other
professional advice
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19. Specifics of a USA for Employee Owned
Corporation
• “triggering events” – death, disability, termination of
employment (whether for cause or not), retirement
• Consider different categories of employee shareholders based
on shareholdings
• Who is the purchaser – the corporation, a nominee or other
employee shareholders?
• Determination of purchase price (i.e. by annual agreement of
the board of directors, by accountants, by a certified business
valuator, or by a formula)
• Life insurance on “key employees” to fund a corporate
repurchase
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20. Is it a “security” under applicable Alberta
securities laws?
• Yes, both options and shares
• The corporation requires a prospectus exemption under
National Instrument 45‐106 Prospectus and Registration
Exemptions to issue or grant securities to employees
• “private issuer” exemption is most often used by private
corporations
• Reporting issuers can rely on a variety of other exemptions
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21. Financing of ESPPs
Presenter: Rich Miller
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22. Sources of Financing for ESPPs
• Employee
– RRSP
– TFSA
– Personal loan
• Employer
– Financial Assistance – Section 45 ABCA
– Exemption
– Disclosure
– Waiver
• Banks
– Structured loan programs
– Choice of banks
• Focus of Presentation on Bank’s Structured Loan Programs
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23. Advantages of Structured Loan Programs
• Expedited processing of loan applications
• Favourable interest rates
• Favourable repayment terms
– Interest Only
– Deferral of principal payments
– Coordinated with dividend payments
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24. Typical Financing Documentation
• Loan application
• Loan agreement or promissory note
• Pledge of shares, share transfer form and acknowledgement
• Share certificate, control agreement or PPSA registration
• Waiver of investment advice
• Privacy consent
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25. Typical Financing Terms
• Demand loan
• Margining formula
• Events of default
– Termination of employment
– Sale of shares
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26. Public Company Issues
• Volatility of share price
– Margining
• Securities laws
– Restrictions on sale of pledged shares
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27. Private Company Issues
• Valuation of shares
– Margining
• Lack of liquidity or available buyers
– Sale process
• Unanimous shareholder agreements
– Transfer restrictions
– Buy/sell rights
– Rights of first refusal
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28. Employer Involvement
• Put and call rights
– Employer agrees to buy pledged shares
• Guarantee by employer
– Assignment of loan and pledge
• Comfort agreements
– Notice of termination or sale
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29. Taxation of Employee Share Purchase
Plans
Presenter: Mark Woltersdorf
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30. Taxation of Employee Stock Options
• Any agreement between an employer and employee to sell or
issue shares of an employer corporation or a non‐arm’s length
corporation is considered to be an “employee stock option”
under the Income Tax Act
• This includes shares acquired by share subscription from
treasury or acquired from an existing shareholder
• Most employee share purchase plans will be considered to be
an employee stock option for taxation purposes
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31. Taxation of Employee Stock Options
• Phantom Stock Plans do not result in an acquisition of shares
by the employee
• As such, payments received by the employee under a Phantom
Stock Plan are treated for income tax purposes in the same
manner as cash compensation (i.e. taxable in full when
received and subject to applicable statutory deductions)
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32. Taxation of Employee Stock Options
• Under existing legislation, employee stock options (which
include Stock Option Plans, Share Purchase Plans and Stock
Bonus Plans) are subject to taxation as follows:
– Difference between fair market value of shares acquired and amount
paid to acquire them is treated as a taxable employment benefit
– Employee may be entitled to a deduction equal to 50% of the taxable
employment benefit in certain circumstances
– The taxable employment benefit is included in income at the time the
employee stock option is exercised (i.e. shares are purchased)
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33. Taxation of Employee Stock Options
Cont’d
– Employees of Canadian‐controlled private corporations (CCPCs) do not
include the taxable employment benefit in income until the shares are
sold
– Prior to March 4, 2010, under certain circumstances, an employee of a
publicly‐traded corporation could elect to defer recognition of the
taxable employment benefit until the optioned shares are sold
– The deferral was in respect of up to $100,000 of qualifying stock
options vesting in a year
– Gains or losses realized on the disposition of an optioned share are
treated as capital gains or losses
– If CCPC ‐ capital gains may be eligible for the capital gain deduction
and capital losses may be treated as business investment losses
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34. Taxation of Employee Stock Options
Example
– OPCO has a stock option plan for its employees
– Options are granted on the 2nd anniversary date of employment that
permit the employee to acquire a specified number of shares of OPCO
at a purchase price equal to the fair market value of the shares at the
time the option is granted
– Options may be exercised for up to 3 years after being granted
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35. Taxation of Employee Stock Options
Example
– Sam is granted an option to acquire 100 shares of OPCO January 1,
2007, at their fair market value that day of $10 per share
– Sam exercises his option on February 1, 2008, and acquires 100 shares
of OPCO at a purchase price of $10 per share a time that each share
has a fair market value of $13
– In October 2010 Sam sells the 100 shares acquired in 2008 at their fair
market value of $18 per share
– There are no selling costs and Sam is paid in full at closing
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36. Tax Consequences
• Regardless of the type of employer – the amount of taxable
employment benefit is $3 ‐ calculated as FMV at the date
shares were purchased ($13) less the amount paid by Sam to
purchase them ($10)
• The taxable employment benefit is added to the purchase
price paid by Sam to determine adjusted cost base (ACB) of the
shares acquired
• The ACB is used to determine capital gains or losses arising
when the optioned shares are sold by the employee
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37. Tax Consequences
• The taxable employment income benefit is subject to
withholding taxes that the employer is required to take from
other “cash basis” sources of employment income
• Budget 2010 introduced provisions designed to clarify that the
gross taxable employment benefit (and not the net benefit of
50%) is subject to withholding taxes
• Implementation of these changes is deferred until after 2010
to permit employers to adjust their compensation
arrangements and payroll systems
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38. Tax Consequences
• If OPCO is a CCPC the taxable employment benefit is deferred
until the securities are sold
• If OPCO is non‐CCPC that is a “qualifying person” and Sam
made the appropriate election in respect of the shares (only
available for shares issued before March 4, 2010) ‐ the taxable
employment benefit is deferred until the optioned shares are
sold
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39. Tax Consequences
CCPC Non‐CCPC Non‐CCPC
(election made)
FMV of security $13 $13 $13
Amount paid to $10 $10 $10
acquire security
Employment $ 3 $ 3 $ 3
income
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40. Tax Consequences
CCPC Non‐CCPC Non‐CCPC
(election made)
Stock option $1.50 $1.50 $1.50
deduction
Timing of income Year security sold Year security Year security sold
inclusion acquired
Net $ 1.50 $ 1.50 $ 1.50
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41. Tax Consequences
CCPC Non CCPC Non‐CCPC
(election made)
Proceeds of $18 $18 $18
disposition
Adjusted cost base $13 $13 $13
($10 purchase
price + $3 benefit)
Capital $ 5 $ 5 $ 5
gain
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42. RRSP Eligibility
• Should the employer take steps so that the employee can
acquire shares using their RRSP account? (or similar accounts
such as TFSA, DPSP, IPP)
• This is an important issue that requires careful analysis at the
beginning of the planning stage
• The shares must be “qualified investments” as defined in the
Income Tax Act – these provisions are complex
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43. RRSP Eligibility
• A qualified investment includes a CCPC that is a small business
corporation (90% of its assets are used to generate active
business income primarily in Canada) and the investor
shareholder is not connected with the corporation (owns less
than 10%)
• A connected shareholder may also qualify if they deal at arm’s
length with the corporation and the cost of all securities
owned by that person (and all non‐arm’s length persons) is
$25,000 or less
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44. RRSP Eligibility
• Securities, other than shares of a CCPC, may also be RRSP
eligible including:
– units of a mutual fund trust
– shares of a mutual fund corporation
– publicly traded securities (can make an election to be deemed a public
corporation for tax purposes)
– interests in certain limited partnerships
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45. RRSP Eligibility
• The income tax and securities law requirements for each of the
above securities to qualify are complex and beyond the scope
of this presentation
• It is more relevant to examine some of the key differences
between RRSP eligible and non‐eligible plans
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46. What are some key differences?
Non‐RRSP eligible securities
‐ gains and capital gains realized on sale of shares are subject
to taxation immediately
‐ only 50% of the capital gain is taxable as a taxable capital gain
‐ capital gains realized may be eligible for the capital gain
deduction
‐ interest on money borrowed to acquire shares should be
deductible for tax purposes
‐ losses realized may be able to be claimed
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47. What are some key differences?
• RRSP Eligible Shares
– capital gains realized on sale of shares are not subject to taxation until
withdrawn from RRSP
– the entire gain is subject to taxation when funds withdrawn from RRSP
– capital gains are not eligible for the capital gain deduction
– interest on money borrowed to acquire shares is not deductible for tax
purposes
– losses are “trapped” in the RRSP plan
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48. QUESTIONS
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49. Thank You For Joining Us
• Leah Tolton 780.423. 7192 e: leah.tolton@fmc‐law.com
• Leanne Krawchuk 780.423.7198 e: leanne.krawchuk@fmc‐law.com
• Rich Miller 780.423.7242 e: rich.miller@fmc‐law.com
• Mark Woltersdorf 780.423.7250 e: mark.woltersdorf@fmc‐law.com

50. The preceding presentation contains examples of the kinds of
issues companies looking at employee share purchase plans
could face. If you are faced with one of these issues, please
retain professional assistance as each situation is unique.