8 January 2002 Ruling 2001-0105023 - STOCK OPTIONS CHANGE EXCHANGE

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: In certain situations where there is no change in the benefit associated with the option, can an employee claim a s.110(1)(d) deduction when a reduction in the option price to an amount below the fmv at the time the option was granted is made?

Position: In a comfort letter, Finance has indicated that they will recommend a change so that a s.110(1)(d) deduction may be claimed in certain situations.

Reasons: CCRA will not reassess anyone who claims such a deduction until acceptance of this recommendation is resolved.

XXXXXXXXXX 							2001-010502
R. Albert
January 8, 2002

Dear Sirs:

Re: Request for an Advance Income Tax Ruling
XXXXXXXXXX (the "Corporation")

We are writing in reply to your letter of October 5, 2001, wherein you requested an advance income tax ruling on behalf of the above-noted Corporation. We acknowledge our telephone conversations concerning this request.

Your request concerned stock options that were granted at fair market value; that is, the exercise price of such options was equal to the fair market value of the underlying securities at the time the options were granted. For various reasons, the economic value of such options, based on the exercise price that was set at the time of grant, was eroded and the usefulness of the options as an incentive instrument was compromised. In an effort to reverse this erosion, the options were adjusted in a manner that was specifically designed to retain the equivalent economic value of the stock options prior to and after the adjustment. The economic value was calculated as the difference between the fair market value of the underlying shares and the exercise price of the options and the equalizing adjustment was such that the existing stock options yielded a greater number of adjusted options, each with a reduced exercise price. With respect to the exercise of the adjusted options, you had asked for a ruling concerning whether, in the determination of the amount of taxes to be withheld, the Corporation could take into consideration the application of paragraph 110(1)(d) of the Income Tax Act (the "Act").

As discussed, and as noted in paragraph 7 of Information Circular 70-60R4 dated January 29, 2001, advance income tax rulings are not issued on transactions that are already completed. As the transactions upon which you have asked us to rule have already occurred, we are unable to provide an advance income tax ruling. We have not attempted to resolve whether any particular provision, such as subsection 7(1.4) or paragraph 110(1)(d) of the Act, applies to the particular set of facts. However, we are able to provide the following comments.

As a result of our discussions (XXXXXXXXXX/Albert), you obtained from the Department of Finance a sanitized copy of a July 13, 2001 comfort letter issued by Finance which included the following comments: "As you know, we are prepared to recommend that the Act be amended to ensure that an employee is not disqualified from claiming the stock option deduction because of a reduction in the option exercise price to an amount below the value of the underlying share when the option was granted, provided the reduction could have been accomplished by way of an exchange of options to which subsection 7(1.4) of the Act would have applied. The effect of the amendment would be to allow paragraph 110(1)(d) to apply as though there had, in fact, been such an exchange of options. By requiring that the hypothetical option exchange satisfy the conditions of subsection 7(1.4), this relief would be limited to those situations in which the reduction in exercise price provides no immediate increase in the net benefit associated with the option. We will recommend that this amendment, if adopted, apply to reductions in exercise price occurring after 1998."

During our discussions, you were informed that a question at the APFF -2001 Conference in October 2001 had been posed concerning the application of paragraph 110(1)(d) of the Act. Both Canada Customs and Revenue Agency and the Department of Finance responded to the question and, as CCRA's response was based on Finance's comments, we suggested that you contact Finance to obtain their response. However, CCRA's response was: "As noted by the Department of Finance, it is prepared to recommend that subparagraph 110(1)(d)(iii) of the Act be amended. Meanwhile, the CCRA will not make any reassessments based on the current wording of this subparagraph before the changes in question are published and adopted except in situations of abuse. We invite taxpayers who could benefit from the deduction in the current or amended subparagraph 110(1)(d)(iii) to contact their tax services office to claim this deduction."

We trust that these comments will be of assistance. We will refund your deposit under separate cover.

Yours truly,

Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate