CRA appears to imply that a “bad” (offside s. 7(1.4)) option exchange merely accelerates tax rather than resulting in double taxation [corrected]

To use illustrative numbers that were not provided in the question posed or CRA response, s. 7 stock options of an employee on Target shares  with an in-the-money value of $100,000 are exchanged for options on Buyer’s shares with an in-the-money value of $101,000 (rather than $100,000) so that the continuity rule in s. 7(1.4) does not apply. If the employee subsequently surrenders her new options to Buyer for $110,000, is her s. 7(1)(b) benefit $110,000 – or is it $10,000 on the basis that the $100,000 value of the exchanged old options qualifies as "the amount…paid by the employee to acquire those [surrendered] rights"?

CRA appears not to have answered this question directly, but instead indicated that there is a s. 7(1)(b) benefit realized on the "exchange" of the old options for the new options– which is not reduced by their value at the time of the exchange.  (A previous version of this post, where I thought the CRA answer was in response to the question which likely was posed, may be misleading.)  However, CRA finishes with a cryptic statement that "the new options acquired as a result of the exchange will have a cost equal to the value of the exchanged options at the time of the exchange."  This could be interpreted as an affirmative response to the above question.

Accordingly, to return to the illustrative numbers, the employee would realize a $101,000 s. 7(1)(b) benefit on the bad stock option exchange (even though in fact the old options likely were surrendered to Target for nil consideration), and might realize a further benefit of $10,000 rather than $110,000 on the subsequent surrender of her new options – on the basis that her "cost" of $100,000 reduces her second s. 7(1)(b) benefit, as suggested in the question posed.  If there is no such reduction, there is double taxation, and the cryptic reference to cost makes no sense.

Neal Armstrong. Summary of 13 May 2015 T.I. 2015-0570801E5 under s. 7(1)(b).