16 February 2000 External T.I. 1999-0014495 - DESIGNATION UNDER U.S. STOCK OPTIONS

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:

Some U.S.A. based stock option plans allow employees to exercise their options and "certify" shares owned by the employee in a manner described in the letter as an alternative to paying the option exercise price. The "certification" allows the employee to receive new shares equal in value to the benefit under the option. However, because the certified shares covering the exercise price of the option are not, in fact, disposed of for U.S. tax purposes, there is no gain or loss. We were asked what the tax consequences would be to a Canadian resident employee if the employee surrendered existing shares to pay the exercise price or if the employer exercised such an option through the certification process. (i.e., would there be a disposition of existing shares on the exercise of the option and would there be a deduction under 110(1)(d) of the Act?)

Position:

It is a question of fact but in similar situations we have addressed there is no disposition and paragraph 110(1)(d) deduction available.

Reasons:

Section 51 applies if shares are surrendered and are converted into shares of the same corporation; if shares are not surrendered but a lesser amount of shares are acquired under the option, then there is no disposition of existing shares. The 110(1)(d) deduction is available where no consideration is paid and shares are acquired with the in-the-money option increase in value since grant.

XXXXXXXXXX 		1999-001449
W. C. Harding
Attention: XXXXXXXXXX 

February 16, 2000

Dear Sirs:

Re: Employee Stock Option Plans

This is in reply to your letter of December 8, 1999, in which you requested several interpretations on the application of the Income Tax Act (the "Act") in situations where Canadian resident employees exercise certain employee stock options.

Because your enquiry deals with an existing factual situation, we are unable to provide specific comments on the application of the Act. Such situations may only be considered by us when they are referred to us by the tax services office of the parties involved. Accordingly, should you require any assistance with respect to the particular situation, you should refer these to the employer's tax services office together with all relevant details including the name of the employer.

In the interim, we can provide the following general information which may or may not apply to your situation. Please note that it does not form a ruling and it is not binding on the Canada Customs and Revenue Agency.

You advised that some U.S. based stock option plans provide options that are not described under the U.S. Internal Revenue Code ("nonqualified options"). These plans allow employees to exercise the options and pay the option price in full or in part with shares they already own. If the employee elects to pay the exercise price with shares, the employee may actually surrender the shares. However taxation may then result from the disposition.

To avoid this result, an employee may instead certify to the employer that the employee owns shares (the "certified shares") of the employer that have a fair market value that is at least equal to the exercise price. When this is done, the employee will only receive new stock equal in value to the value of the stock option benefit and will not be considered to have disposed of the certified shares.

Given this explanation. you asked us to confirm that the surrender of shares already owned by an employee to pay the exercise price of an option would not constitute a disposition for the purposes of the Act if no consideration other than new shares were received in return. In particular you asked if it could be treated in the same manner as discussed in our file 9811345 issued August 21, 1998, which discussed a transaction that was similar to yours.

In the above-noted letter we provided a technical interpretation with respect to the application of section 51 and section 7(1) of the Act when shares of a corporation owned by an individual are used by the individual to acquire shares of the corporation under an employee stock option. We stated that, subject to subsection 51(4) of the Act, section 51 will apply to any situation where a share of the capital stock of a corporation is acquired by a taxpayer in exchange for a capital property that is another share of the particular corporation and no other consideration is received for the old shares. In our opinion these comments would seem to be applicable to the situation at hand. If so, then paragraph 51(1)(c) would deem the exchange of the old shares not to be a disposition except for the purpose of subsection 20(21) of the Act. Please note however that the letter was not an advance income tax ruling and the propriety of the application of the provisions remains a question of fact.

You also asked if the certification process as described above would constitute a disposition of the certified shares for purposes of the Act and whether a deduction would be available under paragraph 110(1)(d) of the Act.

Without knowing the actual terms of the certification process we cannot state whether or not there would be a disposition of any shares for purposes of the Act. However, the certification appears to be similar in nature to a stock appreciation right (a "SAR") component of many stock option plans. SARs generally permits employees to receive the benefit under a stock option plan in the form of shares without paying any amount in respect of the option exercise price. If this is the case in the present situation, our comments previously provided in respect of SARs would also seem to be applicable here. (For additional information on SARs, please refer to our letter of April 22, 1988, file number E55754 and our letter of June 17, 1985 our file EA1125). To summarize, we would generally concur that a disposition of property would not occur where no shares or other property is paid by an employee to satisfy the exercise price under an option. Furthermore a deduction under paragraph 110(1)(d) of the Act would normally be available. In this respect, please be advised that this issue has recently been under review and as a consequence we are prepared to state that a deduction will be available where a SAR is exercised and shares are issued for no consideration. Further information on this will be released in an upcoming issue of the Income Tax Technical News.

Your last question pertained to the application of subsection 6204(1) of the Income Tax Regulations (the "Regulations") for the purposes of paragraph 110(1)(d) of the Act in respect of the facts as set out in your letter. In our opinion it would not be appropriate to answer this question except on a case-by-case basis where the actual facts are known. Nevertheless, we do not concur with your opinion on the application of paragraph 6204(b) of the Regulations. In our opinion the exchange of existing shares may constitute a redemption acquisition or cancellation of the shares by the corporation for the purposes of this provision and it may be reasonable in some circumstances to expect such an exchange to occur within two years of the share's issue.

We trust this explanation will be of assistance to you.

Yours truly,

P. Spice
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

??