23 February 2001 External T.I. 1999-0015735 - Stock Option Deduction Foreign Affiliate

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:

Whether deduction taken by U.S. foreign affiliate in respect of a stock option plan where options for its shares are issued to its employees can be added back to earnings.

Position:

Since this is a notional deduction, it should not be deducted in the determination of earnings under Regulation 5907(1). However, if the foreign affiliate has compensated the Canadian parent, there should be no addback as the affiliate does not have that surplus.

Reasons:

See the summary on file 2000-002196, which deals with the same issue.

XXXXXXXXXX 1999-001573
J. Stalker
February 23, 2001

Dear XXXXXXXXXX:

Re: Subsection 5907(2) of the Income Tax Regulations (the "Regulations")

This is in reply to your letter of December 23, 1999 in respect of the above-noted provision.

You have presented a hypothetical situation where a Canadian public corporation has a controlled foreign affiliate which is resident in the U.S. The employees of the affiliate are entitled to participate in the Canadian parent's stock option plan. We understand that for U.S. tax purposes, when an employee of a corporation exercises a stock option and the benefit is taxed as ordinary income to the employee, the amount of the benefit is an amount eligible for deduction in arriving at the foreign affiliate's taxable income.

You have asked if the earnings of the foreign affiliate should be increased by the amount that is deducted by it in respect of the stock options pursuant to paragraph 5907(2)(f) of the Regulations.

We assume that the foreign affiliate has not compensated and will not compensate the parent for the stock option benefits.

In our opinion, paragraph 5907(2)(f) of the Regulations does not apply. However, the computation of "earnings" for the purposes of subsection 5907(1) does not include any amounts of notional deductions or inclusions in the computation of the income or profits of the foreign affiliate. In this case, as the stock option deduction is purely a notional adjustment, it has no impact on the foreign affiliate's actual income from carrying on an active business and on the amount that the foreign affiliate has available to pay dividends. Accordingly, the stock option deduction should be excluded from the computation of "earnings" as that term is defined in subsection 5907(1) of the Regulations.

The above comments represent our general view with respect to the subject matter of your letter. These comments do not constitute an advance income tax ruling and therefore, as described in paragraph 22 of Information Circular 70-6R4, are not binding on the Canada Customs and Revenue Agency.

We trust our comments are helpful.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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