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 a 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).
Reasons:
It is our view that the notional deduction should not be included in computing earnings as defined in subsection 5907(1) of the Regulations. This is consistent with our view on notional monetary inflationary adjustments and notional interest expense (see E9830735.) In these situations the adjustment in the computation of earnings under subsection 5907(1) is necessary to accurately portray actual income realized and available for distribution. (Note this position overrides the position taken in E5C6315 November 12, 1986, M. Carsley, where we said 5907(2)(b) was not applicable and no other provision would adjust the earnings.)
The broad wording in paragraph 5907(2)(f) could also result in an addback. However, it is our view that 5907(2)(f) should only be applied in situations where there is a realization of actual income as a result of a transaction which is not recognized in the foreign jurisdiction. This is consistent with E9827645. (Note that paragraph 5907(2)(b) is not applicable as no expenditure has been incurred.) In the situation at hand, there has been an understatement of the earnings derived from the business as a result of the notional deduction. The amount of earnings should be corrected from the starting point in subsection 5907(1), before determining the application of the adjustments in subsection 5907(2).
In summary, such a notional deduction should not be included in the determination of "earnings" under subsection 590791) of the Regulations.
XXXXXXXXXX 2000-002196
J. Stalker
Attention: XXXXXXXXXX
January 9, 2001
Dear Sirs:
Re: Subsection 5907(2) of the Income Tax Regulations (the "Regulations")
This is in reply to your facsimile transmission of April 19, 2000 to Peter Roach of the International Tax Directorate, forwarded to us, in respect of the above-noted provision.
You have presented a hypothetical situation where a stock option deduction is taken by a foreign affiliate of a Canadian corporation, which is resident in the U.S. The U.S. foreign affiliate issues its own shares to employees under an employee 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 treated as ordinary income is an amount eligible for deduction by the U.S. corporation issuing the stock options. The corporation does not incur an expenditure when it issues stock options to an employee or when they are exercised. You have asked if the earnings of the foreign affiliate should be increased by the amount that is deducted by the corporation in respect of the stock option it issues pursuant to paragraph 5907(2)(b) of the Regulations.
It is our view that paragraph 5907(2)(b) does not apply to adjust the earnings as there has been no expenditure by the foreign affiliate, as required by paragraph 5907(2)(b). However, in our opinion, 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. 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 70-6R3, are not binding on the Canada Customs and Revenue Agency.
We trust our comments are helpful.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch
cc. Peter Roach, International Tax Directorate
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