27 February 2001 Internal T.I. 2001-0068447 - Stock options, order of dispositions

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: Where an individual owns shares of his employer that he acquired on the open market and he subsequently acquires shares under an employee stock option, is there a method to determine the order of any disposition of the shares held by the individual?

Position: Yes.

Reasons: An ordering provision has been proposed in the Legislative Proposals and Explanatory Notes Relating to Income Taxes published by the Department of Finance in December 2000.

			February 27, 2001

		EDMONTON TAX SERVICES OFFICE	HEADQUARTERS
	Arlene J. Morin 	M.P. Sarazin, CA
	Business Enquiries - Technical Interpretations	(613) 824-5441
	Client Services, 5th Floor

			2001-006844

Stock Options and Order of Disposition of Shares

We are writing to you in response to your memorandum of February 1, 2001, requesting our views regarding the order of disposition of shares held by an individual where the individual holds shares of his employer which were acquired on the open market and he subsequently acquires shares of the employer after February 27, 2000 under employee stock options that are eligible for the deferral of the stock option benefit.

You have asked us to address the following example. An employee holds 15,000 shares of his employer that he acquired on the open market. In March 2000, the employee acquired 10,000 shares of the employer under stock options that were subjected to paragraph 7(1)(a) of the Income Tax Act (the "Act") and the benefit will be deferred under the February 2000 budget proposals. In December 2000, the employee disposed of 12,000 shares of his employer. You ask us to provide our views regarding which shares were disposed of in December 2000 and which shares will be disposed of when there are future dispositions.

Comments

In December 2000, The Honourable Paul Martin, P.C., M.P., Minister of Finance published "Legislative Proposals and Explanatory Notes Relating to Income Tax" (the "Proposed Amendments"). The Proposed Amendments contain significant changes to section 7 and 47 of the Act. The Explanatory Notes contained within the Proposed Amendments contain several examples to reflect how the proposals will be applied to shares acquired under employee stock option arrangements.

The Proposed Amendments included an amendment to subsection 7(1.3) of the Act whereunder a new ordering provision will apply where an individual disposes of shares that are identical properties. Amended subsection 7(1.3) will apply to shares acquired under a stock option arrangement after February 27, 2000 and to shares acquired under a stock option arrangement, but not disposed of, before February 28, 2000. Amended subsection 7(1.3) will also apply for the purpose of proposed subsection 7(8) and for the purposes of existing subdivision c of the Act, subparagraph 110(1)(d)(ii) of the Act and subsection 147(10.4) of the Act.

Amended subsection 7(1.3) provides two rules for determining the order in which identical properties will be considered to have been acquired. Proposed paragraph 7(1.3)(a) provides that where a taxpayer holds shares that have the stock option benefit deferred under proposed subsection 7(8) and shares that do not have a stock option benefit deferred in respect of the shares, the taxpayer will be considered to dispose of the non-deferral shares first. Consequently, the deferral shares will be disposed of last thereby allowing the taxpayer to defer the recognition of his deferred stock option benefit until after he has disposed of all of his non-deferral shares. Proposed paragraph 7(1.3)(b) provides that where shares are acquired under several stock options at one time, the taxpayer is considered to dispose of those shares in the order in which the relevant options were granted.

Based on the application of proposed subsection 7(1.3), the employee will dispose of the shares that he acquired on the open market before he disposes of the stock option shares that are eligible for the deferral under proposed subsection 7(8). Consequently, the 12,000 shares that the taxpayer sold in December 2000 will be shares that are not eligible for the stock option benefit deferral (i.e., from the 15,000 shares that were acquired on the open market prior to February 27, 2000). For future dispositions, the employee will dispose of the remaining 3,000 non-deferral shares before he disposes of any of his deferral shares that were eligible under proposed subsection 7(8).

The Proposed Amendments also include a new subsection 47(3). Under proposed subsection 47(3), shares acquired after February 27, 2000 that qualify for the deferral under subsection 7(8) are deemed, for the purpose of the cost-averaging rule in subsection 47(1), not to be identical to any other shares held by the employee. Therefore, the cost of the shares acquired by the employee on the open market will not be averaged with the cost of the shares acquired under the stock option arrangement, provided that the shares acquired under the stock option qualify for the deferral under proposed subsection 7(8).

The Proposed Amendments also include a new subsection 7(1.31). Proposed subsection 7(1.31) applies to shares acquired under stock option arrangements after February 27, 2000 and to shares acquired under stock option arrangements before February 28, 2000 where the shares are still held as of February 28, 2000. Where certain conditions are satisfied, proposed subsection 7(1.31) allows the employee to specifically identify the shares that are being disposed of at that time. The Explanatory Notes for proposed subsection 7(1.31) contain an example of how the proposed specific identification provision will be applied.

With the enactment of the Proposed Amendments, the new position described in Technical News No. 19 under the heading "Disposition of Identical Properties Acquired Under a Section 7 Securities Option", which became effective on June 16, 2000, is, generally, no longer applicable. In order to specifically identify the stock option shares that are being disposed of subsequent to February 27, 2000, the employee will have to satisfy proposed subsection 7(1.31). However, we do note that there may be some circumstances under which the new position described in Technical News No. 19 may apply to the disposition of stock option shares preceding February 28, 2000.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

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