8 March 2001 External T.I. 2001-0070445 - Stock options exercised by a corporation

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:

1. Can a corporation report employment income?

2. Does the corporation get the 110(1)(d) deduction?

Position:

1. Yes

2. No if the corporation did not exist at the time the option was granted.

Reasons:

1. The corporation is "deemed" to have received employment income by paragraph 7(1)(c).

2. Clause 110(1)(d)(ii)(B) requires that the corporation was arm's length to the grantor at the time of the grant.

XXXXXXXXXX 2001-007044
S. E. Thomson
March 8, 2001

Dear XXXXXXXXXX:

Re: Employee stock options exercised by a corporation

This is in reply to your letter of February 14, 2001 in which you ask for our interpretation of paragraph 110(1)(d) of the Income Tax Act (the "Act").

Although you have asked for our technical interpretation on a hypothetical situation, it appears that your request involves a transaction or series of transactions contemplated by a specific taxpayer. Please note that we can only respond to your request in the context of an advance income tax ruling, as set out in Information Circular 70-6R4 Advance Income Tax Rulings, available at our website at www.ccra-adrc.gc.ca. However, we can offer the following general comments which may or may not apply to your situation. As such, these comments are not binding on the Canada Customs and Revenue Agency.

Scenario 1 - Option exercised during the lifetime of the employee

Where an employee transfers employee stock options which have been granted to the employee pursuant to section 7 of the Act, to a corporation with which the employee is not dealing at arm's length, no benefit will be taxable to the employee on the transfer. However, the employee will be deemed to have received a benefit from employment in the year in which the corporation exercises the option pursuant to paragraph 7(1)(c) of the Act.

Assuming the conditions of paragraph 110(1)(d) are otherwise met, in our view, the employee would be eligible for the deduction under that paragraph where the non-arm's length person (in this case, the corporation) exercises the option and acquires the shares.

Scenario 2 - Option exercised after the death of the employee

However, if the employee dies prior to the exercise of the options, the benefit is deemed by paragraph 7(1)(c) to have been received by the non-arm's length corporation as income from employment in the year in which the corporation acquires the shares.

In our view, the corporation may not be eligible for the deduction under paragraph 110(1)(d). Paragraph 110(1)(d) provides a deduction to a "taxpayer" (i.e., the non-arm's length corporation) who is deemed by subsection 7(1) to have received a benefit if certain conditions are met. One such condition, in clause 110(1)(d)((ii)(B), requires that the "taxpayer" had to have been dealing at arm's length with the person who granted the option (or certain persons not dealing at arm's length with the grantor) immediately after the option was granted.

As you have pointed out, the requirement in clause 110(1)(d)(ii)(B) cannot be met if the corporation did not exist at the time the option was granted. In addition, the legislation appears to provide for the unusual result that the deduction will be available to the corporation if it did exist and was arm's length to the grantor at the time of the grant, regardless of the employee's relationship to the grantor at the time of the grant.

We will forward your concerns to the Department of Finance.

Yours truly,

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