15 April 2003 Ruling 2002-0127633 - STOCK OPTION SHARE REDEMPTIONS

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Will sections 7 and 84 apply on the redemption of shares under a particular stock option plan?

Position: No ruling provided.

Reasons:

The request for a ruling was terminated when the client was advised that the position taken in our file 2000-0016875 had been reconsidered because it was not supportable in law and that, as a consequence, 248(28) of the Act could not apply to prevent the application of both subsections 7(1.1) and 84(3) in the proposed transactions.

XXXXXXXXXX 							2002-012763
W. C. Harding
April 15, 2003

Dear XXXXXXXXXX:

Re: 2002 Share Option Plan
XXXXXXXXXX

This is in reply to your letters of March 6 and April 3, 2002, in respect of your request for an advance income tax ruling on behalf of the above-noted corporation. In our telephone conversation of March 5, 2003, (XXXXXXXXXX/Harding) we advised you that we would not be able to provide you with all of the requested rulings. You informed us that you would consult with your client and asked that we defer closing the file in order to enable your clients to reconsider several provisions in the proposed plans. Since we have not received any further instructions from you, we are now closing our file. Should your client wish to pursue the matter at a later date, we would be pleased to resume consideration at that time.

In the meantime, our interim billing for the time spent on your ruling request will be forwarded under separate cover.

As discussed in our telephone conversations, in a letter dated August 10, 2000 (our file number 2000-001687), we indicated that where an employee has income from employment under paragraph 7(1)(a) of the Income Tax Act (the "Act") by virtue of subsection 7(1.1) of the Act, that is related to the disposition of shares, and also has a deemed dividend under subsection 84(3) of the Act related to the redemption of shares of the same class in the same or a different year, we were of the opinion that subsection 248(28) of the Act would apply so that there would be no income inclusion under subsection 84(3) of the Act of the amount assessed under section 7(1)(a) of the Act.

We have recently reconsidered this opinion and have concluded that subsection 248(28) of the Act would not apply to prevent the taxation of the amount under subsection 84(3) of the Act because the benefit under section 7 of the Act and the dividend computed under subsection 84(3) of the Act are determined as a result of different events and there is no amount that has been included in income under section 7 of the Act that is included a second time contrary to paragraph 248(28)(a) of the Act.

With respect to the exercise of an option to acquire shares of a Canadian-controlled private corporation, any benefit under subsection 7(1)(a) of the Act is determined as a consequence of the exercise of the option, although the inclusion of that benefit is deferred until there is a disposition of the shares acquired under the option. Generally speaking, there would be no argument that taxation of any capital gain on the subsequent disposition of the shares would result in double taxation prohibited by subsection 248(28) of the Act. However, the amount of the taxable benefit under section 7 of the Act is added to the adjusted cost base of the shares pursuant to paragraph 53(1)(j) of the Act and is, therefore, taken into account in computing any capital gain or allowable capital loss on any disposition of the shares.

If a taxpayer disposes of the shares acquired under the option as a result of a repurchase by the employer, a deemed dividend under subsection 84(3) must be determined and reported at the time of the disposition. However, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54 of the Act, this dividend is carved out of the proceeds of disposition of the shares for the purposes of the computation of any capital gain or capital loss on the disposition. Accordingly, a taxpayer will generally have a capital loss on the disposition, which will already account for both the inclusion of the section 7 benefit and the subsection 84(3) dividend.

As an example, consider an employee who exercised an option to acquire a share of an employer at a cost of $5.00 when the share was worth $10.00. The PUC of the share would be equal to the cash consideration paid for the share. The employer subsequently redeems the share for $15.00. In this situation, the employee will have a taxable benefit from employment of $5.00 that is determined at the time the employee exercises the option but is reported at the time the employee disposes of the share. The employee will also have a deemed dividend of $10.00, being the proceeds of disposition less the paid up capital of the share. In addition, the employee will have a capital loss of $5.00 computed as the $15.00 proceeds of disposition less the deemed dividend of $10.00, minus the adjusted cost base of the share, which is the total of the $5.00 cost of the share and the $5.00 taxable benefit computed under section 7 of the Act.

We trust that these comments will be of assistance to you.

Yours truly,

Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch