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: Can a deferral of a stock option benefit be claimed where there is a holdback on the proceeds on the redemption of the Shares?

Position: Not in this case.

Reasons: The provisions of 7(1.1) and 7(8) do not provide a deferral in the circumstances.

August 11, 2003

	TORONTO EAST TSO	HEADQUARTERS
	Sollaman Jameer	W.C. Harding
	Large Files	(613) 957-8953

		2003-001578
	Stock Option Benefit

This is in reply to your correspondence of April 29, 2003, concerning the ability to defer the income inclusion of stock option benefits.

Background

On XXXXXXXXXX acquired all of the outstanding shares of a company called XXXXXXXXXX Prior to XXXXXXXXXX purchase, some employees of XXXXXXXXXX had vested but unexercised employee stock options. On XXXXXXXXXX, these employees exercised their options. However, before any shares were actually acquired, the employees tendered them to XXXXXXXXXX in accordance with a separate share purchase agreement. In exchange, the employees became entitled to receive proceeds that were intended to reflect the fair market value of the shares at the time of exercise, less the stock option purchase price. Furthermore, in accordance with the terms of the share purchase agreement, a XXXXXXXXXX% holdback, payable on closing, was applied to the purchase price. As a result, the employees only received XXXXXXXXXX% of the shares net proceeds in XXXXXXXXXX.

Question

You have asked if the employees can:

(i) request a deferral of the stock option benefit which is attributable to the XXXXXXXXXX% holdback not received on XXXXXXXXXX; and

(ii) report the benefit relating to the XXXXXXXXXX% holdback in the year of its receipt.

Our Views:

In our discussions (Jameer/Harding), you confirmed your understanding that the employees exercised their options to acquire the shares of XXXXXXXXXX and that the employees did not dispose of the options for proceeds. Without having the documents that pertain to the transactions, we cannot confirm that this was the case and for the purposes of this reply, we have assumed that the options were in fact exercised. (Nevertheless, it should be noted that typically, when an employee receives a cash settlement equal to the value of the shares that may be acquired through the exercise of an option, less the option price, it is indicative that the options were not exercised but that the rights under the option were disposed of, for an amount equivalent to the net proceeds. In such cases, paragraph 7(1)(b) of the Income Tax Act (the "Act") would normally have application and paragraph 7(1)(a) of the Act would not apply. Accordingly, if on further examination it is determined that the options were not exercised and the benefit was calculable in accordance with paragraph 7(1)(b) of the Act, neither subsection 7(1.1) nor 7(8) of the Act would have any application.)

You also indicated that it was your understanding that XXXXXXXXXX was a Canadian-controlled private corporation (CCPC) prior to the share acquisition by XXXXXXXXXX. Given this information, and the description of the facts as outlined above, in our view, as discussed, the employees would not be entitled to any deferral under the provisions of either subsection 7(1.1) of the Act, if XXXXXXXXXX is a CCPC, or 7(8) of the Act, if XXXXXXXXXX is not a CCPC.

CCRA has not published its position on when shares are acquired under an option when the shares are not traded on an exchange. However, interpretation bulletin IT-133 Stock Exchange Transactions - Date of Disposition of Shares indicates that a share traded on a stock exchange will usually be considered to have been disposed of or acquired for income tax purposes, on the settlement date, which is the date on or before which the vendor is required to deliver the share certificates and the purchaser is required to make payment. The IT also indicates that an acquisition will be made when a sale is completed on the same date that the trade goes through the exchange and there is both delivery of and a payment for the shares. Where shares acquired under an option are not traded on an exchange, the above position is not specifically applicable. However, we have generally taken a parallel view that an acquisition will occur when the option holder is entitled to the shares and has a legal obligation to pay for them. IT - 70R Sale of Property - When Included in Income Computation, provides more comments on the ownership of property in this respect. Paragraph 7 and 8 of the IT state:

"7. Formal agreements of purchase and sale are frequently explicit as to the date of exchange and, unless circumstances indicate that a specified date was changed or was not the true intent of both parties, the date so specified is presumed to be the date of entitlement. Where the date of exchange is not expressly agreed between the parties, the time that the attributes of ownership pass from the vendor to the purchaser is presumed to be the date of entitlement. Since this test is the same test that is applied to determine the date of acquisition of depreciable property by a purchaser, the comments contained in IT-50R are equally valid in determining a vendor's date of disposition in these cases.

8. Since possession, use and risk are the primary attributes of beneficial ownership, registration of legal title alone is of little significance in determining the date of disposition. Factors that are strong indicators of the passing of ownership include:

(a) physical or constructive possession (refer to IT-50R)
[see IT-285R2 which replaced IT50R],
(b) entitlement to income from the property,
(c) assumption of responsibility for insurance coverage, and
(d) commencement of liability for interest on purchaser's debt that forms a part of the sale price."

Accordingly, in our view, the employees in your situation acquired the shares under the options described above, in XXXXXXXXXX, when the employees were obliged to pay for them under the terms of the option, had entitlement to them and had the right to sell them to XXXXXXXXXX. Therefore, assuming XXXXXXXXXX was a CCPC, subsection 7(1.1) of the Act provides that the benefit otherwise determined under paragraph 7(1)(a) of the Act, would be included in the employee's income in the year of sale. In our view, the deferral of the receipt of a portion of the proceeds from the sale of the share of XXXXXXXXXX does not defer the sale until XXXXXXXXXX. Similarly, if the shares were not shares of a CCPC, but otherwise qualified for the deferral provided under subsection 7(8) of the Act, in our view, the full amount of the benefit would still be included in income in the year of sale.

Using the example provided by XXXXXXXXXX, if it is assumed the grant price was $20, the fair market value of a share of XXXXXXXXXX at the time of exercise in XXXXXXXXXX was $100, and the purchase price of a XXXXXXXXXX share as offered by XXXXXXXXXX was also $100, we are of the view that the benefit under paragraph 7(1)(a) of the Act that had to be reported on a T4 would be $80.

Section 7 of the Act does not provide for a reserve in respect to any unpaid portion of any proceeds received on the sale of any shares to which the provision applies. On the other hand, a reserve might be available under paragraph 40(1)(a) of the Act if the shares are capital property and a capital gain is earned on their disposition. However, since it appears the shares were sold at their adjusted cost base, this reserve would not be available in the situation at hand.

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 Department'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. You should make requests for this latter version by phoning (613) 957-2137. The severed copy will be sent to you for delivery to the client.

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