23 December 2003 Internal T.I. 2003-0049927 - SAR-STOCK OPTION PLAN

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 an employer be allowed a deduction for a cash payment made to an employee in lieu of the employee receiving shares under a stock option agreement, where the employee elects to receive cash and the employer has the right to decline to pay cash?

Position: Yes, where the employee elects to receive cash and the employer pays cash.

Reasons:

The position reflected in paragraph 11 of IT-113R4 concerning the tax consequences when an employee has the right to elect to receive cash in lieu of shares under a stock option agreement will apply, despite the fact the employer has the right to decline to pay cash.

										December 23, 2003

		CALGARY TSO						HEADQUARTERS
Abu Dandia	 						G. Allen
Large Case Files					   	(613) 952-9853

									2003-004992

XXXXXXXXXX - Employee Stock Option Plan

This is in reply to your memorandum dated November 18, 2003 and the telephone conversation on December 17, 2003 (Dandia/Allen), wherein you requested our opinion regarding certain issues concerning the Employee Stock Option Plan of XXXXXXXXXX (the "Plan").

Facts

1. A board resolution on XXXXXXXXXX amended the Plan to permit optionees the right to elect to receive cash, subject to XXXXXXXXXX right to decline, in lieu of exercising their right to acquire shares under the stock option (the "Put Right").

2. The board resolution also amended the Plan to allow optionees to subscribe for common shares, issuable on a flow-through basis, with the proceeds from the exercise of the Put Right.

3. In XXXXXXXXXX, employees exercised the Put Right that resulted in XXXXXXXXXX making cash payments of $XXXXXXXXXX in XXXXXXXXXX and $XXXXXXXXXX in XXXXXXXXXX. These amounts were deducted on the XXXXXXXXXX T2s of XXXXXXXXXX. As per information provided in your telephone conversation (Dandia/Allen), the employees have reported the proceeds from the exercise of the Put Right as capital gains on the employees' T1s.

4. Also, as discussed in your telephone conversation (Dandia/Allen), no employee has subscribed for flow-through shares with the proceeds from the exercise of the employees' Put Right.

Our Comments

Paragraph 11 of IT-113R4 and Income Tax Technical News #7 discuss the tax consequences of an employee receiving a cash payment in lieu of exercising the employee's right to acquire shares under a stock option agreement. Where the employee has the right to elect to receive cash in lieu of receiving shares under a stock option agreement, paragraph 7(1)(b) of the Income Tax Act (the "Act") will deem a benefit to have been received in the taxation year in which the employee disposes of the employee's right to acquire shares under the stock option agreement.

The cash benefit is received by the employee by virtue of the employee's employment and is therefore taxable under either subsection 5(1) or paragraph 6(1)(a) of the Act in the year received. The employee may be entitled to a deduction under paragraph 110(1)(d) of the Act, provided the conditions in that paragraph are satisfied, and paragraph 7(3)(b) of the Act will not apply to deny the employer a deduction for the cash payment made to the employee.

Although the election by the employee to receive cash in lieu of receiving shares under the stock option agreement is subject to the right of XXXXXXXXXX to decline to pay cash, XXXXXXXXXX, in our opinion, the employee still has the right to elect to receive cash and our position in paragraph 11 of IT-113R4 will apply (document 2000-0063133).

Although no employees have subscribed for the flow-through common shares with the proceeds from exercising the employee's Put Right, we are concerned with this situation and are providing our views. It is a question of fact whether an employer issues shares under a stock option agreement. Where an employer sells or issues shares to an employee under a stock option agreement, the employer will be denied a deduction for the benefit provided to the employee as a result of selling or issuing shares to the employee, pursuant to paragraph 7(3)(b) of the Act. In our view, in a situation where an employee elects under a stock option agreement to have the cash proceeds that would otherwise be payable on the disposition of rights under an option used to acquire shares of the employer, an argument may be made that the employee did not receive the cash payment and that, in fact, the employer has sold or issued shares to the employee under the terms of the agreement. In this event, it would be appropriate to rely on paragraph 7(3)(b) of the Act and deny the employer a deduction for the cash payment made to the employee.

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
Manager
Income Tax Rulings Directorate
Policy and Legislation Branch