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Principal Issues: Can subsection 7(1.31) apply to a donation and a transfer of shares when an employee exercises a stock option and afterwards transfers a portion of the shares acquired to a holding corporation and donates the other portion of the shares acquired.
Position: No. Subsection 7(1.31) would only apply to the first event that takes place between the donation and the transfer.
Reasons: The condition in paragraph 7(1.31)(a) would not be met since there were two separate dispositions of identical securities
Financial Strategies and Financial Instruments Roundtable, October 9, 2015
2015 APFF Conference
Question 2
Exception to the average cost rule - Subsection 7(1.31)
Mr. A holds an option to purchase 100,000 PublicCo shares pursuant to an agreement described in subsection 7(1) (the "Option"). Mr. A is the sole shareholder of Holdco. Holdco is a shareholder of PublicCo. Mr. A wishes to exercise the Option (the "Exercise"), and then, out the 100,000 securities acquired, donate 35,000 to a qualified donee (the "Donation") and dispose of 65,000 to Holdco (the "Transfer").
At the time of the Exercise, Mr. A will include in his income the taxable benefit that he will be deemed to have received under paragraph 7(1)(a). Prior to the Exercise, Mr. A was already the holder of shares in the capital stock of PublicCo which were identical to those acquired on the Exercise, but which had a low cost. Mr. A's objective is to benefit from the high cost of the shares acquired on the Exercise when proceeding with the Donation and the Transfer.
Subsection 7(1.31) creates an exception to the average cost rule found in subsection 47(1) and thus permits a minimization of the tax effects that are normally associated with the application of the general rules applicable to the disposition of identical properties.
One of the five conditions that must be met for subsection 7(1.31) to apply in a given situation is found in paragraph 7(1.31)(a). This condition requires that no other securities that are identical to the particular security are acquired, or disposed of, by the taxpayer after the particular time and before the disposition.
In reading subsection 7(1.31), and considering the situation in this case where Mr. A will dispose of the securities acquired on two separate occasions, namely at the time of the Donation and then at the time of the Transfer, it would appear that the condition under paragraph 7(1.31)(a) could prevent Mr. A from benefiting from subsection 7(1.31) on theTransfer.
Question to CRA
Assuming that all the conditions set out in subsection 7(1.31) are met, except for that provided in paragraph 7(1.31)(a), does the exception to the average cost rule in subsection 7(1.31) apply to the Donation and to the Transfer?
CRA Response
Subsection 7(1.31) deals with the situation where a taxpayer acquires a security under an agreement referred to in subsection 7(1) (the “Acquired Security”) and, on a day that is no later than 30 days after the acquisition of the Acquired Security, disposes of a security that is identical to the Acquired Security. When all the conditions of subsection 7(1.31) are satisfied, this subsection deems the newly-acquired security to be the one which the taxpayer disposed of. In brief, subsection 7(1.31) specifies the order of disposition of the securities.
In applying the average cost rule for identical property in subsection 47(1), subsection 47(3) indicates, among other things, that a security to which subsection 7(1.31) applies is deemed to not be identical to any other security acquired by the taxpayer. Consequently, the adjusted cost base (“ACB”) of each security to which subsection 7(1.31) applies will be calculated without taking into account the ACB of each other security held by the taxpayer.
In order for subsection 7(1.31) to apply, paragraph (a) requires that the taxpayer have neither acquired nor disposed of any identical security to the Acquired Security between the moment of its acquisition and that of its disposition.
In the situation presented, only the first event to occur as between the Donation and the Transfer would comply with the requirement stipulated in subsection 7(1.31). Respecting the second event, there would have been a disposition of a security identical to the Acquired Security between the time of the acquisition of the acquired security and that of its second disposition.
Catherine Ayotte
(819) 243-7306
October 9, 2015
2015-059584
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