10 November 1986 Income Tax Severed Letter 5-2115 - [Employee Stock Options—Cash in Lieu of Shares]

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.

N.R. Mitchell Tel: (613) 957-2139

November 10, 1986

Dear Sirs:

Re: Employee Stock Options - Cash in Lieu of Shares

This is in reply to your letter of August 26, 1986 concerning the taxation of an employee's stock option benefit where the employee may elect under the stock option plan to receive cash in lieu of shares.

You have asked us to consider the following situation. Under a stock option plan, an employee of a company is granted an option to acquire common shares of the parent company. The option is granted after February 15, 1984 and is assumed to meet all of the other tests specified in paragraph 110(1)(d) of the Income Tax Act (the "Act"). Under the terms of this plan, the employee may, in lieu of acquiring the shares, elect to receive a cash payment from the parent company equal to the difference between the fair market value of the parent's shares on the date this election is exercised and the option price for these shares under the agreement. In other words, the employee may choose to receive in cash the value of what are commonly referred to as "stock appreciation rights".

It is your view that when, in the circumstances described above, the employee elects to receive cash, the amount so received represents consideration for the disposition of his rights to acquire shares under the stock option plan. You submit that a benefit equal to the value of the consideration so received would be included in the employee's income for the year by virtue of paragraph 7(1)(b) of the Act and that the employee would be entitled to deduct one-half of this benefit pursuant to paragraph 110(1)(d) of the Act.

We would agree that where the election to receive cash instead of shares under the agreement is the employee's choice to make, rather than the employer's decision, the benefit described above would be included in the employee's income under subsection 7(1) of the Act. On the other hand, if the decision to pay cash rather than issue shares remains with the employer, and cash is actually paid, we would maintain that the benefit so received would be included in the employee's income by virtue of subsection 5(1) or paragraph 6(1)(a) of the Act. The basis for this view is that, in such circumstances, the employer has not (necessarily) "agreed to sell or issue shares" as is required by the preamble to subsection 7(1) of the Act. We would reach a similar conclusion if, having regard to the terms of the agreement and all of the surrounding circumstances, it is apparent that the parties never truly contemplated the issuance of shares under the agreement and the cash payment by the employer was simply a means of compensating the employee through a "phantom" stock option plan.

With respect to the applicability of paragraph 110(1)(d) of the Act to the cash benefit described in your letter, it is our view that this deduction would not be available. As we see it, the deduction provided for in paragraph 110(1)(d) of the Act may only be claimed where the benefit deemed to have been received under subsection 7(1) of the Act is actually in the form of shares. We note in this regard that subparagraph 110(1)(d)(ii) of the Act sets out as a requirement for the deduction that "the share is a prescribed share at the time of its sale or issue, as the case may be".

Finally, we would simply point out that where an employer company makes a cash payment to discharge obligations under an employee stock option agreement, paragraph 7(3)(b) of the Act would not apply to deny a deduction in computing the employer's income for the year.

We hope this letter will be of some assistance to you.

For Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch

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