15 March 1989 Income Tax Severed Letter 5-7255 - [Request for Technical Interpretation - Employee Stock Options]

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.

Dear Sirs:

This is in reply to your letter of December 13, 1988 wherein you requested our views with respect to employee stock options in the following situations.

Situation I

An option is granted in January 1985, for 100 common shares of the employer public corporation at $3 per share (the fair market value of the shares at the time). In 1988 the shares have a fair market value of $10 per share. The employee desires to exercise his options and immediately sell the acquired shares. The option rights are transferred at their fair market value of $7 per share to a corporation wholly-owned by the employee. The corporation exercises the options and immediately sells the acquired shares for $10 per share. The sale proceeds are distributed to the enployee as repayment of the purchase price for the options and repayment of funds, loaned to the corporation.

It is your view that the tax implications to the employee and corporation would be as follows:

Impact to Employee

• • Gain on sale of options - $7 per share
• • Paragraph 7(1)(c) of the Income Tax Act (the "Act") benefit - $7 per share

Impact to Corporation

• • Selling price of shares equal to the adjusted cost base of the shares to the corporation

In our view, the non-arm's length transfer of the stock option does not give rise to a tax liability to the transferor at tie time of the transfer in the above situation.

At the time of the exercising of the option by the corporation, the employee would be required to include the $7 per share in income pursuant to paragraph 7(1)(c) of the Act and would be entitled to a deduction under paragraph 110(1)(d) of the Act.

In our view, if the corporation were to claim a capital loss of $7 per share on the disposition of the shares section 245 of the Act could have application in this situation.

Situation 2

Same fact situation as situation I except that instead of selling his option rights to a wholly-owned corporation, the employee settles his rights on a trust of which he is the sole beneficiary. The trust exercises the option, acquires and sells the shares and distributes all proceeds to the beneficiary.

In your view, the tax implications to the employee and the trust would be as follows:

Impact to Employee

No impact on transfer of option rights to the trust as there has been no change in beneficial ownership. A benefit under subsection 7(1) of the Act would be included in the employee's income and a deduction under paragraph 110(1)(d) of cite Act would be available by virtue of subsection 7(2) of the Act.

Impact to Trust

The adjusted cost base of the shares acquired by the trust would be $10 per share (the $3 exercise price plus $7 paragraph 53(1)(j) addition).

In our view, the provisions of subsection 75(2) of the Act would be applicable to attribute the income and any capital gain or loss on the disposition of the shares to the settlor.

Paragraph 7(1)(c) of the Act would include the 57 per share benefit in the employee's income and the employee would have a deduction available under paragraph 110(1)(d) of the Act. In our view, subsection 245(1) of the Act would not have application in this situation.

We trust our comments will be of assistance.