12 January 1990 Income Tax Severed Letter 7-4437 - [Stock Option, Stock Option Deduction and Capital Gains Deduction]

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.

JAN 12 1990

Business and General Division J.D. Jones (613) 957-2104

FILE DOSSIER 7-4437

SUBJECT: OBJET: Stock Option, Stock Option Deduction and Capital Gains Deduction

This is in reply to your memorandum of October 18, 1989, and further to our telephone conversation (McGuigan/Jones) of November 1, 1989, wherein you requested our opinion on the application of a stock option deduction and the capital gains exemption in the following situation.

It is our understanding that a taxpayer was hired by a Canadian Controlled Private Corporation and exercised an option in October of 1986 to acquire 100,000 shares of the company. The purchase price for these shares was $1.00 and the fair market value was $170,000.00. This block of shares (certificate x/17) was sold in November of 1988 for $380,000.00. The taxpayer also exercised another option on May 4, 1988, for 100,000 shares (certificate 1/32) at a cost of $250,000.00 and sold them the same day for $350,000.00. Both blocks of shares were previously unissued treasury shares.

It is your view that the taxpayer should be taxed as follows:

1988 STOCK OPTION BENEFIT

Under subsection 7(1.3) a taxpayer is deemed to dispose of shares that are identical in the order in which he acquired them.

May 4, 1988 FMV of Block 1         $170,000.00
Less: ACB                                 1.00
Benefit                                         $169,999.00

November 1988 FMV of Block 2       $350,000.00
Less: ACB                           250 000 00
Benefit                                         $100.000.00
                                                -----------
Total Stock Option Benefit                      $269,999.00
                                                ===========

CAPITAL GAIN CALCULATION

Proceeds - Block 1                 $380,000.00
Block 2                             350.000.00  $730,000.00

Less:ACB
Block 1                                   1.00
Block 2                             250,000.00
Stock Option Benefit                269.999.00   520.000.00

Total Capital Gain                              $210,000.00

Taxable Capital Gain - 2/3                      $140,000.00

The taxpayer's accountant is of the view that his client is entitled to the stock option deduction pursuant to paragraph 110(1)(d.1) of the Act and the capital gains deduction in respect of qualified small business corporation shares pursuant to subsection 110.6(2.1) of the Act on the sale of the Block 1 shares in November of 1988.

It is your view that paragraph 110(1)(d.1) of the Act and subsection 110.6(2.1) of the Act do not apply as the taxpayer is deemed to have disposed of the first block of shares on May 4, 1988, in accordance with subsection 7(1.3) of the Act and, accordingly, the shares referred to in paragraph 110(1)(d.1) and subsection 110.6(2.1) of the Act were not held for a two year period.

Our Comments

We are in agreement with your view that the deduction available pursuant to paragraph 110(1)(d.1) of the Act in respect of both blocks of shares is not available to the taxpayer as subsection 7(1;3) of the Act deems the taxpayer to have disposed of his first block of shares on May 4, 1988, and as such has not met the two year holding period referred to in subparagraph 110(1)(d.1)(ii) of the Act. The second block of shares purchased on May 4, 1988, and disposed of in November of 1988 also do not meet this condition.

It is our view, however, that the taxpayer would be entitled to the capital-gains deduction with respect to both blocks of shares pursuant to subsection 110.6(2.1) of the Act provided the shares otherwise qualify due to the following factors:

(1) As both blocks of shares were treasury shares issued prior to June 14, 1988, the restriction on the definition of "qualified small business corporation share" found in subsection 110.6(14) of the Act is not applicable with respect to the issuance of these shares.

(2) The shares meet the requirement in paragraph (b) of the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act of not having been owned by anyone other than the individual throughout the 24 months immediately preceding the determination time as the shares were previously unissued treasury shares.

ORIGINAL SIGNED BY ORIGINAL SIGNÉ PAR P.D. FUOCO for Director Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch

c.c. Mr. R. Roy 11th Floor. 123 Slater Street