29 August 1989 Ruling 74021 F - 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.

Subject:  24(1)

This is in reply to your memoranda of June 13, 1989, requesting our opinion on the tax consequences of the following transactions. We note that, while it is not appropriate to send an entire file along with an opinion request, the request should set out the relevant facts and should be accompanied by copies of the key documents, if any.

Our understanding of the facts is as follows:

Prior to the transactions, the corporate structure is: Holdco controls OPCO 1; OPCO 1 controls OPCO 2.

Prior to the sale of OPCO 1, the group is reorganized so that Holdco controls OPCO 2 directly.

Holdco then sells OPCO 1 to a third party.  In the course of the sale, Holdco and OPCO 2 issue an option on the business of OPCO 2 to the third party.  No years later, OPCO 2 pays $1,000,000 to the same third party for the termination and surrender of the option. OPCO 2 treats the $1,000,000 as an eligible capital expenditure.

It is your opinion that the $1,000,000 is a capital loss to OPCO 2 based upon IT 403R paragraph 3 and the fact that the option is "terminated and surrendered".

Our Comments

Paragraph 3 of IT-403R states that, where the grantor of an option purchases it back from the grantee and they are dealing at arm's length, the adjusted cost base of the property to the grantor is generally increased by the amount of the purchase price of the option from the grantee.  Thus, it would seem that the adjusted cost base of the business of OPCO 2 would be increased by the amount paid by OPCO 2 to reacquire the option from the third party.

Generally, an option takes on the identity of the property to which it relates.  We are unable to determine, however, the identity of the property as we have not reviewed the option agreement (a copy was not included with your request for an opinion).  If the property in question is an eligible capital property (for example, the goodwill of OPCO 2), it is our opinion that the option payments should be treated as if they were payments for an eligible capital property.  If, on the other hand, the option includes other assets (for example, land) the adjusted cost base of that asset would be increased as stated in paragraph 3 of  IT-403R.  Another possibility is that the option was to acquire the shares of OPCO 2 from Holdco, in which case it is our view that the $1,000,000 would increase the adjusted cost base of the shares of OPCO 2 in the hands of Holdco; in this case there should have been a dividend declared, an inter-corporate loan set up or some other transaction to move the $1,000,000 from OPCO 2 to Holdco.

We trust our comments are of assistance.

for DirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch