18 January 1990 Ruling 74623 F - Revision of IT-96R4 - Options Granted by Corporations

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:  Revision of IT-96R4 - Options Granted by Corporations to Acquire Shares, Bonds or Debentures

This is in reply to your memoranda dated August I5, 1989 and January 5, 1990, wherein you requested our comments regarding the revision of IT-96R4.

Paragraph 12 of the current version of the bulletin ("Old Paragraph 12") states that the Department will apply-he provisions of subsection 55(1) of the Income Tax Act (the "Act") to a taxpayer who has granted a non-arm's length non-commercial option to acquire a security of another entity, when the option is exercised, if:

(a)     the price of the option and the exercise price together are materially less than the fair market value of the security otherwise determined at the time of the exercise of the option; and

(b)     the reason for the material difference is not some unexpected event that occurred between the granting of the option and the exercise of the option.

Subsection 55(1) of the Act was repealed by Bill C-l39 concurrently with the enactment of the general anti-avoidance rule in section 245 of the Act, the scope of which is intended to be broad enough to cover the transactions to which subsection 55(1) of the Act was intended to apply.

Accordingly, in draft paragraph 11 of IT-96R5 ("New Paragraph 11") you propose to indicate that, with respect to options exercised on or after September 13, 1988, the rules in section 245 may apply in respect of the disposition of the property pursuant to the option.  You have requested our comments concerning this proposed revision.

It would seem that, whereas Old Paragraph 12 appeared under the heading "Option to Acquire Security of Another Entity", New Paragraph 11 appears under the separate heading "Anti-Avoidance Provisions".  This placement, together with the reference in New Paragraph 11 to "... a non-arm's length non-commercial option on a capital property ..." suggests that the comments therein are intended to apply to options to acquire a granting corporation's own securities as well as to options to acquire securities of another entity.  In our view, it is more appropriate to distinguish between these two categories of options, as the current version of the bulletin does.  It would not appear to be necessary or appropriate to resort to former subsection 55(l) or existing section 245 with respect to non-commercial options in respect of the granting corporation's own securities because:

(a)     Subsection 15(l) would, subject to the exception set out in paragraph 15(1)(c), apply to most of such options, i.e.

(i)       options granted to a person who is already a shareholder of the granting corporation; and

(ii)      options wanted to a non-shareholder to acquire shares of the granting corporation (in that such an option could generally be said to be granted to the grantee "in contemplation of his becoming a shareholder").

(b)     Such options could not generally be used to achieve the potential abuse which a non-commercial option to acquire securities of another entity could.  That is, when the granting corporation issues its own securities pursuant to an option, subparagraphs 54(c) (vi) or (vii) deem the transaction not to be a disposition.  Accordingly, there is no capital gain of the grantor which can be inappropriately reduced by way of the non-commercial option.

We do not have a concern with the comment that section 245 may apply in respect of the exercise of a non-arm's length non-commercial option to acquire a security of another entity after September 13, 1988.

You did not request our comments concerning draft paragraph 2 of IT-96R5.  However, you may wish to consider whether the comments therein should be expanded to reflect the 1988 amendment to subsection 15(1) which broadened its application to benefits conferred "... on a person in contemplation of his becoming a shareholder ...".  Thus, where a.corporation grants to a non-shareholder an option to acquire shares in the corporation for inadequate consideration, it could ordinarily be said that a benefit is conferred upon the grantee in contemplation of his becoming a shareholder, such that subsection 15(1) would be applicable.

Finally, given that the subject of the bulletin is options granted by corporations, it is not clear to us why the comment in New Paragraph 11 (and in Old Paragraph 12) concerning paragraph 70(5) (a) is relevant.

M.A. Hiltzfor Director GeneralSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch