8 September 1989 Ministerial Letter 89M09038 F - Stock Options in U.S. 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: Stock Options in U.S. Corporations Subparagraph 110(1)(d)(iii) of the Income Tax Act (the "Act")

Background

1.     In certain situations where an employee acquires a share pursuant to a stock option offered by his employer, subsection 7(1) of the Act deems him to receive, as income from employment in the year he acquired the share, a benefit equal to the amount by which the fair market value of the share at the time of the exercise of the option exceeds the exercise price.

     Paragraph 110(1)(d) of the Act then allows a deduction in computing that employee's taxable income, in certain situations, of one-quarter of the stock option benefit included in calculating his income from employment.

2.     In a letter from 24(1) dated October 17, 1988, we were asked to opine as to whether the provisions of subparagraph 110(1)(d)(iii) of the Act would have been met in the following situation:

(i)     A U.S. corporation ("U.S. Co.") had a stock option plan whereby management employees of U.S. Co. or its Canadian subsidiary were given stock options which enabled them to acquire shares of U.S. Co. at a cost equal in amount to their fair market value at the time of issuing the options.

(ii)     When the stock options were issued, the option exercise price expressed in Canadian dollars or in U.S. dollars as the case may be, was equal in amount to the fair market value of the stock when expressed in Canadian or U.S. dollars, respectively, at that time.

(iii)     When the stock options were exercised, the Canadian taxpayers paid an amount to acquire their shares, when expressed in U.S. dollars, equal to the fair market value of the shares at the time the option was issued, when expressed in U.S. dollars.

(iv)     However, between the time when the options were issued and when they were exercised, exchange rate fluctuations resulted in the Canadian dollar appreciating against the U.S. dollar.  When the options were exercised, the amount payable for the shares, in Canadian dollars, was an amount less than the fair market value of the shares at the time that the options were granted, when expressed in Canadian dollars.

3.     In our reply to 24(1) dated January 17, 1989, we advised them that it was our opinion that Canadian employees in the above scenario would not be eligible to claim a deduction under paragraph 110(1)(d) of the Act, because the requirements of subparagraph 110(1)(d)(iii) would not have been met.

     We noted that subparagraph 110(1)(d)(iii) states "the amount  payable by the taxpayer to acquire the share under the agreement is not less than the fair market value of the share at the time the agreement was made".

     Since we are dealing with the Income Tax Act, the amount payable and the fair market value referred to above, must be established in Canadian dollars.  This is consistent with Justice Pinard's comments at page 6396 in the Federal Court-Trial Division case of Gaynor v The Queen (88 DTC 6394), where he states:

     "...when the Income Tax Act, a Canadian statue, requires that a gain, a loss, a cost or a price be established or considered, that must be done in Canadian dollars at the relevant time, i.e. at the average exchange rate prevailing at the time such gain or loss occurs, and such cost or price is encountered."

     Fluctuations in the exchange rate caused an element of uncertainty as to the precise amount the employees would be required to pay upon the exercise of their options to acquire U.S. Co. shares.  Therefore, the actual amount payable for the shares was only determined when the options were exercised and not at the time the options were granted.

     Since the amount payable to acquire each share was less than the fair market value of each share at the time the option agreement was made, the requirements of subparagraph 110(1)(d)(iii) were not met and no paragraph 110(1)(d) deduction was available to the employees.

4.     While addressing a hot line query, G. Middleton of Technical Interpretations enquired of Current Amendments to see if they agreed with the position outlined in our January 17, 1989 letter to 24(1) .  Consequently, Current Amendments referred the matter to Finance for their comments on the policy intentions vis-a-vis paragraph 110(1)(d) of the Act (letter to Finance dated March 13, 1989).

5.     21(1)(b)

6.     In Current Amendments' April 24, 1989 memo to G. Middleton it was requested that our earlier position (see 1 and 2 above) be reconsidered to see if it was possible to interpret the law to achieve Finance's policy intent.  If this was not possible then suggested solutions were requested.

Significance and Analysis

Based on our opinion as expressed above, a paragraph 110(1)(d) deduction would be denied to a Canadian taxpayer who acquires shares in a U.S. corporation under a stock option plan where the conditions of subparagraph 110(1)(d)(iii) are not met solely as a result of an increase in the value of the Canadian dollar relative to the U.S. dollar between the time the option is acquired and the time it is exercised.

The number of taxpayers affected by this position is not known.

Legal Opinion

In the course of preparing for our reply to Current Amendments we obtained a legal opinion dated August 14, 1989.

23

21(1)(b)

Alternatives

21(1)(b)

Recommendation

21(1)(a)

J.T. GauvreauChiefResource Industries SectionBilingual Services and ResourceIndustries Division