1 December 1992 External T.I. 9205535 F - Stock Options Exercised by a Non-Resident

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.

920553

24(1)          K. B. Harding

957-2111

Attention:  19(1)

December 1, 1992

Dear Sirs:

Re:  Stock Options Paid to Non-Residents of Canada

This is in reply to your letter of February 18, 1992 wherein you requested our opinion concerning the treatment of stock options in the following hypothetical situation.

A Canadian private company (Canco) has subsidiary operating companies in Canada, the United States and the United Kingdom.  Canco plans to implement a stock option plan (the "Plan")  under which employees of the operating companies in the above three countries will receive stock options to acquire shares of Canco.  The option price under the Plan will be the fair market value of the shares of Canco at the time the option is granted.  Canco is to issue the shares under the Plan from Treasury.

You are concerned with the treatment of the stock options granted to employees of subsidiaries who do not perform services in Canada.

Subsection 7(1) of the Income Tax Act (the "Act") deals with the situation where a corporation has agreed to sell or issue shares of the capital stock of the corporation to an employee of a corporation with which it does not deal at arm's length.  Where the employee acquires shares under the agreement, a benefit equal to the amount, if any, by which the value of the shares at the time the employee acquires them exceeds the total of the amount paid or to be paid to the corporation by the employee for the shares shall be deemed to have been received by the employee by reason of the employee's employment in the taxation year in which the employee acquired the shares.

Pursuant to subparagraph 115(1)(a)(i) a non-resident is required to include in income any incomes from the duties of offices and employments performed by him in Canada.  Where employees of the U.K. or U.S. subsidiaries perform all of their employment outside Canada, they are not required to include in income any amounts deemed to have been received by virtue of paragraph 7(1)(a) of the Act.  Where an employee in the U.K. or U.S. subsidiaries exercises part of his employment in Canada and part in the country where the subsidiary is resident, a relative portion of his employment income will be regarded as being earned from employment performed in Canada.  In such situations, a relative portion of the stock option benefits that relate to the portion of the employment performed in Canada will be regarded as income from the duties performed in Canada.

Where the employee is a resident of the United Kingdom or the United States, Article XV of the Canada-U.K. Income Tax Convention (1978) or Article XV of the Canada-U.S. Income Tax Convention (1980) may provide some relief to the taxpayer in such situations if a resident of one of those countries is taxable in Canada on a portion of the stock option benefit.

In accordance with paragraph 54(b) of the Act, the option to acquire shares cannot be considered a "capital property" since any gain from the disposition of such option is treated as income under section 7 and not a capital gain.  See comments on the last paragraph of Interpretation Bulletin IT-96R5.  In accordance with paragraph 54(a) of the Act the adjusted cost base of the shares to the employee will be the cost to him of the property plus the amount of the benefit deemed to have been received under section 7 of the Act.

When the shares of Canco are subsequently disposed of, the taxpayer will calculate his capital gain in accordance with section 40 of the Act and the will include in income, pursuant to subparagraph 115(1)(a)(iii), the taxable capital gain determined in accordance with section 38 of the Act.  Pursuant to Articles XIII of the Canada-U.K. Income Tax Convention and the Canada-U.S. Income Tax Convention, the capital gains from the disposition of shares of a private company will generally be exempt from tax in Canada provided the value of the shares is not derived principally from real property situated in Canada.  However, this general rule may be overridden by paragraph 9 of Article XIII of the Canada- U.K. Income Tax Convention or paragraph and 5 of Article XIII of the Canada-U.S. Income Tax Convention.

Paragraph 7(e) of the Act provides that if the employee has died and immediately before his death the employee owned a right to acquire shares under the agreement, a benefit equal to the amount, if any, by which the value of the right immediately after the death exceeds the amount, if any, paid by the employee to acquire the right shall be deemed to have been received by the employee by reason of the employee's employment in the taxation year in which the employee died, and will be subject to the rules outlined above and may be exempt from tax in Canada by virtue of Article XV of the Canada-U.S. and Canada-U.K. Income Tax Conventions.

Where a corporation has agreed to sell or issue the capital stock of the corporation or of a corporation with which it does not deal at arm's length to an employee of the corporation or of a corporation with which it does not deal at arm's length, paragraph 7(3)(b) of the Act provides for the treatment of income for a taxation year of the corporation or the corporation with which it does not deal at arm's length.

We trust these comments are adequate for your purposes.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch