5 August 1994 External T.I. 9416645 - CAPITAL GAINS EXEMPTION FOR STOCK OPTION TRUST

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether the capital gains election to accrue gains to February 22/94 is available to employee whose shares are vested in a subsection 7(2) trust.

Position TAKEN:

	Not likely but we haven't seen proposed wording so 	cannot confirm.

Reasons FOR POSITION TAKEN:

Wording of 7(2) makes deeming applicable for purposes of subsection 7 and 110 deductions, not for 110.6 or subdivision c.

XXXXXXXXXX 941664

Attention: XXXXXXXXXX

August 5, 1994

Dear Sirs:

Re: Subsection 7(2) and the Election to Claim
Capital Gains Accrued Up To Budget Day

This is in reply to your letter of June 24, 1994, in which you ask whether employee beneficiaries under an employees profit sharing plan can make the above-noted election where shares are held by a subsection 7(2) trust, have been allocated to an employee but have not vested in the employees. References to the Income Tax Act unless as otherwise stated are to the Income Tax Act S.C. 1970-71-72, c. 63 as amended, consolidated to June 10, 1993 - the "Act".

The proposed wording of the election has not been released by the Department of Finance and we are unable to comment on its effect in the situation described by you. We point out two matters for your consideration, however.

Firstly, subsection 7(2) of the Act deems the employee to acquire, exchange or dispose of a share at the time, respectively, the trust acquires, exchanges or disposes of a share which the trust holds for the employee. The deeming, however, is for the purposes of section 7 (i.e. an income inclusion of an employment benefit) and paragraphs 110(1)(d) and (d.1) of the Act (i.e. a deduction equal to 25% of the employment benefit included in income), not for the purposes of subdivision c of Division B or section 110.6 of the Act. Subsection 7(2) does not apply to deem a flow-through of capital gains or losses, whether accrued or realized.

For example, if the stock option plan of a public corporation were terminated and the trust disposed of shares in a year in which no shares were vested in the employee, the actual capital gain or loss arising from the disposition of the shares would not affect the income of that employee. Instead, the employee would be considered to have disposed of the shares for nil pursuant to paragraph 54(c) of the Act, and since paragraph 53(1)(j) of the Act provides that the adjusted cost base is equal to the section 7 benefit included in the employee's income, the employee could claim a capital loss. This results in partial compensation for the taxation under subsection 7(2) of the Act to the extent that the employee has capital gains, a result which would not be achieved if the actual gain or loss on the sale of the shares (i.e. the difference between the proceeds of sale and the adjusted cost base of the share to the trust) were attributed to the employee.

(Note that if the trust instead disposes of the shares to the corporation for proceeds, or the corporation redeems or cancels the shares for an amount, no greater than the price paid to acquire the shares from the corporation, then the employee would be entitled to a deduction and deemed to have a nil capital gain or loss pursuant to subsection 8(12) of the Act.)

Secondly, if the arrangement is an employees profit sharing plan (EPSP) and the shares in the trust are acquired on the open market, the provisions of section 144 of the Act take precedence and section 7 would be inapplicable. There is an election available to the trustee of an EPSP under subsection 144(4.2) of the Act to treat capital property of the trust as having been disposed of on any day designated by the trustee. All capital gains arising from such an election must be allocated to the employees in the year for which the election was made and such allocated capital gains are deemed, pursuant to subsection 144(4) of the Act, to be a capital gain of the employee from the disposition of that property for the taxation year in which the allocation was made.

The foregoing comments are an expression of opinion only and are not binding on the Department. If you wish to write to us again once the proposed amendments have been released by the Department of Finance, we will be pleased to respond to your specific query.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate