21 June 1996 External T.I. 9620075 - INTEREST DEDUCT, STOCK OPTION PLAN

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:

Interest deductibility with respect to debt associated with a stock option plan?

Position:

maybe, depending on facts

Reasons:

Money borrowed now but stock acquired two years from now so the current use of the borrowed funds will determine whether interest is deductible.

		962007
XXXXXXXXXX			M.P. Sarazin

Attention: XXXXXXXXXX

June 21, 1996

Dear Sirs:

Re: Interest Deductibility and Employee Stock Option Plan

This is in reply to your letter dated May 28, 1996, wherein you requested our comments regarding the deductibility of interest incurred with respect to loans secured by employees to finance the employee's participation in an employee stock option plan ("ESOP"). Based upon the limited information provided, it would appear that under the terms of the ESOP an employee has funds withheld from his or her net after tax pay in order to pay for the shares that can be acquired under the ESOP and, at the end of two years when the full acquisition price has been paid, the employee can request the shares acquired under the ESOP or a return of his or her money plus interest. It may be that the second alternative is present in order to protect employees participating in the ESOP in the event the fair market value of the shares at the end of the two year period is less than the price paid by the employee to acquire the shares.

Comments

Written confirmation of the tax implications inherent in particular proposed transactions are given by this Directorate only where the transactions are outlined in an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R2. Questions concerning actual fact situations should otherwise be directed to your district tax services office. Although we cannot provide a specific answer to your query, we offer the following general comments which are not binding on the Department.

Under the provisions of subparagraph 20(1)(c)(i) of the Income Tax Act (the "Act"), a taxpayer is entitled to deduct an amount paid in the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property. In any case, the actual use of the borrowed funds will determine whether the interest on such borrowed funds will be deductible for purposes of the Act. Where borrowed funds are used to reimburse a taxpayer for personal funds which were originally used to acquire income producing property, the interest on such debt would not be deductible for purposes of the Act because the borrowed funds were not used directly to acquire the income producing property.

The Department's general position with respect to moneys borrowed to purchase common shares remains as stated in the 1981 Canadian Tax Conference:

"Normally the Department considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that the potential return to the common shareholder may exceed the shareholder's borrowing cost. It is conceivable that in certain fact situations it would be quite unreasonable to expect a potential return in excess of the borrowing cost related to such shares. We do not have any guidelines that might be used to isolate such situation and feel each situation must be dealt with on the basis of the facts involved."

Consequently, where money is borrowed to acquire shares under a stock option plan and the potential return may exceed the borrowing cost associated with such loan, the interest on the loan will be deductible under subparagraph 20(1)(c)(i) of the Act. Where the borrowed funds will be used at some point in the future to acquire shares under a stock option plan, the current use of the borrowed funds would determine whether the interest thereon would be deductible for purposes of the Act.

We regret that, without a thorough review of the particular plan offered by the employer, we are not able to offer any general comments concerning the accrual of interest income, the benefits to be included in income under the ESOP or the deferral of any benefits resulting from an employee's involvement in the ESOP. However, the Department's general views with regards to the issue of accrued interest on debts and the taxation of stock option benefits are found in Interpretation Bulletins IT-396R and IT-113R3, respectively. A copy of each of IT-396R and IT-113R3 is enclosed.

We trust the above comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate