16 January 1997 External T.I. 9637505 - OPTION TRANSACTIONS

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:

Taxpayer requesting information on option
transactions and treatment for tax purposes

Position:

General explanation and discussion

Reasons:

N/A

963750
XXXXXXXXXX J.P. Dunn

January 16, 1997

Dear XXXXXXXXXX:

Re: Security Transactions

We are writing in response to your correspondence of September 4, 1996 addressed to the Ottawa Taxation Services Office of Revenue Canada which has been forwarded to this division for reply. We apologize for the delay in responding to your enquiries.

You had requested clarification of the treatment for income ax purposes of various security transactions including, primarily, those involving the purchase and sale of listed security options. We have enclosed for your reference a copy of Interpretation Bulletin IT-479R which describes, at paragraphs 23 to 32, the Department's general views on the taxability of option transactions.

As an initial comment, we would note that the following statements assume that the investment instruments subject to discussion are held by the investor on account of capital and are not held in the course of carrying on a business of investing in such instruments.

The Income Tax Act (the "Act") contains certain provisions in section 49 thereof which deal with the purchase, exercise and/or expiry of certain options including those types commonly known as equity or index options. Generally, the purchase of an option will result in a gain or loss being realized at the time the option expires or the position is closed out in the secondary market by the purchase of an offsetting position. If, however, the purchased option is exercised such that securities are acquired or disposed of at the option strike price, the cost of the option to the purchaser will either be added to the cost of the securities acquired or deducted from the proceeds of disposition of the securities disposed of pursuant to the option. In such a case, there is no gain or loss related to the exercise of the option itself.

With respect to options which are sold, the same basic principles would be applicable. To the extent that the option expires or the position is closed out in the secondary market, a gain or loss would be realized at the time of the expiration of the option or of the closing the Position. Likewise, if the option is exercised by the holder at the option strike price such that the option vendor must either acquire or dispose of securities, the premium received upon the initial sale of the option would be either deducted from the cost of securities acquired or added to the proceeds received for the securities sold. As above, there would be no gain or loss related to the option itself if it is exercised.

As you will note, there is an adjustment to the cost or the proceeds of disposition, as the particular case may be, of a security only in the event that the security is acquired or disposed of pursuant to the terms of the option. In the case in which a security is currently owned at the time that an option in respect of that security is purchased or sold and the option expires without exercise, there would be no adjustment to the cost of the underlying security and the gain or loss on the option would be calculated by reference to the cost and proceeds of disposition of the option itself. As noted previously, the gain or loss on the option is considered to be realized at the time that the option expires, the time of the sale of the option or the time of a purchase of an offsetting option position, whichever is applicable in the particular circumstances. In the case in which a security must first be acquired in order to be delivered pursuant to the exercise of an option, the cost of that acquired security would be the amount paid together with any transaction costs and the proceeds of disposition, as noted above, would be adjusted for any option premium received or costs paid.

Your second enquiry concerns interest bearing instruments for which the price paid by the investor differs from the principal amount of the instrument because of a variation between the interest rate stated to be payable on the instrument and market interest rates at the time of purchase. In the case in which the instrument is purchased at a discount to its principal amount, interest at the stated rate, if any, will be included in the income of the individual investor on a yearly basis pursuant to either paragraph 12(1)(c) or subsection 12(4) of the Act depending on whether the interest for that year is received or receivable. The discount will also be considered to be interest for income tax purposes and is to be reported annually on a yield to maturity basis pursuant to subsection
12(4) of the Act. Accordingly, if the investment is held to its maturity, the total amount of the discount will be reported as interest income over the term remaining from the date of purchase to maturity.

If such an investment is sold prior to maturity, any amount received as proceeds of disposition in excess of the total of (i) the original purchase price plus (ii) any accrued interest plus (iii) any portion of the discount which is accrued as interest to the date of sale would be considered to be a capital gain of the vendor. Likewise, if the proceeds of disposition are less than the total of the above three amounts, a capital loss would be incurred on the disposition.

We trust that this is the information which you require.

Section Chief
Corporate Financing Section
Financial Industries Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch