21 January 1998 External T.I. 9731165 - EXCHANGE OF EMPLOYEE STOCK OPTIONS

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:

Will any undue taxation arise on the application of section 7 in certain specific situations where options are exchanged.

Position:

Where one option is exchanged for a new option, 7(1)(b) may apply to assess a benefit. Furthermore, the cost of the new option will be equal to the value of the option given up. Accordingly, the cost of the new option will reduce the income inclusion on its exercise or disposition. However, if the values of the two options are not equal at the time of the exchange, this series of transactions may result in the inclusion of benefits that exceeds the value ultimately received. Neither 52(1) nor 53(1)(j) apply and it is not clear that the provisions of 248(28) of the Act will apply to this result. Therefore we have referred the problem to the Department of Finance for their future consideration.

Reasons:

The 1991 amendments to section 7 were added to allow the deduction of any costs incurred to acquire the option. However the provisions do not provide a mechanism to include benefits taxed under 7(1)(b) in the cost of the new options. It is not clear that 248(28) can apply to limit the taxation of benefits derived from the disposition of separate and distinct options.

XXXXXXXXXX 973116

Attention: XXXXXXXXXX W.C. Harding

January 21, 1998

Dear Sirs

Re: Exchange of Employee Stock Options

This is in reply to your facsimile of November 20, 1997 in which you requested our clarification of the application of section 7 of the Income Tax Act (the “Act”) as it applies to a situation described in your letter.

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 70-6R3. Questions concerning actual fact situations must be directed to your local tax services office. Accordingly, since your situation appears to relate to a factual situation, we can not provide any specific answers to your queries at this time. As an alternative, however, we can provide the following general comments which are not binding on the Department but may be of some assistance.

You are concerned with a merger where the trading price before the merger of the shares of the predecessor company is different than the trading price of the shares of the merged company after the merger. Generally where the share of a predecessor corporation is exchanged for a share of the merged corporation on a one for one basis, we would expect the value immediately before the exchange of the share disposed of to equal the value immediately after the exchange of the share received. However, if an employee exchanges old options for new options and the conditions set out in paragraph 7(1.4)(c) are not met with respect to the exchange, the rules set out in that subsection will have no application. A disposition of the old options will occur and the new options will be received as consideration. Furthermore, if the disposition is made to a person who deals at arm’s length with the employee, the provisions of 7(1)(b) will have application.

Paragraph 7(1)(b) provides that a benefit equal to the value of the consideration received less any amount paid by the employee for the right will be deemed to have been received in the year in which the disposition of the right occurs. When section 7(1)(b) applies to the exchange of an old option for a new option, it is our opinion that, for the purposes of any subsequent application of section 7 and 110(1)(d) of the Act, the new options will have a cost equal to the value of the old option at the time of the exchange. Accordingly, if the new options are subsequently exercised, the provisions of paragraph 7(1)(a) will result in a reduction of the benefit otherwise determined at that time, by that value. If the value of the two options is not equal at the time of the exchange, the series of transactions may result in the inclusion of benefits that exceeds the value ultimately received.

This latter result seems to occur since the value of the new option received, while included in income in accordance with paragraph 7(1)(b), is not added to the option's cost. Normally where the value of property is included in income subsection 52(1) provides that the amount so included is to be added to the cost of the property. However, it does not apply to amounts included pursuant to section 7 Furthermore, it is not clear that the provisions of 248(28) of the Act will apply to such transactions. In consequence, we have referred the problem to the Department of Finance for their future consideration.

Please note that information concerning valuations of options should be addressed to the Tax Services Office serving the region in which your client resides. For Toronto residents, this service is provided by the Toronto Centre Tax Services Office.

Although our comments are not binding on the Department we trust they will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch