18 February 1999 Internal T.I. 9900816 - STOCK OPTIONS, 7(3)(B), U.S. PARENT

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: Can a corporation deduct payments made to a parent corporation for its lost profit on shares issued by the parent corporation to employees of the corporation?

Position: No.

Reasons: It is clear that 7(3)(b) should apply to the payments made by the corporation and there is no reason to apply our administrative position that where corporation pays cash a deduction will be allowed.

February 18, 1999

	Audit Directorate	Income Tax Ruling and
	Tax Avoidance & Legislative	  Interpretations Directorate
	  Recommendations Division	M.P. Sarazin
	GAAR & Technical Support Section	952-9853

	Attention:  S. Gulliver
	                I/Manager	990081

Stock Options and Payments to Parent Corporation

This is in reply to your E-Mails of January 12 and 26, 1999, wherein you ask for our views regarding the deductibility of amounts paid by a Canadian corporation (“Canco”) to a U.S. parent corporation (“Parentco”) in respect of stock options provided to employees of the Canadian corporation.

FACTS

1. Canco is owned by a Luxemburg company which is owned by Parentco, a U.S. public corporation.

2. Parentco has an employee stock option plan (the “Plan”) under which employees of Parentco and its subsidiaries may be granted options to purchase shares of Parentco. Under the terms of the Plan, the option price to be paid by an employee to acquire a share of Parentco is the fair market value of Parentco’s shares on the date that the particular option being exercised was granted to the employee. Parentco buys the shares that are to be distributed under the Plan on the open market and holds them in a special treasury account.

3. Canco entered into an agreement with Parentco (the “Agreement”) entitling its employees to participate in the Plan. Under the terms of the Agreement, Canco has to reimburse Parentco for the difference between the option price paid by the Canco employees and the actual purchase cost to Parentco of the shares distributed to the Canco employees.

4. Employees of Canco have exercised their options under the Plan and paid the exercise price to Parentco. Canco has paid amounts to Parentco equal to the difference between the fair market value of the Parentco shares on the exercise date and the amount paid by its employees to acquire such shares from Parentco.

5. Canco has claimed a deduction for the amounts paid to Parentco which exceeds the amount paid by Parentco for the particular shares issued to the Canco employees. Presumably, Canco has also claimed a deduction for the amount paid to Parentco for the cost of the shares in excess of the option price received from the employee (in accordance with the agreement).

Comments

This is the first time that we have been asked to address this particular situation.

Based upon the limited facts presented above, we would conclude that the Plan would constitute an agreement described in subsection 7(1) of the Income Tax Act (the “Act”). The employees of Canco that acquired shares of Parentco under the Plan had an income inclusion under paragraph 7(1)(a) equal to the difference between the fair market value of the shares acquired and the amount paid by the employees for such shares.

We are also of the view that paragraph 7(3)(b) of the Act would apply to disallow any deduction for the amounts paid by Canco to Parentco (for the reimbursement per the agreement and any excess reimbursement). The provision states specifically that the income of the corporation or of a corporation with which it does not deal at arm’s length shall be deemed to be not less than its income for the year would have been if a benefit had not been conferred on the employee by the sale or issue of the shares to the employee. In support of the non-deductibility of amounts related to stock option benefits, we would refer you to the Federal Court of Appeal’s decision in Her Majesty the Queen v. Placer Dome Inc. (92 DTC 6402). In addition, the principle of generalibus specialia derogant, as described in the Federal Court - Trial Division decision in The Minister of National Revenue v. Chrysler Canada Ltd., ..., would apply. As a result, where a specific provision like paragraph 7(3)(b) denies a deduction in respect of certain amounts then a general deduction provision like paragraph 18(1)(a) of the Act will not apply to allow for a deduction of such amounts.

We trust our comments will be of assistance to you.

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