8 June 1988 Income Tax Severed Letter RCT 5-5711

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.

Dear Sirs:

This is in reply to your letter of March 8, 1988 in which you requested our opinion with respect to the application of paragraph 85.1(2)(d) of the Income Tax Act (the "Act") in a hypothetical situation which may be described as follows:

• 1. In 1988 Mr. X, an individual, receives $500 from Publico, a Canadian resident public corporation that is a taxable Canadian corporation, in exchange for the granting of an option, the terms of which are that Publico may acquire all of the outstanding shares of Opco owned by Mr. X in 1989 in exchange for additional consideration consisting only of shares of Publico with a fair market value of $1,500. Public corporation and taxable Canadian corporation have the meanings assigned by paragraphs 89(1)(g) and (i) of the Act respectively.
• 2. The adjusted cost base of Mr. X's shares of Opco is nil.
• 3. The shares of Opco are capital property to Mr. X. Capital property has the meaning assigned by paragraph 54(b) of the Act.
• 4. In 1989 Publico will exercise its option to acquire the outstanding shares of Opco held by Mr. X in exchange for shares of Publico with a fair market value of $1,500 that Publico will issue to Mr. X.

It is our opinion, based on this example, that for the purposes of the Act Mr. X would have a capital gain of $500 in 1988 within the meaning of capital gain assigned by paragraph 39(1)(a) of the Act. The exercise of the option in 1989 by Publico would not affect this capital gain. Since Mr. X is an individual, subsection 49(3) of the Act would not apply as a result of the exercise of the option.

Provided that Mr. X only receives shares of Publico in exchange for his shares of Opco on the exercise of the option in 1989, it is our opinion that the fact that Mr. X had previously granted the option to Publico for cash, would not in and of itself, result in a denial of the application of subsection 85.1(1) of the Act to the exchange pursuant to paragraph 85.1(2)(d) of the Act. The cash paid for the option could, for the purposes of paragraph 85.1(2)(d) of the Act, be considered to be consideration received for the option and not for the shares of Opco.

In the event that Mr. X and Publico file a joint election pursuant to the provisions of subsection 85(1) of the Act, with respect to the shares of Opco transferred upon the exercise of the option to Publico in exchange for the shares of Publico, the consideration for the disposition of Opco shares by Mr. X, for the purposes of subsection 85(1) of the Act, would be the shares of Publico only. In our opinion, the cash received on the granting of the option would be consideration for the granting of the option which would be subject to the provisions of the Act for the year in which the option was granted, as described above.

The above comments are based on the facts as presented in your hypothetical example and in particular on the fact that Mr. X is an individual. These general comments should not be interpreted as confirming or implying that subsections 85.1(1) or 85(1) of the Act would be applicable with respect to an actual transfer of shares in circumstances similar to those described above. Such a determination would have to be made based on a review of all of the relevant facts and would depend on the satisfaction of all of the relevant conditions set out in sections 85.1 or 85 of the Act.

As our comments herein are only expressions of our opinion they are not rulings and are not binding on the Department, as explained in paragraph 24 of Information Circular 70-6R.