14 June 1989 Ministerial Correspondence 57754 F - 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.

June 14, 1989

Dear Sirs:

Re:  Paragraph 110(1)(d) and Subsection 7(3) of the Income Tax Act

This is in reply to your letter of March 22, 1989, wherein you requested a technical interpretation with respect to paragraph 110(1)(d) subsection 7(3) of the Income Tax Act (the Act) as it relates to 24(1) (1987) Stock Option Plan (the Plan) submitted in draft form with your letter.

The Plan was amended effective November 10, 1988, to include stock appreciation rights (SAR) and to delete the then existing "stock substitution" privilege.

You provided us with the following example to illustrate the application of the SAR.

24(1)

Based upon the above and the copy of the draft Plan submitted with your letter, we will answer your questions in the order in which they were posed.

In our view, the amendment to the Plan to include the SAR and to delete the "stock substitution" privilege does not change our view with respect to the application of paragraph 110(1)(d) of the Act as stated in our previous correspondence to you dated November 13, 1986.  That is, with respect to the prase "amount payable" under subparagraph 110(1)(d)(iii) of the Act, it is our view that this refers to the stated option price per share that is payable under a stock option agreement.  As a result, if the other requirements of paragraph 110(1)(d) are met, it is our opinion that the employee in the above example would be entitled to a deduction under paragraph 110(1)(d) of the Act of one-third (one-quarter for the 1990 and subsequent taxation years) of the benefit deemed to have been received by the employee pursuant to subsection 7(1) of the Act if the benefit arises in 1988 or 1989.  This would be the case whether the employee elects to receives shares, cash or a combination thereof.

The basis for the Department's view stated in paragraph 8 of IT-113R3 is that, in such circumstances, the employer has not (necessarily) "agreed to sell or issue shares" as is required by preamble to subsection 7(1) of the Act.  We would reach a similar conclusion if, having regard to the terms of the agreement and all of the surrounding circumstances, it is apparent that the parties never truly contemplated the issuance of shares under the agreement and the cash payment by the employer was simply a means of compensating the employee through a "phantom" stock option plan.

In the very limited and defined circumstances as set forth in the draft copy of the Plan submitted, where optionees are automatically deemed to have elected to receive cash equal to the appreciation of the shares underlying the option as described in subparagraph (i)(3) of the Plan (i.e. upon a "change in control of the Company" as defined in paragraph (e) of Section V), we would be of the view that the employee has received a benefit pursuant paragraph 110(1)(d) of the Act and is, therefore, entitled to a deduction pursuant to subsection 110(1)(d) of the Act notwithstanding the Department's position as stated in paragraph 8 of IT-113R3.  This view is based on our understanding that subparagraph V(i)(3) of the Plan appears to have been inserted into the plan solely to comply with Rule 16b-3(a) of the United States Securities and Exchange Commission.  Accordingly, the basis for the Department's views as stated in paragraph 8 of IT-113R3 do not appear to be applicable in this situation.

In our view, where the employee elects to receive to SAR value in cash under the Plan, paragraph 7(3)(b) of the Act would not apply to deny a deduction of the expense so incurred to the corporation.

The foregoing represents our considered opinion as to how the law applies generally, but this in not a ruling and is not binding upon the Department.

Yours truly,

for Director Small Business And General DivisionSpecialty Rulings Directorate Legislative and Intergovernmental Affairs Branch