22 February 1985 Income Tax Severed Letter

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.

February 22, 1985

Revenue Canada, Taxation 875 Heron Road Ottawa, Ontario K1A 0L8

Attention: Mr. Ed Campbell

Dear Sir:

1980 Canada-U.S. Income Tax Convention (1980 Convention)

We request your department's technical interpretation regarding the following situation.

Facts

1) A U.S. citizen resident in the U.S.A. is granted an incentive stock option by his U.S. resident employer. For U.S. tax purposes incentive stock options may be received and exercised by an employee without recognizing income at those times. Provided the stock is held for the required holding period any gain realized upon sale of the stock is a capital gain. The employee must hold the stock for a minimum of two years after the option is granted, and one year after the option is exercised. If these conditions are not met then the entire gain is treated as income at the time of the disqualifying disposition.

2) For the purposes of this interpretation assume the employee was granted the option prior to February 16, 1984 and became resident in Canada a few years after the option was granted, but just prior to its exercise. Under the terms of the option it was not possible to exercise the option until a certain date, which is after the employee becomes resident in Canada. The employee continues to be employed by the U.S. resident corporation, but now performs his employment services in Canada.

3) The employee recognizes employment income under section 7 of the Income Tax Act (the "Act") at the time of the exercise of the option. For U.S. tax purposes, if, before a year expires, the employee disposes of the stock he has to recognize income at the time of the disqualifying disposition. For purposes of this technical interpretation please assume the exercise of the stock option takes place in one taxation year, and the sale of the stock occurs in the following taxation year. Further assume that the sale takes place within one year of the exercise of the option and therefore a disqualifying disposition occurs at the time of sale.

4) As most of the employment services in the period between the grant and exercise of the option were performed in the U.S.A., for Canadian foreign tax credit purposes the source of the section 7 benefit would seem to be mainly from a source in the U.S.A. Following the decision in Vincent N. Hurd v. Her Majesty The Queen, 81 DTC 5140 it might be argued that the entire section 7 benefit should be sourced to the U.S.A. Similarly for U.S. foreign tax credit purposes the income recognized at the time of disqualifying disposition would be sourced mainly to the U.S.A. For purposes of this discussion assume the individual did not pay any U.S. taxes for the year in which the option was exercised, but did pay U.S. taxes for the subsequent year due to the U.S. source portion of the income generated by the disqualifying disposition. Whether or not the individual is a citizen of the U.S.A. a U.S. tax liability will arise by virtue of the transaction, unless the amount of remuneration is $10,000 or less, in which case Article XV of the 1980 Convention should provide an exemption from U.S. tax.

5) Therefore the individual has paid both Canadian and U.S. taxes on that portion of the stock option benefit that relates to employment services performed in the U.S.A. Section 126 of the Act would not enable a foreign tax credit to be claimed in the year of exercise as it does not afford a carry back of non-business foreign income taxes from a subsequent taxation year.

6) Paragraph 2(a) of Article XXIV of the 1980 Convention would not provide any relief from this double taxation as it is stated to be subject to the provision of the laws of Canada. However, that paragraph is stated to be subject to the provisions of paragraph 4 of the 1980 Convention.

7) Paragraph 4(a) requires Canada to allow a deduction from Canadian tax in respect of income tax paid or accrued to the U.S.A. on income which arises in the U.S.A. It should be noted that the provisions of this paragraph are not subject to the provisions of the law of Canada.

Opinion Sought

Under the above circumstances we wish to know if you concur with our interpretation that in computing the deduction for foreign taxes, Canada would allow a deduction for the U.S. income taxes paid on that same U.S. source income, but in the subsequent taxation year, assuming that the amount of the deduction is within the limitations imposed by paragraph 4(a) of the 1980 Convention.

Very truly yours,

XXXX