19 July 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.

July 19, 1985

XXXX

C.G. Toussaint

Dear Sirs:

This is in reply to your letter dated February 22, 1985, wherein you requested our opinion on the application of the Canada- United States Income Tax Convention (1980) (hereinafter the "Convention"). We apologize for the delay in replying.

Your letter outlines a hypothetical situation where a United States citizen resident in that State was granted an incentive stock option by his U.S. resident employer. After the option was granted, the employee became resident in Canada. He continues to be employed by his U.S. resident employer but performs employment services in Canada. While he is resident in Canada, he exercises his stock option and he disposes of the stock within a year after he received it but in the following taxation year. You are concerned that the individual in such a case may be subject to double taxation.

It is our understanding that for U.S. tax purposes, an incentive stock option produces no tax consequences when the option is granted or, except in certain cases for the alternative minimum tax, when the option is exercised. If the stock is held for a minimum of two years after the option is granted and one year after the option is exercised, the gain at the time of disposition will be taxed at capital gains rates. If the stock is disposed within a year after the exercise date, the gain on the disposition will be taxed as regular income.

For Canadian tax purposes, at the time of the exercise of the option, the employee will be subject to the application of subsection 7(1) of the Income Tax Act (hereinafter the "Act") and will be deemed to have received a taxable benefit, by virtue of his employment, equal to the amount by which the fair market value of the shares exceeds the amount paid. Since the stock option was granted at the time he was employed in the United States, it is our view that generally the benefit realized at the time the option is exercised will be considered as arising from a source in the United States.

Accordingly, if this U.S. citizen employee disposes of the shares he acquired pursuant to the option in the same taxation year as their acquisition, he would be entitled to claim a foreign tax deduction pursuant to subsection 126(1) of the Act for tax paid by him to the United States government in that year in respect to his income realized on the sale. On the other hand, if the sale occurs in a following taxation year, since no income tax will have been paid or accrued, in respect to the disposition of the shares, in the United States in the year that the option is exercised, this employee would not be entitled to any foreign tax credit either pursuant to paragraphs 2 or 4 of Article XXIV of the Convention except for the alternative minimum tax, if any.

In our opinion, this timing problem is not solved by any specific provision in the Convention and if the individual wants to avoid double taxation, he should dispose of his shares in the same taxation year in which he exercises the option. However, if you have a specific case, you may wish to present it in writing to the competent authority of Canada for further consideration. you.

We hope the above comments will be of some assistance to you.

Yours sincerely,

Original Signed by

Director Provincial and International Relations Division