Section 49

Respecting the application of s. 49(1) to the writing and sale on an exchange of a naked call option and the reporting of the “cost” of the option on the T5008 issued by the securities dealer, CRA stated:

[W]here an option is capital property … subsection 49(1) … provides (subject to the application of subsections 49(3) and 49(3.1) … and the exceptions in paragraphs 49(1)(a) to (c) …) that the granting of an option is equivalent to a disposition of property having an adjusted cost base of nil … [so that] there is no need to allocate cost to the option.

Where there is a real estate lease with a purchase option, is the landlord deemed to have disposed of the option when granting it, and is a portion of the rent paid under a lease with a bargain purchase option allocated to the option? CRA responded:

Subject to subsections 49(3) and 49(3.1), subsection 49(1) provides that, for the purposes of Subdivision c … the granting of an option represents a disposition of property whose adjusted cost base is nil. …

Where the landlord receives a payment during the term of a lease with a bargain purchase option … the landlord must allocate a portion of that amount to the lease and another portion to the purchase option, where that option has a value. …

[A] method of allocating a payment between the lease and the proceeds of disposition of the option that unduly defers the inclusion of the rent in the lessor's income will not give an accurate picture of profit.

In order to effectively convert an otherwise-expiring non-capital loss to a net capital loss, a CCPC (Aco) sells covered options (Options #1) on shares of a public corporation, thereby realizing a taxable capital gain under s. 49(1)(a) equaling the loss amount, and then purchases offsetting options (Options #2) at the beginning of the following year to close out its option position, thereby realizing a net capital loss. In confirming that this worked as a technical matter, but before noting the GAAR could be engaged, CRA stated:

If it were determined that the gain or loss realized by Aco in respect of Options #1 and #2 was on capital account, we would be of the view that subsection 49(1) would apply in this case to the sale by Aco of Options #1 in the particular taxation year and that, in accordance with our position in paragraph 29 of … IT-479R … the cost to Aco of acquiring Options #2 at the beginning of the taxation year following the particular taxation year would be a capital loss incurred at that time.

Where the owner of a farm granted an option for consideration to sell his farm in 2005 and received a further sum in 2006 to extend the option, those amounts would be recognized as gains in 2005 and 2006, respectively, pursuant to s. 49(1) except for the portions received respecting the principal residence (the farmhouse).

CRA noted its position that where a lease had a bargain purchase option, a portion of each lease payment was to be treated as allocable to consideration paid for the option and not as deductible rent, and then noted that if the lessee sold its interest in the lease agreement for an amount equaling the difference between the FMV of the property and the value of the future lease-payment obligations, such purchase price likely should be allocated to the embedded option.

Discussion of CRA position that where a lease contains a bargain purchase option, a portion of each rent payment may be considered to be a payment for the right to purchase the property in the future.

The shareholders, in consideration for granting the acquirer an option to acquire their shares in two years for a nominal sum, were entitled to receive, over the two-year period an amount equal to the agreed sale price (calculated on the basis of the corporation's profitability) less the nominal exercise price.

After indicating that the cost-recovery method under IT-426 would not be available assuming that, here, there was a disposition of stock options rather than of shares, CCRA further indicated that “it is possible that paragraph 12(1)(g) could apply to all payments made under the earnout clause or that the total proceeds must be calculated on the date of sale for the purposes of subsection 49(1).”

An individual, after having paid $12,500 in lease expenses during the first 48 months of an automobile lease, exercises the option under the lease to acquire the automobile for $15,000, at a time that its FMV is $20,000, then immediately sells it for $20,000.

CRA confirmed that if the individual had been using the vehicle in the course of carrying on a business then, by virtue of s. 13(5.2), the capital cost would be deemed to be $20,000 (i.e., the lesser of the vehicle’s FMV, and the sum of the actual cost of $15,000 and the lease expenses), and the individual would be deemed to realize recapture of depreciation of $5,000 on the sale, rather than a capital gain.

On the other hand, if there was no business use of the automobile, s. 13(5.2) would not apply. Assuming that the relationship between the parties was legally that for a vehicle lease and that no part of the leasing costs was reasonably attributable to the acquisition of the purchase option, the ACB of the purchase option under the s. 49 rules would be nil. If so, the ACB of the vehicle was equal to the exercise price of $15,000 plus the nil ACB of the option, for a total of $15,000, so that there would be a $5,000 capital gain on the sale.

Regarding a lease to “Aco” of a truck tractor (the “Vehicle”) with a term of 48 months and a bargain purchase option at maturity, CRA indicated that the bargain purchase option would not cause it to recharacterize the lease as a purchase by the lessee of a depreciable asset under a secured loan. Furthermore, the monthly rental payments should be allocated between deductible rental payments for the use of the vehicle and consideration for the option. (See also 2010-0370561E5 F.) It stated:

To the extent that Aco exercises its purchase option … Aco's cost of the Vehicle pursuant to subsection 49(3) will be the sum … paid in accordance with the exercise price … plus the adjusted cost base of the option, which will be the portion of the consideration paid that is attributable to the acquisition of that option.

The cost (for purposes of C of the standby charge formula under s. 6(2)) of an automobile acquired by the employer at the end of its lease pursuant to exercise of bargain purchase option was increased under s. 49(3) by the portion of each preceding lease payment that was to be reasonably treated as an option premium, i.e., that “could be considered as a payment in respect of the right to purchase the property in the future.”

A lease is amended to add an option to purchase and to increase the annual lease payment by an amount that would be in excess of the fair market value rent in the absence of the option. The additional lease payment are treated for purposes of s. 49(5) as payments in respect of the extension of the original option, with the result that, for purposes of s. 49(1), such amount are deemed to be proceeds of disposition in respect of the grant of the option at the time of receipt of each such payment.

Upon the exercise of the option, the vendor by virtue of s. 248(28) will not be required to include in its proceeds of disposition the amounts included as capital gains under s. 49(5) and 49(1) except to the extent that pursuant to s. 49(4) it files amended tax return to exclude such amounts from the computation of its income for those taxation years as proceeds of disposition.

S.49(3) did not apply to deem the exercise of employee stock options held by a non-resident former employee to not be a disposition of the options, given that s. 49(3) applied only to capital property, whereas employee stock options are governed by s. 7. However, there was no liability under s. 116(5) to the Canadian corporation that had issued the options as it should not be considered to have acquired the options from the employee and, therefore, had no cost therefor.

Special warrants to acquire shares that if not exercised prior to the specified expiry time are deemed to be exercised at that time without any further action on the part of the holders, likely would not qualify as an "option to acquire property" given such deemed or mandatory exercise.

Regarding where the owner of a farm (the correspondent’s father) granted an option for consideration to sell his farm in 2005 (resulting in the recognition of a capital gain under s. 49(1)), and the option was exercised in 2006, CRA stated:

[S]ubsection 49(4) may allow your father to file an amended return for 2005 to exclude from income the proceeds he received for granting and extending the option. Your father would then get a refund of the tax paid in 2005.