Principal Issues: [TaxInterpretations translation] In the context of short selling, how should the value of a benefit be calculated under subsection 7(1)?
Position: General comments.
Reasons: Need contracts and agreements to be able to determine the tax consequences.
FEDERAL TAX ROUNDTABLE 7 OCTOBER 2011
2011 APFF CONFERENCE
QUESTION 6
STOCK OPTIONS
A public corporation put in place a system with a securities dealer to facilitate the exercise of stock options by its employees. Employees must notify a broker of their intention to exercise the options and to monetize their shares at the same time.
Where a notice is given by an employee, the broker makes a short sale of the corporation's securities for the number of shares required. The broker then remits the funds to the corporation, which then issues the shares to the broker. The broker then covers the short position with the shares received from the corporation.
Consider the following example:
- An employee was granted 5,000 options at an exercise price of $15 per share;
- On December 1, he advised a broker of his intention to exercise his options and to monetize his shares;
- On the same day, the broker carried out a short sale of 5,000 shares of the corporation while the market value was $20 per share;
- On December 5, after the settlement of the transaction and after receiving the funds, the broker paid $100,000 to the corporation;
- On the same day, the corporation issued the shares while the market value was $20.75 per share;
- The employee received an amount of $25,000 (($20 - $15) x 5,000 options) less source deductions. The corporation retains the exercise price of $75,000 ($15 per option).
- The employer calculated a taxable benefit of $28,750 for the exercise of stock options, being pursuant to paragraph 7(1)(b) the market value of the issued shares of $20.75, less the exercise price of the options. In fact, the shares of the corporation were acquired on December 5, while the market value was $20.75 per share.
Questions to the CRA
A. Does the CRA agree with the calculation of the taxable benefit made by the employer?
B. If yes, can the employee take a capital loss of $0.75 per share, or $3,750, since he received only $20 per share, while his adjusted cost base, taking into account the benefit under section 7, is $20.75?
CRA Response
Paragraph 7(1)(a) of the Act provides that an employee who acquired shares is deemed to have received, by reason of employment, for the taxation year in which the acquisition occurs, a benefit equal to the excess of the fair market value of the shares at the time of acquisition over the total of the amount paid or to be paid by the employee to acquire the shares and the amount paid by the employee to acquire the right to acquire the shares. As indicated in T4130 Employers' Guide -- Taxable Benefits and Allowances, shares or units are generally considered to be acquired when ownership of the shares has been transferred to the employee or the broker, and they have been paid for. For this purpose, the analysis of contracts and agreements is necessary to determine when that transfer took place.
Paragraph 7(1)(b) applies to an employee who has transferred or otherwise disposed of rights under the agreement in respect of some or all of the securities to a person with whom the employee was dealing at arm’s length. The benefit that the employee is deemed to have received, because of the employee’s employment in the taxation year, is equal to the amount, if any, by which the value of the consideration for the disposition exceeds the amount paid by the employee to acquire those rights.
The situation you submitted to us does not allow us to clearly identify the legal relationships between the various parties involved and, as a result, the tax consequences related to that series of transactions. A detailed analysis of all contracts and agreements is necessary to determine whether the employee has acquired securities under the agreement and comes within paragraph 7(1)(a) or if he has instead transferred his rights under the agreement and is then subject to paragraph 7(1)(b). The CRA is, however, prepared to consider that issue as part of an advance income tax rulings request where all relevant information and documents are provided to us.
Catherine Ayotte
613-957-8962
2011-041203