Principal Issues: [TaxInterpretations translation] Must a taxpayer rely on subsection 7(1.31)?
Position: No
Reasons: This is an elective decision. In the absence of the application of subsection 7(1.31), subsection 7(1.3) will determine the order of disposition of the securities. In a gift context, not doing so may compromise eligibility for the deduction under paragraph 110(1)(d.01).
Financial Strategies and Financial Instruments Roundtable-- 2010 APFF Conference
Question 6
Application of the average cost in the case of an exercise of options, followed by a donation of shares
Subsection 7(1.31) allows for an election that results in a departure from the average cost rule in subsection 47(1) where an option is exercised, and the share acquired by that option is disposed of within 30 days and in accordance with certain other conditions. Subsection 7(1.31) reads as follows:
Where a taxpayer acquires, at a particular time, a particular security under an agreement referred to in subsection (1) and, on a day that is no later than 30 days after the day that includes the particular time, the taxpayer disposes of a security that is identical to the particular security, the particular security is deemed to be the security that is so disposed of if
(a) no other securities that are identical to the particular security are acquired, or disposed of, by the taxpayer after the particular time and before the disposition;
(b) the taxpayer identifies the particular security as the security so disposed of in the taxpayer’s return of income under this Part for the year in which the disposition occurs; and
(c) the taxpayer has not so identified the particular security, in accordance with this subsection, in connection with the disposition of any other security.
Question to the CRA
We believe that this provision is elective since it requires a designation in the income tax return under paragraph 7(1.31)(b). Can a taxpayer NOT designate the shares and use the cost-averaging method in a situation where the options are exercised and the shares are donated to a charity within 30 days?
CRA Response
Subsections 7(1.3) and (1.31) specify the order of disposition of securities acquired in the stock options context. Subsection 7(1.31) targets newly acquired securities. In effect, when a taxpayer acquires a particular security under an agreement referred to in subsection 7(1) and then disposes of that security no later than 30 days after its acquisition, the particular security is deemed to be the security the taxpayer had disposed of if certain conditions are satisfied. One of those conditions is that the taxpayer identifies in the taxpayer’s tax return the particular security as the security that the taxpayer had disposed of. The CRA is of the view that a taxpayer is not required to make that identification in the taxpayer’s return, even if the taxpayer satisfies the other conditions of subsection 7(1.31).
However, where a taxpayer does not make that identification in the taxpayer’s return, it is subsection 7(1.3) that will establish the order of disposition of the securities that are identical properties. That subsection applies in particular to paragraph 110(1)(d.01) and subsection 110(2.1).
The Department of Finance (footnote 1) commented on the application of subsection 7(1.3) in paragraph 110(1)(d.01) and in subsection 110(2.1) by stating this:
“Extending the application of subsection 7(1.3) to these provisions [paragraph 110(1)(d.01) and subsection 110(2.1)] ensures that, in those cases where the taxpayer holds identical securities and new subsection 7(1.31) does not apply, a determination can be made as to which security is being disposed of and, consequently, whether or not the conditions for the deduction have been satisfied.”
In order to qualify for the deduction under paragraph 110(1)(d.01), the gift must be made in the year and on or before the day that is 30 days after the day on which the taxpayer acquired the security. However, under subsection 7(1.3) a taxpayer is deemed to have disposed of securities that are identical property in the order in which the taxpayer acquired them. This rule corresponds to the "first-in, first out” rule (footnote 2). In addition, paragraphs 7(1.3)(a) and (b) include presumptions with respect to the timing of the acquisition of such securities. As well, pursuant to paragraph 7(1.3)(a), "a taxpayer holding both deferral and non-deferral securities is considered to dispose of the non-deferral securities first.” (footnote of page 3). Depending on the circumstances, the application of the presumptions in subsection 7(1.3) could result in the requirement of paragraph 110(1)(d.01) in respect of the acquisition of securities in the year of disposition not being satisfied. It could be otherwise if the identification under paragraph 7(1.31)(b) was made in the taxpayer's income return for the year of disposition.
Catherine Ayotte
(613) 957-8962
October 8, 2010
2010-037050.
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 Department of Finance, Technical Notes, Income Tax Act, subsection 7(1.3), March 2001.
2 Id.
3 Id.