Principal Issues: [TaxInterpretations translation] Is it possible to set up stock option transactions to "rejuvenate" a non-capital loss?
Position: Question of fact.
Reasons: The GAAR may apply depending on the facts and circumstances.
XXXXXXXXXX 2007-025108 Guy Goulet, CA, M.Fisc. September 13, 2007
Dear Sir,
Subject: Tax treatment of stock option transactions
This is in response to your letter of August 24, 2007, in which you requested our opinion on the tax treatment of the stock option transactions described in the Particular Situation below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
1. Cco is a Canadian-controlled private corporation (CCPC) that has a non-capital loss that expires at the end of its particular taxation year (the Loss). Cco does not expect to have sufficient income in its particular taxation year to be able to deduct the amount of its Loss in computing its taxable income.
2. Aco holds shares in a Canadian public company (Pubco) as a capital property.
3. Immediately prior to the end of its particular taxation year, Aco sells Pubco stock options (Options #1) in the secondary market. These Options #1 would be "covered" as Aco would hold the same number of Pubco shares as the number of shares covered by the Options #1.
4. At the beginning of its taxation year following the particular taxation year, Aco closes its position in respect of Options #1 by purchasing identical Pubco stock options (Options #2) on the secondary market.
5. Aco's purpose in entering into these transactions is to deduct its Loss against the taxable capital gain realized on the sale of Options #1 in computing its taxable income for its particular taxation year and to benefit in the future from a net capital loss incurred on the closing of its position at the beginning of the taxation year following the particular taxation year. The transactions would convert the expiring Loss into a net capital loss available for carry-forward.
Your Opinion:
First, you are of the view that the gain and loss realized by Aco on the completion of the Option #1 and Option #2 transactions will be on capital account since the shares covered by these options are held by Aco as capital property.
Second, you are of the view that the deeming rule in subsection 49(1) that the granting of an option is a disposition of property with an adjusted cost base of nil would apply to the sale by Aco of Option #1.
Third, you believe that the cost to Aco of acquiring the offsetting options in the secondary market at the beginning of the taxation year following the particular taxation year would be a capital loss at that time.
Finally, you are of the view that Cco could pay a dividend from its capital dividend account (CDA) immediately prior to the acquisition of the offsetting options to the extent that its CDA balance is positive.
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments which may not be fully applicable in a particular situation.
It is the facts of a particular situation that will determine whether losses incurred or gains realized on stock option transactions are to be considered on income or capital account. However, as stated in paragraph 25 of Interpretation Bulletin IT-479R Transactions in Securities, the CRA generally assumes that the gain or loss realized by a writer of covered options is on the same account as the underlying shares.
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 Interpretation Bulletin IT-479R - Transactions in Securities, 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.
With respect to the potential application of subsection 245(2) to your specific case, our Directorate's practice is to make a determination only after reviewing all the facts and circumstances surrounding a transaction, and this, in the context of a request for advance rulings made in accordance with Information Circular 70-6R5 of May 17, 2002, by a taxpayer or the taxpayer’s duly authorized representative. However, it is our view that transactions or series of transactions of the type described above could, depending on the facts and circumstances of a particular situation, engage the application of subsection 245(2).
We hope that our comments are of assistance.
Best regards,
Ghislain Martineau
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.