Principal Issues: Do proposed subsections 110(1.7) and 110(1.8) restrict the number of times the exercise price under an option can be reduced?
Position: No, based on the proposed wording of the subsections and the related explanatory notes.
Reasons: The wording of proposed subsections 110(1.7) and (1.8) and the related explanatory notes.
XXXXXXXXXX 2004-009324 G. Allen October 29, 2004
Dear XXXXXXXXXX:
Re: Proposed Subsections 110(1.7) and 110(1.8) of the Income Tax Act (the "Act")
This is in reply to your letter dated August 24, 2004 and further to your telephone conversation of October 14, 2004 (XXXXXXXXXX/Allen) concerning proposed subsections 110(1.7) and 110(1.8) of the Act that were included in the December 20, 2002 technical amendments to the Act (the "Technical Amendments"). Specifically, you are enquiring about the application of these proposed subsections to unit option plans of royalty and income trusts that are also mutual fund trusts for purposes of the Act.
In your telephone conversation, you stated that due to the nature of the royalty and income trust business, the royalty and income trusts are expected to make regular distributions to unitholders, e.g., monthly or quarterly. As a result of these regular distributions, the price of a unit decreases, theoretically, by the amount of the distribution per unit and, therefore, the value of options held by employees of the royalty and income trusts declines. As a result, the royalty and income trusts would like to be able to reduce the exercise price of the options held by employees such that the employees' "in the money" amount after the exercise price reduction does not exceed the employees' "in the money" amount prior to the exercise price reduction. Your concern is whether the regular, e.g., monthly or quarterly, exercise price reductions would be acceptable given the provisions of paragraph 110(1)(d) and proposed subsections 110(1.7) and (1.8) of the Act.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. For more information concerning advance tax rulings, please refer to Information Circular 70-6R5 dated May 17, 2002. Copies of information circulars are available at your local Tax Services Office or on the Internet at http://www.ccra-adrc.gc.ca/formspubs/menu-e.html. Where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office.
The determination of how proposed legislation will be applied by the Canada Revenue Agency (the "CRA") can only be determined after the final legislation has been passed into law. Consequently, we can only provide general comments that are not binding on the CRA. The following comments are based on the proposed amendments and explanatory notes described in the Technical Amendments, and are contingent on the proposed amendments being passed in the form reflected in the Technical Amendments.
Proposed subsection 110(1.7) of the Act is intended to apply in situations where there is a reduction in the exercise price to be paid by an employee to acquire securities under an employee security option (the "option") and the conditions under proposed subsection 110(1.8) are satisfied. For purposes of section 7, paragraph 110(1)(d) and subsections 110(1.7) and 110(1.8) of the Act, "security" of a qualifying person is defined in subsection 7(7) to mean
a) if the person is a corporation, a share of the capital stock of the corporation; and
b) if the person is a mutual fund trust, a unit of the trust.
In general, subsection 110(1.7) ensures that where there is a reduction in the exercise price under an option and the conditions of subsection 110(1.8) are satisfied, that the employee will not be prevented from claiming a deduction under paragraph 110(1)(d), if the reduction in the exercise price could have been accomplished by means of an exchange of options in accordance with subsection 7(1.4) of the Act.
Subsection 7(1.4) of the Act applies in situations where an individual disposes of rights to acquire securities under an option in exchange for rights to acquire securities under another option. In general, subsection 7(1.4) of the Act applies, where certain conditions are satisfied, to deem the disposition of rights under the option not to have occurred and deems the new option to be the same as the exchanged option. Where the conditions of subsection 7(1.4) are satisfied, the deeming provisions of paragraphs 7(1.4)(d) through (f) will apply and a benefit will not be deemed to be received by an employee in accordance with paragraph 7(1)(b) of the Act. Paragraph 7(1.4)(c) contains one of the conditions that must be satisfied and in general provides that:
i) the total value of the securities that may be acquired under the new option immediately after the exchange, minus
ii) the total amount payable by the taxpayer to acquire the securities under the new option,
cannot exceed,
iii) the total value of the securities that could have been acquired under the old option immediately prior to the exchange, minus
iv) the total amount payable by the taxpayer to acquire the securities under the exchanged option.
To summarize, where there is a reduction in the exercise price under an option and the conditions of proposed subsection 110(1.8) are satisfied, proposed subsection 110(1.7) is intended to ensure that an employee is not disqualified from claiming a deduction under paragraph 110(1)(d), where the exercise price reduction could have been achieved by means of an exchange of options and the conditions of subsection 7(1.4) are satisfied. There is nothing in proposed subsections 110(1.7) and 110(1.8) that would limit the application of these proposed subsections in situations where there are regular exercise price reductions under an option plan. As well, we have reviewed the explanatory notes to the Technical Amendments and see no indication that proposed subsections 110(1.7) and 110(1.8) will not apply to situations where there are regular exercise price reductions under an option plan.
We trust our comments will be of assistance.
Yours truly,
Roberta Albert, CA
Manager
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch