| 19(1) | File No. 5-9015 |
| S. Short | |
| (613) 957-2134 | |
| January 18, 1990 |
Dear Sirs:
Re: Paragraph 1110(1)(d) of the Income Tax Act (the "Act") Stock Splits
This is in reply to your correspondence dated October 12, 1989, wherein you asked our interpretation of paragraph 110(1)(d) of the Act as it pertains to stock splits. You are specifically concerned with the application of subparagraph 110(1)(d)(iii) in the following example:
24(1)
Assume an option is granted to purchase 5,000 shares at $4.80 per share, being the fair market value of the share on the date the option is granted. Assume a bonus issue of one new share for every five issue of one new share for every five existing shares of capital stock of the company. In other words, the shares are split six for five. The adjustment to the number of shares which may be acquired under the option would be:
5,000 X 5/6 - 6,000 shares
The adjustment to the exercise price would be:
$4.80 X 5/6 - $4.00.
The total cost of exercising the option is the same under both) scenarios. Before the stock split, the total exercise price is 5,000 shares X $4.80 - $24,000. After the split and the adjustment to the number of shares and the exercise price under the option, the total exercise price is 6,000 shares X $4.00 - $24,000.
Given the above example, you have requested that we confirm that:
1. The amount payable by the taxpayer to acquire the share under the agreement ($4.80) is not less than the fair market value of the shares at the time the agreement was made.
2. The adjustments to the terms of the option as a result of the structuring of the issued share capital are contemplated in the original agreement and do not constitute termination of the old agreement and the start of a new agreement.
3. The taxpayer is eligible for the deduction under paragraph 110(1)(d) of the Act on exercise of the shares at $4.00, notwithstanding the fact that the amount actually paid, being $4.00 per share, is less than the fair market value of the shares at the time the agreement was made, being $4.80 and may be less than the fair market value of the shares at the time of the stock split.
4. The employee stock option benefit under subsection 7(l) of the Act would be calculated as the fair market value of the shares after the split minus the actual exercise price paid of $4.00 per share.
We agree that the employee stock option benefit under subsection 7(1) of the Act would be equal to the difference between the fair market value of the shares after the split and the amount paid by the employee ($4.00 per share). This would be so as the benefit under paragraph 7(1)(a) of the Act is calculated as the difference between the "value of the shares at the time he acquired them" and the amount paid or to be paid to the corporation. As the employee does not acquire the shares until after the stock split, it is the value of the split share that is used in this determination.
We cannot, however, agree with your findings 1-3 inclusive. In our view, the use of the word "payable" in paragraph 110(1)(d) of the Act encompasses both amounts already paid under the agreement or which will be paid at a future date. Thus, it is the amount actually paid by the employee or that amount which will be paid that determines whether the employee can utilize a paragraph 110(1)(d) deduction. If the amount ultimately paid or payable for a share is $4.00 and the fair market value of the share at the time the agreement was made is $4.80, then the requirements of subparagraph 110(1)(d)(iii) of the Act have not been met.
We are of the opinion that the changes to the original Plan could be so significant as to represent a fundamental change to the original option so that they represent a new agreement. It may be somewhat irrelevant that the Board has the power to effect the changes within the terms of the original agreement as arguably, the Directors may be considered to have the power to cancel the agreement in defined or limited circumstances which does not alter the fact that the Plan has been cancelled when the Board exercises such authority.
We trust that the above comments will be of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch
c.c. Current Amendments Division
Note to File
21(1)(b)