| 24(1) | 901660 |
| A. Humenuk | |
| (613) 957-2135 | |
| 19(1) |
October 23, 1990
Dear Sirs:
Re: Options to Purchase Shares
We are replying to your letter of July 17, 1990, concerning a situation where a Canadian controlled private corporation intends to repurchase an option it had previously granted to an individual in respect of shares held by the corporation.
You provided us with the following facts:
1. Corporation A, a Canadian-Controlled private corporation, granted an option to individual B (an arm's length individual) approximately live years ago. 24(1) (This was the estimated fair market value of the shares at the date of the option).
2. The shares of C have appreciated substantially over the last several years and corporation A expects to receive an offer from an unrelated third party to acquire the shares of C.
3. The potential sale of the shares of C will be facilitated if corporation A can sell 100% of the shares rather than have individual B exercise the option and then sell the other 50% of the shares to the unrelated third party.
4. Therefore corporation A proposes to buy back individual B's option for consideration equal 24(1)
5. Corporation A would then sell 100% of the shares to the unrelated third party for approximately 24(1)
You have asked us to confirm that:
(a) individual B would realize a capital gain of 24(1) less the cost of the option, provided the option was held as capital property,
(b) corporation A would realize a capital gain of 24(1) on the sale of the shares of C provided the adjusted cost base of the shares was nominal and the shares were held as capital property, and
(c) corporation A would realize a capital loss of 24(1) in respect of the option it had acquired from individual B.
We are not prepared to confirm the accuracy of tax-related calculations such as that which you requested in respect of (a) and (b) above. The amount of the adjusted cost base, the amount of the proceeds of disposition and the determination of whether a capital property has been disposed of are all questions of fact which can only be determined upon review of all relevant information and documentation. If you have concerns about the interpretation of tax law in respect of a particular proposed transaction you may wish to obtain an advance income tax ruling as described in Information Circular 70-6R2 "Advance Income Tax Rulings" dated September 28, 1990, or you may wish to contact your local district taxation office in respect of a completed transaction.
However, we can offer the following general comments concerning your third request.
It is a question of fact as to whether corporation A repurchases the option or whether it pays individual B to forfeit the individual's rights under the plan. Where the amount is viewed as a payment to the individual to forfeit the rights under the agreement, the amount paid in respect of the option is added to the cost of the underlying property. As stated in Interpretation Bulletin IT-467 "Damages, Settlements and Similar Payments" a payment made to preserve a capital asset, such as the underlying shares to the option, will be treated as a payment on account of capital and added to the adjusted cost base of that asset.
An exception to this view occurs where the writer of the option treats the option as a separate marketable security, as is the case when the option is traded on a secondary market such as an exchange, and the writer is able to close out his option position by acquiring an offsetting option on the market. Paragraph 29 of Interpretation Bulletin IT-479 "Transactions in Securities" explains the income tax treatment accorded to a writer of options which are traded in the market.
Based on the limited information provided, however, it would appear more likely that the payment to B is a payment in settlement of the individual's rights under the option agreement rather than an acquisition of property by corporation A and that the amount of the payment should be added to the corporation's cost of the underlying shares.
We trust our comments will be of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch