Revenue Canada Taxation Head Office
XXXX
M. Evans (613) 957-2133
Your letter of January 5, 1987, addressed to the Toronto District Taxation office, requesting a ruling on employee stock options, has been referred to us for reply. You advised by telephone that an advance income tax ruling as outlined in Information Circulars No. 70-6R, dated December 18, 1978, and June 23, 1980, is not required and that a letter giving the Department's opinion on the matter in question will suffice for your purposes.
You advise that employee stock options are granted under the following conditions:
1. Options are granted in 1981 by a U.S. company to employees of its Canadian subsidiary to purchase shares of the parent company at their fair market value at that time.
2. The options cannot be exercised for two years from that date.
3. A signed certification is required that the purchase is to be considered to be for investment only and not for purposes of resale, and that resale can only be made with the permission of the issuing company.
4. The shares cannot be sold for two years after exercising the option.
You request our opinion on the tax consequences in the following situation:
1. An option was granted in 1981 to purchase 1,000 shares at the fair market value at that time of $1.00 per share.
2. A stock dividend of 10% was declared in 1982 which you advise reduced the fair market value per share to $0.9091.
3. The option was exercised in 1984 which resulted in 1,100 shares being acquired at $0.9091 per share for a total of $1,000.
4. In 1986, the shares were sold for $2,200.
It is your view that no benefit was realized on exercising the option in 1984 and that on the sale of the shares in 1986 the difference between the sale price of $2,200 and the exercise cost of $1,000 would be treated as a capital gain. It is also your opinion that had the option been exercised in 1986, no benefit would have occurred on the purchase of the shares.
We advise that on the exercise of the employee stock option, pursuant to paragraph 7(l)(a) of the Income Tax Act (the Act), a benefit, equal to the amount by which the value of the shares at the time they were acquired in 1984 exceeds the $1,000 paid for the shares, was deemed to have been received by the employee by virtue of his employment and should have been reported in the 1984 taxation year. A deduction under paragraph 110(1)(d) of the Act, equal to one-half of the amount of the benefit referred to above, is not available to the employee since all of the provisions under that paragraph have not been met.
On the sale of the shares in 1986, the capital gain to be reported is the difference between $2,200 and the adjusted cost base of the shares which is $1,000 plus the benefit under paragraph 7(1)(a) of the Act realized in 1984. The capital gains deduction under section 110.6 of the Act may be available for part or all of the capital gain realized.
We also advise that had the option been exercised in 1986 when the fair market value of the shares acquired was $2,200, a benefit in the amount of $1,200 would have been realized by the employee, pursuant to paragraph 7(1)(a) of the Act.
We trust this information will be of assistance.
Yours truly,
for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch