2015-0570801E5 Exchange of Stock Options-7(1)(b) Applies

Principal Issues: An exchange of employee stock options occurs and the conditions in subsection 7(1.4) are not satisfied. The exchange of stock options would result in a disposition and paragraph 7(1)(b) applying. Could the value of the old stock options that are exchanged for the new stock options be considered "the amount, if any, paid by the employee to acquire those rights", for purposes of 7(1)(b)?

Position: Where 7(1)(b) applies an employee is deemed to receive a benefit equal to the value of the consideration received as a result of the disposition of rights under the stock option minus the amount, if any, paid by the employee to acquire those rights. The reference to "paid by the employee to acquire those rights", refers to the rights under the stock option that is disposed of or exchanged.

Reasons: Provisions of 7(1)(b).

Author: Allen, Gary
Section: 7(1)(b), 7(1.4), 248(1)

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                                                                                                                                                                      2015-057080
                                                                                                                                                                      G. Allen

May 7, 2015

Dear XXXXXXXXXX:

Re:  Exchange of Stock Options – Paragraph 7(1)(b)

This is in reply to your email sent to us on February 13, 2015 concerning an exchange of employee stock options in a takeover situation where the conditions under subsection 7(1.4) of the Income Tax Act (the “Act”) are not satisfied.  You specifically enquire whether the value of the old options exchanged to acquire the new options could be considered, “the amount, if any, paid by the employee to acquire those rights”, for purposes of paragraph 7(1)(b) of the Act.

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

In general, where the conditions of paragraphs 7(1.4)(a),(b) and (c) are satisfied, subsection 7(1.4) provides for a tax-free rollover where employee stock options are exchanged (the “exchanged options”) for new employee stock options (the “new options”).  In a situation involving an exchange of employee stock options where the provisions of subsection 7(1.4) do not apply, the exchange of stock options will result in a disposition of the exchanged options for the new options and the application of paragraph 7(1)(b) of the Act.

In calculating the benefit deemed to be received by an employee under paragraph 7(1)(b), “the amount, if any, paid by the employee to acquire those rights” under the employee stock option is subtracted from the fair market value of the proceeds received by the employee as a result of the disposition of the stock option.  In a situation involving an exchange of stock options where subsection 7(1.4) does not apply, and therefore there is a disposition of the exchanged option, the reference in subparagraph 7(1)(b)(ii) to “the amount, if any, paid by the employee to acquire those rights (under the employee stock option)” refers to an amount paid by the employee to acquire the rights under the employee stock option that is being disposed of, i.e., the exchanged option. In our view, the value of the exchanged options at the time of the exchange/disposition would not be considered part of “the amount, if any, paid by the employee to acquire the rights disposed of under the exchanged options”.  However, the new options acquired as a result of the exchange will have a cost equal to the value of the exchanged options at the time of the exchange.

We trust that our comments will be of assistance. 

Lita Krantz, CPA, CA
for Director
Deferred Income Plans Section II
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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