2015-0572901I7 Deferral of employment benefit under ss. 7(8)

Principal Issues: Does the deferral of the employment benefit provided by ss. 7(8) continue once the shares are transferred to a former spouse pursuant to a divorce settlement?

Position: No.

Reasons: Once the shares are disposed of, the employee dies, or the employee becomes non-resident the deferral under ss. 7(8) no longer applies.

Author: Tsang, Peky
Section: 7(1); 7(8); 69(1); 73(1)

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XXXXXXXXXX                                                                                                                        L. Krantz
Centre Fiscal XXXXXXXXXX                                                                                                  (905) 721-5091

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      Deferred Security Options Benefits

Thank you for your email of February 25, 2015 requesting our assistance regarding the transfer of certain shares between Taxpayer A and Taxpayer B resulting from a settlement of rights arising out of their marriage. You have asked for our comments on certain income tax implications of the transfer for Taxpayer A and Taxpayer B. We apologize for the delay in our response.

You have provided the following facts:

*     Taxpayer A acquired the shares of a publicly traded company through the exercise of employee stock options.

*     The employment benefit associated with the exercise of the stock options is subject to the deferral allowed under subsection 7(8) (since repealed) of the Income Tax Act (the “Act”).

*     Taxpayer A has been deferring the employment benefit and reporting the deferral on form T1212, Statement of Deferred Security Options Benefits.

*     Taxpayer A is transferring the shares to Taxpayer B as part of the settlement of rights arising out of their marriage.

Unless otherwise stated in this memo, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c. 1 (5th Suppl.), as amended to the date of this memo.

Our comments

Pursuant to paragraph 6(1)(a) an individual is required to include in income in a taxation year any benefit deemed to have been received pursuant to paragraph 7(1)(a).  As you are aware, former subsection 7(8) permitted the deferral of the employment benefit deemed received under paragraph 7(1)(a) when an employee of a corporation that was not a Canadian-controlled private corporation acquired the employer’s shares or shares of a person not dealing at arm’s length with the employer upon the exercise of a stock option.  Although subsection 7(8) was repealed in 2010 the deferral of the employment benefit continues to be permitted, for stock options exercised on or before March 4, 2010 4:00 P.M.(EST), until either the employee disposes of the share, dies, or becomes a non-resident. It is our view that when Taxpayer A transfers the shares to Taxpayer B, there is a disposition of the shares by Taxpayer A. As a result, the deferral of the employment benefit under subsection 7(8) is no longer permitted and Taxpayer A will be required to include the deferred employment benefit in income in the year of the disposition.

In general, there will not be an additional income inclusion in respect of the excess of the value of the shares, if any, on the transfer to Taxpayer B because where capital property is transferred by Taxpayer A to Taxpayer B in settlement of rights arising out of their marriage or common-law partnership (see paragraph 73(1.01)(b) and subsection 73(1)), Taxpayer A will be deemed to have disposed of the shares for proceeds equal to Taxpayer A’s adjusted cost base (ACB) of the shares immediately before the disposition. Pursuant to paragraph 53(1)(j) the ACB of the shares will be increased by the amount of any benefit deemed to have been received under paragraph 7(1)(a) in respect of those shares. Taxpayer B will be deemed to acquire the shares at that ACB.

However, if Taxpayer A chooses to elect out of subsection 73(1) and Taxpayer A and Taxpayer B are not dealing at arm’s length at the time of the transfer subsection 69(1) will apply such that Taxpayer A will be considered to have disposed of the shares for proceeds equal to fair market value (FMV) at the time of transfer. Taxpayer B will be considered to have acquired the shares for an amount equal to Taxpayer A’s proceeds of disposition (i.e. FMV). Individuals connected by marriage are considered to not deal at arm’s length. Whether Taxpayer A and Taxpayer B are not dealing at arm’s length at the time of transfer is a question of fact.

We trust that our comments will be of assistance to you.

Yours truly,

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

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