Canada - English

Cashless Stock Option Exercise Shares - Use Better-Than-Average ACB 

Canadian Tax Adviser

 

December 11, 2012

 

Steve Moore

Halifax, Canadian Corporate Tax

 

Dan Bilenki
Calgary, Enterprise Tax

 

In certain circumstances, a taxpayer may be able to isolate the adjusted cost base (ACB) of newly purchased stock option shares by treating them as a class of shares that is separate from other identical shares that the taxpayer already owns. To qualify for this separate class treatment under subsections 7(1.31) and 47(3), certain conditions must be met, including that the stock option shares must have been bought and sold within a 30-day period. Choosing this alternative allows the taxpayer to minimize the taxable capital gain resulting from the disposition of the newly acquired stock option shares.

Illustrative example

Assume the director of a bank (Ms. A) owns 100,000 of the bank's shares that she purchased over the 2000-2011 period. These shares have an average ACB of $10 per share, or $1 million. Ms. A also owns options to purchase 1,000 additional bank shares at a strike price of $15 per share.

 

In 2012, Ms. A made a cashless exercise of her stock options when the fair market value of the shares was $17 per share so that she only received the net cash from the exercise, or $2,000 ($17,000 less $15,000). As a result of the cashless exercise, the optioned shares were purchased and sold on the same day.

 

Issue

At issue is what the tax consequences to Ms. A are as a result of the cashless exercise of her stock options.

 

Tax consequences - Taxable benefit

When Ms. A exercises her stock options, she will realize a taxable benefit equal to the excess of the fair market value of the optioned shares over the strike price, or $2,000, under subsection 7(1). Ms. A will generally be able to effectively reduce this taxable benefit by claiming the 50% deduction available under paragraph 110(1)(d), as long as the exercise price was at least equal to the fair market value of the shares on the date the stock option was granted.

 

To avoid double taxation on the sale of the optioned shares, the $2,000 taxable benefit is added to the ACB of the optioned shares under paragraph 53(1)(j). Typically, this addition to the ACB is averaged over all identical shares held by a taxpayer under subsection 47(1). Because an employee may hold a number of identical properties with a lower ACB per share, the averaging of the ACB could trigger a significant capital gain, as illustrated below.

 

Tax consequences - Capital gain
For Ms. A, averaging the taxable benefit over the cost of her bank shares would result in an ACB of $10.07 per share, as shown below.

 

 

Because the ACB is averaged, the sale of 1,000 shares would result in a capital gain of $6,930 [($17 - $10.07) × 1,000] or a taxable capital gain of $3,465 in 2012.

 

Fixing capital gain problem

Instead of averaging the ACB of all the shares Ms. A can add the taxable benefit to the ACB of only the optioned shares. Under subsection 7(1.31), only the optional shares are deemed disposed when Ms. A exercises her options if the following conditions are met:

 

  • The optioned shares (or identical shares) are sold within 30 days of the cashless exercise
  • Ms. A does not acquire, or dispose of, any other bank shares after the exercise and before the disposition
  • Ms. A identifies the shares in her income tax return for the year of the disposition (by reporting the share disposition as having proceeds equal to ACB).

 

Further, a separate share class for the optioned shares is provided for in subsection 47(3), which deems the optioned shares not to be identical to any other security acquired by Ms. A if subsection 7(1.31) applies.

 

Together, subsections 7(1.31) and 47(3) effectively reduce the capital gain resulting from the disposition of the optioned shares. Ms. A will not realize a capital gain from her disposition of the optioned shares by relying on subsections 7(1.31) and 47(3), because the ACB of the optioned shares will equal her proceeds of disposition for those shares, or $17,000 ($15,000 + $2,000).

 

For more information, contact your KPMG adviser.

 

Information is current to December 11, 2012. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500