Stock Option Deduction Is Available on Death

An employment benefit in respect of unexercised employee stock options that arises on death is eligible for the paragraph 110(1)(d) deduction through the use of a subsection 110(1.1) election, according to a new CRA technical interpretation (2013-0484181E5, May 4, 2015). The CRA states that eligibility will be allowed “on an administrative basis,” implying that the legal basis for eligibility is at least unclear and possibly non-existent.

This eligibility has been at issue since subparagraph 110(1)(d)(i) was added to the Act (as a result of the 2010 budget) for a completely different purpose; an employment benefit on death was clearly eligible before. (The question relates only to the paragraph 110(1)(d) deduction; the paragraph 110(1)(d.1) deduction does not apply to unexercised options.)

Employee stock options may be cancelled on death as a term of a stock option contract; such a cancellation is not a taxable event. However, if exercise of the option continues to be possible for a period of time, paragraph 7(1)(e) deems the employee to have received an employment benefit in the year of death equal to the fair market value of unexercised stock options owned less the amount paid to acquire such options. The similar benefit in a pre-death situation is computed under one of paragraphs 7(1)(a) through 7(1)(d.1).

Provided that the requirements in paragraph 110(1)(d) are met, a taxpayer is entitled to a deduction of one-half of the employment benefit arising from employee stock options. Effectively, since only one-half of the benefit is taxed, the result is that the benefit is taxed at a rate similar to the one applied to capital gains, as opposed to being taxed at the same rate as employment income.

The 2010 budget added an extra condition that must be met for a taxpayer to qualify for the paragraph 110(1)(d) deduction. Under subparagraph 110(1)(d)(i), a deduction is permitted only where securities are acquired by the taxpayer under the stock option agreement (or by a person not dealing at arm’s length with the taxpayer in circumstances described in paragraph 7(1)(c), which relates to a cashout situation, and does not apply here). No securities are acquired under the deemed disposition on death, because the stock options have not yet been exercised. Thus, at this first stage in the analysis, a deemed disposition on death does not qualify for the paragraph 110(1)(d) deduction (CRA document nos. 2009-0327221I7, December 21, 2012, and 2011-0423441E5, December 11, 2012).

A point not addressed in these technical interpretations is that the taxpayer can be exempted from the requirement in subparagraph 110(1)(d)(i) if an election is made under subsection 110(1.1). This election involves a qualifying person (normally, the company that issued the stock option) filing the election with the CRA and the taxpayer attaching the election to his or her return. It appears that the wording was never intended to apply to the deemed disposition on death, since it is about the qualifying person promising not to take a deduction for “a payment” relating to the transfer or disposition of the taxpayer’s rights under the stock option agreement. Perhaps the wording can encompass a deemed disposition on death, and so the making of an election would qualify the taxpayer for the paragraph 110(1)(d) deduction (see Robert Lee, “Death of a Taxpayer: Employee Stock Option Benefits,” Tax for the Owner-Manager, April 2013). On the other hand, the reference to a “payment” (of which there is none in this situation) may prevent this. In any event, the new technical interpretation states that the CRA will allow eligibility for this deduction, regardless of the legal merits of the alternative views.

The amendments introduced by the 2010 budget were intended to prevent double deductions—one by the employer and one by the employee. With respect to a deemed disposition on death, there is no possibility of a deduction by the employer. Thus, allowing the paragraph 110(1)(d) deduction through the subsection 110(1.1) election appears to be an appropriate policy result.

Andrew Morreale
Grant Thornton LLP, Toronto
[email protected]

Canadian Tax Focus
Volume 5, Number 3, August 2015
©2015, Canadian Tax Foundation