Rev. Rul. 70-335

Advice has been requested as to when a transfer of stock occurs, for purposes of section 421 of the Internal Revenue Code of 1954, under the circumstances described below.

A corporation granted an employee a restricted stock option, as defined in section 424 of the Code, to purchase a certain number of shares of its stock. The plan under which the option was granted required that in order to exercise the option, either in full or in part, written notice must be delivered to the corporation together with full payment for the shares. The plan also contained a clause providing that the participants would have no interests in the shares covered by the option until certificates for such shares were issued.

On July 3, 1968, in strict conformity with the terms of the option, the optionee delivered to the corporation written notice of exercise and tendered his check in full payment for the shares subject thereto. However, he did not become a shareholder of record until July 6, 1968.

Section 1.421-7(g) of the Income Tax Regulations provides, in part, that, for purposes of section 424 of the Code, the term "transfer," when used in reference to the transfer to an individual of a share of stock pursuant to his exercise of a statutory option, means the transfer of ownership of such share, or the transfer of substantially all the rights of ownership.

In George Swenson, et al. v. Commissioner, 309 F. 2d 672 (1962), the court considered a similar situation. In that case, the taxpayer also exercised his option in strict conformity with the terms of the option by delivering notice together with full payment to the corporation. The court held that since the taxpayer by such action had acquired substantial contractual rights to the shares of stock, he also acquired substantial ownership rights therein within the meaning of section 1.421-1(f) of the regulations, comparable to the present section 1.421-7(g).

The court stated that the clause in the option contract to the effect that the participants would have no interest in the option shares until the certificates were issued was not intended to take away the substantial rights to the option stock conferred upon the taxpayer by the contract, but was inserted only for purposes of protecting the corporation from possible violation of stock exchange rules and regulations. Since the corporation had ironed out all difficulties with respect to the stock exchange and securities laws and regulations before the taxpayer exercised his option, and since the contract gave no right or discretion to the corporation to refuse to issue the stock to which the taxpayer was entitled at the time of exercise and payment of the purchase price, the court concluded that this clause did not prevent the taxpayer's holding period from starting at such time.

As in the Swenson case, the instant taxpayer exercised the option in strict accordance with its terms and paid the purchase price for the stock in full. He thereupon acquired substantial contractual rights in the stock and thus substantial ownership rights therein within the meaning of section 1.421-7(g) of the regulations.

Accordingly, in the instant case, it is held that the stock was transferred to the optionee of the restricted stock option under section 424 of the Code, for purposes of section 421 of the Code, on July 3, 1968, the date on which the optionee delivered written notice of exercise together with full payment for the shares subject to the option to the grantor corporation, in strict accordance with the terms of his option.