Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 63-47

1963-1 C.B. 97

Sec. 421

IRS Headnote

A variable price option with a maximum price stated in terms of a percentage of the fair market value of the stock subject to the option on the date of grant may qualify as a restricted stock option.

Full Text

Rev. Rul. 63-47

Advice has been requested whether an option which otherwise qualifies as a restricted stock option as defined in section 421(d)(1) of the Internal Revenue Code of 1954 is a `variable price option' which meets the requirements of section 421(d)(1)(A)(ii) of the Code if the option price is determinable in the manner described below.

In the instant case, the terms of the option provide that the option price shall be equal to the lesser of (a) 85 percent of the fair market value of the stock subject to the option on the date of grant, or (b) 85 percent of the fair market value of the stock subject to the option on the date of exercise.

Section 421 of the Code provides, in part, as follows:

(d) DEFINITIONS.-For purposes of this section-

(1) RESTRICTED STOCK OPTION.-The term `restricted stock option' means an option granted after February 26, 1945, to an individual, for any reason connected with his employment by a corporation, if granted by the employer corporation or its parent or subsidiary corporation, to purchase stock of any of such corporations, but only if-

(A) at the time such option is granted-

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(ii) in the case of a variable price option, the option price (computed as if the option had been exercised when granted) is at least 85 percent of the fair market value of the stock at the time such option is granted * * *

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(7) VARIABLE PRICE OPTION.-The term `variable price option' means an option under which the purchase price of the stock is fixed or determinable under a formula in which the only variable is the fair market value of the stock at any time during a period of 6 months which includes the time the option is exercised; except that in the case of options granted after September 30, 1958, such term does not include any such option in which such formula provides for determining such price by reference to the fair market value of the stock at any time before the option is exercised if such value may be greater than the average fair market value of the stock during the calendar month in which the option is exercised.

Section 1.421-1(d)(2)(ii)(a) of the Income Tax Regulations provides, in effect, that the formula for determining the option price may also depend upon factors other than the value of the stock, but such other factors must not be variable and must be fixed in the option when granted. An example of a formula which meets the requirements of this subdivision of the regulations is a provision that the option price shall be 95 percent of the fair market value of the stock on the day the option is exercised, but not more than $95.

The only variable in the formula in this case is the fair market value of the stock subject to the option, and the option price is determinable without reference to such fair market value at any time before the option is exercised, except insofar as the maximum price is expressed in terms of a percentage of fair market value on the date of grant.

Since the maximum price is fixed as of the date of grant, it could be expressed in terms of dollars at that time. A maximum price so stated is considered to be substantially similar to that used in the example in section 1.421-1(d)(2)(ii)(a) of the regulations referred to above. It is clearly distinguishable from the `look-back' provision used in the example given in Senate Report No. 1983, Eighty-fifth Cong., C.B. 1958-3, 922 at 961, to illustrate the type of options intended to be excluded from the term `restricted stock options' by section 421(d)(7) of the Code.

Accordingly, it is held that the option under consideration in this case will not be disqualified from treatment as a restricted stock option merely by reason of the formula for determining the option price.