Montminy – Tax Court of Canada finds that the exercise of employee stock options and immediate sale of the acquired shares to the controlling shareholder following an asset sale did not generate a s. 110(1)(d) deduction

When a third-party purchaser agreed to acquire all the assets of Opco, the management employees agreed with the 100% shareholder of Opco (“Holdco”) that when the asset sale closed, they would exercise their options to acquire common shares of Opco and immediately sell their newly-acquired shares to Holdco for an agreed cash sale price.

The Crown accepted that this right to sell their shares to Holdco was a fair market value liquidity right described in Reg. 6204(2)(c), so that the shares were not prevented from being prescribed shares under Regs. 6204(1)(a)(iv) and (vi) (re right for their shares to be acquired by a specified person, i.e., Holdco). However, D’Auray J accepted the Crown’s submission that the shares were tainted under Reg. 6204(1)(b). In addition to noting the text of Reg. 6204(1)(b), which on its face referenced a reasonable expectation of the shares being acquired by a specified person within two years rather than legal rights and obligations, she also noted that:

The underlying tax policy of paragraph 110(1)(d)…and paragraph 6204(1)(b)…is to ensure that the stock option regime does not become disguised remuneration and that the employees who subscribe for the shares are subject to a certain level of risk.

Accordingly, the employees were not able to reduce their employee stock option benefits by the s. 110(1)(d) deduction.

Neal Armstrong. Summary of Montminy v. The Queen, 2016 CCI 110 under Reg. 6204(1)(b) and General Concepts – FMV - shares.