Montminy – Federal Court of Appeal finds that employees enjoyed the ½ deduction on exercising their stock options notwithstanding an immediate sale of the acquired shares to the controlling shareholder

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 on the asset sale closing date, 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 in the Tax Court had accepted the Crown’s submission that the shares were tainted under Reg. 6204(1)(b).

In allowing the taxpayers’ appeal, Noël CJ found that Reg. 6204(2)(c), by providing that the taxpayers’ right to sell their shares to Holdco was to be ignored for purposes of Reg. 6204(1), had the effect of also deeming there to be no reasonable expectation under Reg. 6204(1)(b) of such an acquisition occurring within two years of the options’ exercise. He also found that providing the ½ deduction under s. 110(1)(d) to the taxpayers accorded with the broader context of the stock option rules. In particular, the taxpayers had been fully at risk during the lengthy period of their holding of their options to fluctuations in Opco’s value.

Neal Armstrong. Summary of Montminy v. Canada, 2017 FCA 156 under Reg. 6204(1)(b).