Principal Issues: In the course of an estate freeze, Mr. X would receive preferred shares and voting shares in exchange for the common shares he held in the capital stock of Opco. The voting shares held by Mr. X would allow him to control Opco. In the course of that reorganization, Opco would grant stock options to a key employee (not related to Mr. X) giving that employee the right to acquire common shares of the capital stock of Opco for a consideration of $1. Mr. X would then transfer some of the non-voting preferred shares he holds in the capital stock of Opco to Holdco. Those non-voting preferred shares would then be redeemed by Opco, which transaction would result in a deemed dividend for Holdco pursuant to subsection 84(3), except if subsection 55(2) applies.
a) Would the granting of the stock options to the key employee be considered an event referred to in subparagraph 55(3)(a)(ii) or (v) of the Act?
b) If not, would the exercise of the stock options by the key employee be considered an event referred to in subparagraph 55(3)(a)(ii) or (v) of the Act?
c) Would the answer be different if the stock option plan was put in place before the estate freeze?
Position: a) The CRA would examine the rights, conditions and restrictions attached to the stock option to determine, inter alia, whether the exercise of the stock option is, at the time of the granting, contingent in fact and in law. Subject to subsection 245(2), the granting of an option would not generally be considered an increase in an interest as referred to in subparagraph 55(3)(a)(ii) or (v) of the Act where the right to acquire is contingent in fact and in law. However, the CRA would consider that the granting of an option is an increase in the interest of a corporation if the characteristics of the option and the price for which the option can be exercised are such that there is no real uncertainty or contingency with respect to the exercise of the said option.
b) If subparagraph 55(3)(a)(ii) and (v) does not apply at the time the stock option is granted because of the contingency of the rights, the CRA would consider that there is an increase in the interest of a corporation at the time the stock option is exercised. The exception provided by paragraph 55(3)(a) would not apply if the exercise of the stock option results in a significant increase in the interest in the corporation that occurs as part of a series of transactions or events as part of which the dividend was received.
c) The comments provided for question a) would remain the same. However, even if some comments provided for question b) would be applicable, the facts would be different. Therefore, it is possible that the CRA reaches a different conclusion in a particular situation.
Reasons: a) The meaning of the word "interest" in a corporation is broad and can encompass "economic interest". However, where there is a real contingency, the CRA would generally consider, for the purpose of paragraph 55(3)(a), that the economic interest has not been acquired before the exercise of the option.
b) Where the granting of the stock option did not constitute an increase in the interest in a corporation, there will be an increase at the time of the exercise of the stock option.
c) See reasons for questions a) and b).
