Regulation 6204

Subsection 6204(1)

Paragraph 6204(1)(a)

See Also

Birch Hill Equity Partners Management Inc. v Rogers Communications Inc., 2015 ONSC 7189

board had discretion to determine fixed liquidation entitlement

In addition to denying the s. 110(1)(d) deduction on the basis that executives had sold their optioned shares to a specified person (who on-sold to the arm’s length purchaser of the corporation, namely, Rogers), rather than directly to Rogers, CRA also considered that the shares were not prescribed shares because the Board on liquidation had the discretion to establish a fixed liquidation amount for the shares. This (in addition the fact that the deduction was peripheral to the larger share sale transaction) was a further ground for denying rectification of the transactions to convert them into a direct sale of the optioned shares, i.e., this “fix” to solve only the specified person problem might not be effective to generate the s. 110(1)(d) deduction.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Rectification & Rescission stock option deduction was peripheral to the larger share sale transaction 411

Administrative Policy

7 October 2011 Roundtable, 2011-0411951C6 F - Retenues à la source - options d'achat d'actions

conferral on employer of share repurchase right to set off against source deduction obligation engages the exclusion

Where a stock option agreement is modified to give the employer the right to purchase for cancellation a portion of the shares issued on the exercise of employee stock options so as to generate cash on which it can withhold and satisfy its source deduction obligations, the shares which are so issued will not be prescribed shares under Reg. 6204(1)(a)(iv) or 6204(1)(b).

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 6204 - Subsection 6204(1) - Paragraph 6204(1)(b) loss of prescribed share status where employer granted redemption right to cover s. 153(1.01) withholding obligations 110
Tax Topics 59
Tax Topics - Income Tax Act - Section 153 - Subsection 153(1.01) treatment of net share issuances under review

7 March 2007 External T.I. 2005-0157381E5 - Regulation 6204

Although it would appear that Regulation 6204(1)(a)(i) would cause shares not to be prescribed shares if a loan agreement by the corporation stipulated that it would not pay a dividend of greater than 50% of cumulative net income under the terms of the loan agreement, a different response was given at the 1989 TEI Round Table so that the Directorate would be prepared to deal conclusively with this issue in the context of advance ruling request where all the facts and definitions of terms were known. Further, the TEI response only referred to Regulation 6204 and would not apply inter alia to the definition of "taxable preferred share" in s. 248(1).

18 September 2001 External T.I. 2001-007148 -

Under a Stock Option Plan, employees could exercise their options and pay the option price with shares the employee already owned (a feature referred to as a "Swap") Share(s) acquired under such an option that may be used under a Swap to acquire additional shares may not qualify as prescribed shares. Similarly, under Regulation 6204(1)(b) shares acquired under such options might not qualify as prescribed shares where it is reasonable to expect the employee may use the shares under a Swap within the two-year period.

Respecting the exclusion in Regulation 6204(2)(c), "subsection 6204(2) was added to the Regulations to ensure a share will not cease to be a prescribed share merely because a right or obligation exists to protect an employee against any loss with respect to the share, or to provide a market for the share. Accordingly, if it can be established that a Swap was provided for one of these reasons, the provision should apply assuming all other conditions are met. However, it is not clear to us how a Swap would satisfy either of these conditions ..."

6 August 1992 T.I. (Tax Window, No. 23, p. 5, ¶2142)

The right of a corporation to redeem shares issued under an employee stock option plan for their net book value will not satisfy the test in Regulation 6204(1)(a)(vi) unless there is a price adjustment clause for those situations where the net book value does not approximate the fair market value.

28 January 1991 T.I. (Tax Window, Prelim. No. 3, p. 21, ¶1112)

Where a wholly-owned subsidiary of a public corporation establishes a stock option plan under which the parent is obligated to acquire the shares of the subsidiary for their fair market value on the retirement or death of the participating employee, the requirements of Regulation 6204(1)(a)(iv) will not be fulfilled.

18 October 89 T.I. (March 1990 Access Letter, ¶1150)

Shares which carried a minimum cumulative preferential dividend of $0.01 per share but which otherwise participated fully in the earnings of the corporation after the common shares had received equivalent dividends did not qualify as prescribed shares. Such shares also would be considered to be entitled to a fixed minimum liquidation amount (and, therefore to be off-side) because on the dissolution of the corporation the holders of such shares were entitled to receive at least the amount of declared but unpaid cumulative dividends on the shares.

87 C.R. - Q.23

Where the plan provides that an employee can fund his purchase of an optioned share by requiring that the corporation acquire other shares issued to the employee pursuant to the plan, then a share issued under the plan will not be prescribed.

Paragraph 6204(1)(b)

Cases

Montminy v. Canada, 2017 FCA 156

employees enjoyed the ½ deduction on exercising their stock options notwithstanding an immediate sale of the acquired shares to the controlling shareholder

The taxpayers were management employees of a software company (“Cybectec”), which was a wholly-owned subsidiary of a holding company (“9135-8184”). They were granted options in 2001 to acquire Class A common shares of Cybectec at an exercise price of $0.20 per share, with such options only exercisable on the first to occur of an IPO, a sale of all the Cybectec shares and the passage of 10 years. In January 2007, the options were made immediately exercisable upon the closing of a sale of substantially all the assets of Cybectec to a third-party purchaser, with the taxpayers agreeing to sell their shares on exercise to 9135-8184 for a price of $1.2583 per share.

In finding that Reg. 6204(2)(c), by providing that the taxpayers’ right to sell their shares to 9135-8184 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 (so that the taxpayers’ shares were prescribed shares and they were eligible for the s. 110(1)(d) deduction), Noël CJ stated (at para. 43):

“[T]he fact that paragraph 6204(1)(b) is applicable in cases where there is no […] obligation to redeem” does not justify a reading that ignores the language of paragraph 6204(2)(c), which specifically requires that no reference be given to the obligation to redeem. A reading of the text that is consistent with the words can be made if one accepts that paragraph 6204(1)(b) is an anti-avoidance provision which supports the object pursued by subparagraph 6204(1)(a)(iv).

In noting that broader considerations also supported a finding that the taxpayers’ shares were prescribed shares, he stated (at paras. 55-56, 58):

The fact that the appellants were exposed to a risk from the moment when the options were granted and that the shares described under the terms of the plan were in all respects prescribed shares explain why they could have claimed the 50% deduction if they had simply sold their options to Cybectec… . It also explains why the appellants could have sold the shares to Cooper, a non-specified person, and benefitted from the 50% deduction (subsection 6204(3) of the Regulation).

This shows that for the purposes of paragraph 110(1)(d) of the ITA, it is not the imposition of an holding period that ensures the existence of a risk element, but the particular characteristics of a prescribed share and the minimum price at which the option must be exercised.

… [S]ubparagraph 6204(1)(a)(iv)…prevents the deduction from being claimed with respect to shares which embody an obligation to redeem. Paragraph 6204(1)(b) broadens the scope of this disqualification by extending it to situations where, for instance, an established practice makes the redemption of the shares reasonably predictable. … It seems clear that these two provisions complete one another and that the latter is intended to prevent employees from benefitting from the deduction in circumstances where they can have their shares redeemed at will… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 6204 - Subsection 6204(2) - Paragraph 6204(2)(c) acquisition right also ignored for purposes of Reg. 6204(1)(b) reasonable expectation test 238

See Also

Montminy v. The Queen, 2016 TCC 110, rev'd 2017 FCA 156

shares tainted by right to sell immediately after exercise to controlling shareholder

The taxpayers were management employees of a software company (“Cybectec”), which was a wholly-owned subsidiary of a holding company (“9135-8184”). They were granted option in 2001 to acquire Class A common shares of Cybectec at an exercise price of $0.20 per share, with such options only exercisable on the first to occur of an IPO, a sale of all the Cybectec shares and the passage of 10 years. In January 2007, the options were made immediately exercisable upon the closing of a sale of substantially all the assets of Cybectec to a third-party purchaser, with the taxpayers agreeing to sell their shares on exercise to 9135-8184 for a price of $1.2583 per share.

The Crown acknowledged that Reg. 6204(2)(c) applied to avoid the application of Regs. 6204(2)(a)(iv) and (vi) to the taxpayers’ shares. In rejecting the taxpayers’ submission that Reg. 6204(2)(c) also avoided the application of Reg. 6204(1)(b), D’Auray J stated (at paras. 94 and 101):

I note upon reading paragraph 6204(1)(b) of the Regulations that it is not the rights or obligations to redeem, acquire or cancel the shares that trigger the application of this paragraph but rather the reasonable expectation that the shares will be redeemed, acquired or cancelled within two years following their sale or issue.

The tax policy underlying paragraphs 110(1)(d) … and 6204(2)(b) … is to prevent the turning of stock option plans into forms of additional remuneration and to ensure that the employees subscribing for these shares are exposed to a certain level of risk.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Fair Market Value - Shares capitalization of normalized cash flow accepted 381

Administrative Policy

7 October 2011 Roundtable, 2011-0411951C6 F - Retenues à la source - options d'achat d'actions

loss of prescribed share status where employer granted redemption right to cover s. 153(1.01) withholding obligations

In order to effect s. 153(1.01) withholding, certain employers have some shares redeemed immediately following the exercise of employee stock options in order to raise the requisite source deduction amount – and to accomplish this, the stock option agreements are amended to give the employer the right to redeem the shares in part. Would granting a redemption right to the employer result in the shares ceasing to be prescribed shares? CRA responded:

[A] share issued under a stock option agreement that grants the employer a right to purchase for cancellation the shares issued under that agreement would not be a prescribed share by virtue of ITR subparagraph 6204(1)(a)(iv) and paragraph 6204(1)(b).

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 6204 - Subsection 6204(1) - Paragraph 6204(1)(a) conferral on employer of share repurchase right to set off against source deduction obligation engages the exclusion 63
Tax Topics 59
Tax Topics - Income Tax Act - Section 153 - Subsection 153(1.01) treatment of net share issuances under review

Articles

Joint Committee, "Technical Amendments Package of September 16, 2016", Submission letter of 15 November 2016

Adverse implication re convertible shares

The proposed addition of Reg. 6204(1)(b)(iv) seems to imply that a convertible voting share would not be a prescribed share if it were reasonable to consider that the conversion right would be exercised within the two-year period.

John McClure, Brian Kearl, "Stock Options in Spinout Transactions", Canadian Tax Highlights, Vol. 24, No. 7, July 2016, p. 7

Prescribed share issue if immediate cancellation of acquired share (p. 7)

[R]egulation 6204(l)(b) provides generally that a share does not qualify as a prescribed share…if the corporation can reasonably be expected to redeem, acquire, or cancel the share within two years of its issue.…

S. 86 reorg or s. 84(2) distribution alternatives for spin-out (p. 7)

In some corporate takeovers, the target corporation spins out certain of its assets to a Newco owned by its existing shareholders, including employees who exercised options….A spinout may be achieved…through a section 86 exchange of the Targetco shares by Targetco shareholders for shares to be sold to the acquirer and Newco shares (the share exchange method). A spinout may also involve a return of capital by the Targetco by way of a distribution of the Newco shares to existing shareholders under subsection 84(2) (the return-of-capital method).

No Reg. 6204(1)(b)(iii) exclusion [subject to 29 Nov. 2012 comfort letter]

[T]he benefit reduction may be denied if the share exchange method is used because the transaction involves a redemption or repurchase of shares issued to the employee…On the other hand, the benefit reduction should be available to an employee if the return-of-capital method is used because a return of capital in a spinout transaction is specifically excepted from regulation 6204(l)(b).

Subsection 6204(2)

Paragraph 6204(2)(c)

Cases

Montminy v. Canada, 2017 FCA 156

acquisition right also ignored for purposes of Reg. 6204(1)(b) reasonable expectation test

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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 6204 - Subsection 6204(1) - Paragraph 6204(1)(b) employees enjoyed the ½ deduction on exercising their stock options notwithstanding an immediate sale of the acquired shares to the controlling shareholder 479

Subsection 6204(3)

Administrative Policy

2006 Ruling 2005-0151001R3 - Prescribed Shares / plan of arrangement

where pursuant to an arrangement agreement that is implemented under a plan of arrangement, employee stock options previously granted by the "Target" are transferred by the employees to Target in exchange for cash amounts equal to their in-the-money value before the acquisition pursuant to the agreement and plan by the purchaser of 100% of the shares of Target for cash consideration, such purchaser will not be a "specified person" at the time the options are so transferred.