Canada: Two-Year Holding Of CCPC Options

Montminy ( 2016 TCC 110) is the first case to consider the interaction between regulations 6204(1)(b) and 6204(2) (c). The TCC concluded that the latter does not apply to negate the two­year reasonable holding period in the former.

Were the taxpayers in Montminy entitled to a deduction whereby a CCPC employee defers the recognition of employment income to the year when he or she disposes of the CCPC's shares (paragraph 110(1)(d.1))? In conjunction with section 7, only half of the taxable benefit (simulating a capital gain) is taxed (paragraphs 110(1)(d) and 110(1)(d.1)). The 50 percent deduction is allowed if the shares are prescribed under regulation 6204.

The taxpayers were employed at Cybectec, a tech company in the competitive IT industry, which established a stock option plan in 2001 to retain employees. In 2007, Cybectec received an unsolicited offer from Cooper Industrial Electrical Inc. to purchase all of its shares; Cooper changed the offer to an offer to purchase all of Cybectec's assets. The founders of Cybectec sought to honour its employees' options by allowing the employees to exercise the options and immediately thereafter to sell the shares to a company related to Cybectec. The employees exercised their options in Cybectec and sold the shares the same day to the related company.

The taxpayers relied on paragraph 110(1)(d): paragraph 110(1)(d.1) requires that the shares be prescribed. The minister argued successfully that under regulation 6204(1)(b), the shares were not prescribed because once the options were exercised by the taxpayers, the shares were to be immediately purchased by the related company. Regulation 6204(1)(b) provides that a share is prescribed if the issuing corporation or "a specified person in relation to the corporation cannot reasonably be expected to, within two years after the time the share is sold or issued, as the case may be, redeem, acquire or cancel the share in whole or in part." The taxpayers acknowledged that the two­year holding period in regulation 6204(1)(b) was not met, but they said that regulation 6204(2)(c) allowed an exception to that requirement.

The TCC applied the SCC's guidance in Canada Trustco ( 2005 SCC 54), according to which an interpretation of a statutory provision must accord with a textual, contextual, and purposive analysis. The TCC concluded that regulation 6204(2)(c) does not disregard regulation 6204(1)(b): the former does not apply to the latter. Regulation 6204(1)(b) "raises a factual question," and the sole object of regulation 6204(2)(c) was, according to the TCC, "to disregard certain rights and obligations, notably to redeem, acquire or cancel the share, if all conditions of paragraph 6204(2)(c) are met." The TCC continued:

My conclusion that paragraph 6204(2)(c) of the Regulations does not disregard paragraph 6204(1) (b) is confirmed by the fact that paragraph 6204(1)(b) is applicable in cases where there is no right or obligation to redeem, acquire or cancel the shares at the time of their issue. For example, if, at the time of issue, a share is a common share without conditions, then the share is a prescribed share. However, if the facts show that the corporation knew that it would be redeeming its employees' shares within two years following the issue of the shares, then the share is not a prescribed share, since the expectation that the share will be redeemed is what triggers paragraph 6204(1)(b) regardless of whether the share has rights or obligations attached thereto. This shows that paragraph 6204(2)(c), used to eliminate from consideration certain rights or obligations, is not relevant to paragraph 6204(1)(b).
Moreover, contrary to situations in which there is a logical connection between the application of subsection 6204(2) of the Regulations and certain subparagraphs of paragraph 6204(1)(a), it is difficult to find a logical connection between the factual issue in paragraph 6204(1)(b), the two­year reasonable expectation, and paragraph 6204(2)(c), the purpose of which is to disregard the right or obligation to redeem, acquire or cancel the share or to cause the share to be redeemed, acquired or cancelled.

The TCC acknowledged that the two­year holding criteria did not apply to employees of public companies: tax policy dictates a different treatment for shares of public companies as opposed to those of private companies. The TCC noted the technical complexity of subsections 6204(1) and 6204(2) and said that "surely the time has come for a reform of these subsections."

The case is under appeal to the FCA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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