In order to benefit from the 50% deduction for stock-option-employment income under s. 110(1)(d), the share acquired on exercise of the option must be a prescribed share as described in s. 6204 of the regulations.  In broad outline, a prescribed share is a plain-vanilla common share.  Any special rights attached to the share, or an agreement in respect of the share, will in most cases disqualify the share as a prescribed share.  In Montminy et. al. v. The Queen, 2017 FCA 156, employees of a corporation were granted stock options in 2001.  In 2007, following a sale of the corporation’s assets, the employees exercised their stock options and then immediately sold the issued shares at fair market value to the parent of the corporation (pursuant to a commitment and undertaking agreed to a few days before the sale of the corporation’s assets).  On these facts, the Federal Court of Appeal (FCA) considered whether the market-making exception in s. 6204(2)(c) of the regulations applied to prevent the operation of the reasonable-expectation-of-acquisition restriction in s. 6204(1)(b) of the regulations.  Without the market-making exception, the commitment and undertaking of the parent to acquire the shares would engage the reasonable-expectation-of-acquisition restriction and cause the common shares not to be prescribed shares.  The FCA concluded that the market-making exception applied, with the result that the shares were prescribed shares and the employees were entitled to the 50% deduction.  Here are the key points supporting the decision:

  • The market-making exception in s. 6204(2)(c) of the regulations expressly applied “for the purposes of” s. 6204(1) of the regulations, which provision obviously included reasonable-expectation-of-acquisition restriction in s. 6204(1)(b).  This meant that the commitment and undertaking of the parent to acquire the shares at fair market value could not be considered when applying the reasonable-expectation-of-acquisition restriction in s. 6204(1)(b) (see paragraphs 38 and 39).
  • S. 6204(1)(b) of the regulations is an anti-avoidance provision intended to ensure full compliance with the object pursued by s. 6204(1)(a)(iv) of the regulations.  This connection further supported the view that exception in s. 6204(2)(c) applied to both s. 6204(1)(a)(iv) and s. 6204(1)(b) (see paragraphs 43, 58, and 61).
  • The policy objective of the 50% deduction in s. 110(1)(d) is to ensure that employees are subject to a certain level of risk and that stock option plans are not used to pay disguised salaries (see paragraph 45).  The risk requirement is not reflected by the imposition of any holding period, but rather by the particular characteristics of a prescribed share and the minimum price at which the option must be exercised (see paragraph 56).  These requirements were met in this case.     

The case can be found here: http://decisions.fca-caf.gc.ca/fca-caf/decisions/en/item/232867/index.do