Mr. X implemented an estate freeze in favour of his children and a holding corporation respecting his wholly-owned operating corporation, which he continued to control. During the the reorganization, stock options to purchase common shares for $1 were issued to a key employee, who was not related to Mr. X, being the controlling shareholder of the holding corporation, which is the dividend recipient for the purposes of ss. 55(3) and (3.01). Shares received during the estate freeze were transferred to the holding corporation and subsequently redeemed, with the resulting deemed dividend not fully covered by safe income on hand.
Is the granting or the exercise such stock options a triggering event under s. 55(3)(a) causing s. 55(2) to apply? After noting that ss. 55(3)(a)(i), (iii) and (iv) would not apply to the granting of the option, as s. 49(1)(b) deemed such grant not to be a disposition, CRA then addressed ss. 55(3)(a)(ii) and (v), and stated, respecting the option grant:
[H]aving an interest in a corporation has a broad meaning and is not limited to the holding of shares in that corporation. Instead it references the holding of an economic interest in the corporation. …
A stock option often has conditions that make the exercise of the option uncertain and contingent. Subject to the application of subsection 245(2), there would generally be no significant increase in the interest in a corporation at the time of such an option, the exercise of which is contingent in fact and in law.
However … an increase in an interest in the corporation occurs when the stock option is granted rather than when the option is exercised … in a situation such as that described, where a key employee, instead of an immediate receipt of shares in the corporation, receives a stock option with characteristics and price such that there is no real uncertainty or contingency as to the exercise of the stock option.
Respecting the option exercise, and after noting that, as the exercise would not constitute a disposition, ss. 55(3)(a)(i), (iii) and (iv) would not apply, it stated:
Where the CRA concludes that there is no increase in an interest in a corporation at the time of the granting of a stock option the exercise of which is contingent in fact and in law, there will be an increase in interest when the option is exercised.
… In this situation, if the exercise of the stock option occurred as part of the same series of transactions or events in which the dividend resulting from the redemption of the freeze shares was received and if the increase in interest in the corporation was a significant increase, subsection 55(2) would apply to the deemed dividend received upon the redemption of the freeze shares.
… In a situation, such as the one you describe, where a corporation grants a stock option to a key employee at the time of an estate freeze, it appears to us that there would be arguments for concluding that the granting and the exercise of the option were part of the same series of transactions or events in which the dividend from the redemption of the freeze shares was received.