We are writing in reply to your letter of October 25, 1990, in which you requested our interpretation of "prescribed share" in section 6204 of the Income Tax Regulations (the "Regulations") for purposes of paragraph 110(1)(d) of the Income Tax Act (the "Act") as these provisions relate to the following situation.
As we understand it, a wholly-owned subsidiary of a public corporation wishes to issue options to acquire shares of its capital stock (rather than stock of its public corporation parent) to its employees. Because there is no market for the shares of the employer corporation, the parent corporation will be obligated to purchase any shares acquired pursuant to the options upon the retirement or death of an employee at a price equal to the fair market value "FMV") of the shares.
In determining whether the shares would be prescribed shares for purposes paragraph 110(1)(d) of the Act, you noted that subparagraph 6204(1)(a)(vi) of the Regulations would not be violated in this situation because the parent corporation has the obligation to acquire the shares for an amount approximating the FMV of the shares. However, subparagraph 6204(1)(a)(iv) of the Regulations would be violated if the employees could cause the parent corporation to acquire their shares.
Opinion Requested
Your view is that if subparagraphs 6204(1)(a)(iv) and (vi) of the Regulations are read together, the only reasonable interpretation appears to be that the pre-existing obligation of the parent corporation to purchase the shares at FMV would not be a case where the employees can cause the shares to be acquired and, therefore would not result in the shares losing their status as prescribed shares
Our Comments
In order for a share of the capital stock of the subsidiary corporation to be considered a "prescribed share" under subparagraph 110(1)(d)(ii) of the Act, it must fulfil all of the requirements of section 6204 of the Regulations. If any of the conditions in subparagraphs 6204(a)(i) to (vi) of the Regulations are violated, the share will not be a prescribed share. Subparagraph 6204(1)(a)(iv) of the Regulations addresses the holder's right to have the share redeemed regardless of whether or not the redemption price is at FMV. Subparagraph 6204(1)(a)(vi) of the Regulations addresses the right of the corporation to acquire the share at an amount other than FMV. These are two separate tests that must be met.
In our view, these subparagraphs do not interact in the manner suggested. In the scenario described in your letter, upon retirement the employees can cause the parent corporation to redeem their shares. As a consequence, these shares fail to fulfil the requirements of subparagraph 6204(1)(a)(iv) of the Regulations and would not, therefore, be prescribed shares for purposes of the Act or Regulations.
We hope these comments will be of assistance to you.
Yours truly,
for Director Business and General Division Rulings Directorate Legislative and Intergovernmental Affairs Branch .