84.1 and employee buycos

I gave a talk today at the Hamilton Law Association on shareholder agreements and tax issues. David Howell asked me a question, on which I drew a blank, relating to employee buycos. Thanks to Shelley Wickenheiser, I was able to zero in on technical interpretation 2013-0479402C6, which reads in part as follows:

In a typical transaction, employees of a corporation (“Opco”) would have received Opco shares as incentives under an Opco employee share ownership plan (“ESOP”). Under the terms of the ESOP, on retirement or other termination of employment, the employees would be required to dispose of these shares.

To facilitate the disposition, Opco would incorporate and fund another corporation (“Buyco”). Buyco would use those funds to purchase the departing employee’s Opco shares.

In the advance income tax rulings issued in respect of these transactions, we had provided assurance that section 84.1 of the Income Tax Act would not apply to deem departing employees to receive a dividend on the disposition of their Opco shares. However, this assurance was based on representations that the employees would deal at arm’s length with Buyco and that Buyco was not an agent of Opco.

In our opinion, given the degree of accommodation provided by Buyco to the departing employees and the parties’ lack of separate interests, the better view is that the employees and Buyco are generally not dealing at arm’s length.

Of course, if the employees and Buyco do not deal at arm’s length, then 84.1 will apply.