Employee Buyco Transactions: Not Arm's-Length?
Suppose that a shareholder-employee of a private corporation is
departing. She wants to relinquish her shares and receive capital gains
treatment (including the lifetime capital gains deduction) on the
appreciation in value, but the remaining shareholders lack the cash for a
straight buyout of the shares. Redeeming or cancelling the shares
solves the cash problem by using the corporation's funds, but triggers a
deemed dividend under section 84.1. One solution is a buyco or sidecar
arrangement. These types of arrangements have been called into question
by a recent change in the CRA's administrative policy, but the legal
basis for that change is not strong.
Assume that the employees of Opco, a CCPC, own more than 10 percent
of Opco's common shares. Pursuant to a unanimous shareholders' agreement
(USA), on cessation of employment an employee is required to sell his
or her Opco shares to a new corporation (Buyco) for a price equal to
FMV. Buyco obtains a loan from Opco and purchases the employee's Opco
shares at a price equal to FMV. Subsequent to the transaction, Buyco
will transfer the purchased common shares to Opco for FMV consideration.
At the Canadian Tax Foundation's 2012 annual conference, the CRA
indicated that it will no longer issue favourable rulings concerning
buyco transactions and the non-application of section 84.1 in these
circumstances (2002-0146775). (For a description of the new policy, see
"CRA's GAAR Update," Canadian Tax Highlights, January 2013.)
Specifically, the CRA has concluded that an employee involved in a buyco
transaction may not be dealing at arm's length with the buyco because
of the degree of accommodation between the parties. The CRA has not yet
issued an official statement concerning buycos, but perhaps one is
The CRA's revised position on buycos is said to follow recent cases such as Petro-Canada (2004 FCA 158). In Petro-Canada,
the court used three questions established as a "framework for
analysis" to evaluate whether a non-arm's-length relationship exists:
(1) Is a common mind directing the bargaining for both parties to the
transaction? (2) Did the parties to the transaction act in concert
without separate interests? (3) Did one party to the transaction
exercise de facto control over the other?
When one asks these questions regarding a buyco situation, it must be
conceded that at times an employee and an employer may appear to be
acting in concert and not at arm's length. However, the departing
shareholder and the other shareholders of the buyco are independent
economic parties with independent interests, even if those interests
coincide on particular points. In contrast, in Petro-Canada,
Petro-Canada was beneficially interested in both the vendor and the
purchaser corporations, and thus there was a clear "common mind" behind
the actions of both the vendor and the purchasers.
Also, there is no artificiality about the USA. A transaction like the
one in the example may be the most significant and substantial
transaction of the employee's life. Normal employment conditions suggest
that acting in concert occurs near the beginning of an employment
relationship and over the course of the employment relationship, when
there is an ongoing relationship to be maintained. In contrast,
cessation of employment suggests the end of any compulsion to act in
concert. At the close of the employment relationship, the employee's
only interest is her own. Presumably, she wants to maximize her shares'
value and arrange her affairs to obtain the best income tax result
allowed by law.
Mowbrey Gil LLP, Edmonton