Ball v. MNR, 92 DTC 2123, [1992] 2 CTC 2770 (TCC)

Mogan, T.C.CJ.:— The issue in this appeal is the amount of the benefit received by the appellant in 1985 as a result of certain stock options granted by his corporate employer. The amount in issue would be taxed under paragraph 7(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

At all relevant times, the appellant was employed by Calgroup Graphics Corporation Limited (" Calgroup"). In the early summer of 1985, Calgroup granted to a number of employees including the appellant options to purchase treasury shares at fixed prices. The appellant was granted an option to purchase 25,000 shares of Calgroup at the price of $2.05 per share. On July 10, 1985, the appellant purported to exercise his option and, according to his evidence, he was issued a certificate for 25,000 shares even though he had paid no amount for the shares. Calgroup asked its employees not to sell all of their shares at one time because the market price of the shares could be affected. Therefore, the appellant delivered his certificate for 25,000 shares to his stockbroker with instructions to sell only a few thousand shares each week. He sold 9,700 shares of Calgroup for total proceeds of $67,012.50 between July 10 and September 23, 1985 when the Ontario Securities Commission issued a cease trading order with respect to all Calgroup shares.

The appellant paid to Calgroup the aggregate amount of $19,885 based on a price of $2.05 per share for the 9,700 shares which he sold but he had not paid any further amount to Calgroup with respect to the other optioned shares. He was left with 15,300 Calgroup shares which had not been sold and his employment by Calgroup ended before he sold any further shares. He testified that, at some later time, he returned a certificate for 15,300 shares to Calgroup and received a receipt for those shares but he did not produce the receipt at the hearing of this appeal.

For 1985, Calgroup issued a T4 supplementary form to the appellant showing employment earnings of $23,192.28 and a stock option benefit of $65,000. The stock option benefit was computed on the basis that the market price for Calgroup shares was $4.65 per share on July 10, 1985 when the appellant received his share certificate:

When filing his 1985 Income Tax return, the appellant reported his gain from the sale of 9,700 Calgroup shares as follows:

In evidence, there was no explanation concerning the source of the adjusted cost base ($45,978) in the above computation but it is close to the fair market value of the 9,700 shares on July 10, 1985. The appellant also reported a “ qualifying stock option” benefit of $25,220 computed as follows:

When issuing the assessment under appeal herein, the Minister of National Revenue included in the appellants income for 1985 an employee benefit under paragraph 7(1)(a) of the Income Tax Act in the amount of $65,000 computed as shown above. Paragraph 7(1)(a) states in part:

7(1) Subject to subsection (1.1), where a corporation has agreed to sell or issue shares of the capital stock of the corporation . . . to an employee of the corporation. . .

(a) if the employee has acquired shares under the agreement, a benefit equal to the amount by which the value of the shares at the time he acquired them exceeds the amount paid or to be paid to the corporation therefor by him shall be deemed to have been received by the employee by virtue of his employment in the taxation year in which he acquired the shares;

There is no question that paragraph 7(1)(a) applies to the 9,700 shares which the appellant sold for total proceeds of $67,012.50 because he paid the option price of $2.05 for those shares. He testified that (i) he delivered a promissory note to Calgroup dated September 2, 1987 in the amount of $26,500 (copy entered as Exhibit A-1) with respect to the optioned shares but he could not relate the amount of the note to the option price or to any particular number of shares; (ii) he did not pay any amount to Calgroup at any time as consideration for the remaining 15,300 unsold shares; (iii) the Ontario Securities Commission (“OSC”) issued a cease trading order with respect to Calgroup shares on September 23, 1985; (iv) although trading was permitted briefly on one or two occasions after September 23, 1985, trading was permanently stopped on November 2, 1987; (v) he returned to Calgroup a certificate for the remaining 15,300 shares and has never been asked to pay any amount for those shares; and (vi) he believes that Calgroup became insolvent and inactive sometime after 1985.

Having regard to the appellants testimony as summarized above and the words in paragraph 7(1)(a) “if the employee has acquired shares under the agreement", I doubt whether the appellant acquired 25,000 shares of Calgroup even if he was put in possession of a certificate for 25,000 shares. There is no evidence as to whether Calgroup was incorporated under the Canada Business Corporations Act, R.S.C. 1985, c. C-44 (CBCA), the Ontario Business Corporations Act, S.O. 1982, c. 4 (OBCA), or the legislation of some other province but it was proven that the shares of Calgroup were publicly traded and that the OSC had jurisdiction to issue a cease trading order. Section 25 of the CBCA provides in part:

25(3) A share shall not be issued until the consideration for the share is fully paid in money or in property or past services that are not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.

25(5) For the purposes of this section, "property" does not include a promissory note or a promise to pay.

The OBCA has a similar provision in section 23 as set out below:

23(3) A share shall not be issued until the consideration for the share is fully paid in money or in property or past service that is not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.

23(6) For the purposes of subsection (3) and of subsection 24(3), a document evidencing indebtedness of a person to whom shares are to be issued, or of any other person not dealing at arm's length with such person within the meaning of that term in the Income Tax Act (Canada), does not constitute property.

I assume that if Calgroup was incorporated under a statute other than the CBCA or the OBCA, that statute would have provisions similar to those set out above. If a share cannot be issued until the consideration is fully paid, how can it be said that the remaining 15,300 optioned shares were issued to the appellant when he was never paid for them or had never been asked to pay for them? The appellant's notice of appeal indicates that he thought that he had exercised his option to purchase all of the 25,000 shares and he gave the same impression when presenting his own case in Court but, because he acted without the benefit of legal counsel, I do not hold him responsible for knowing technical distinctions in corporate law between when a share has been issued by a corporation and acquired by a shareholder, and when an individual has only a piece of paper indicating his right to acquire certain shares upon payment therefor. According to the respondent's reply to notice of appeal, the Minister of National Revenue assumed that the appellant exercised his option and purchased 25,000 shares of Calgroup at $2.05 per share on July 10, 1985. This assumption is rebutted in part, however, by the appellant's testimony that he purchased, paid for and sold only 9,700 shares and returned the remaining 15,300 unsold shares without making any payment therefor.

The decision of the Ontario High Court in Re Dunham and Apollo Tours Ltd. (1978), 86 D.L.R. (3d) 573 indicates that a person to whom shares have been issued without payment is not a shareholder. Carruthers, J. stated at page 578:

I think it is clear that before any share or shares can be "issued" within the meaning of section 44 of the Business Corporations Act, that the par value or consideration as fixed by the directors, whatever the case may be, be received in full by the corporation. As I have found above, that did not occur here and, accordingly, no shares of the respondent corporation have been properly issued to any person or persons, including the three incorporators.

Section 44 referred to by Carruthers, J. contained provisions similar to those in section 23 of the OBCA set out above. Bruce L. Welling, the author of Corporate Law in Canada, (2nd ed.), (Toronto: Butterworths, 1991), states at page 607:

A share cannot be issued until the full price is paid, in money, property or past service. The statutory wording suggests that failure to collect the full amount renders a purported share issue invalid, rather than resulting in an effective issue coupled with a breach of director's duty. This is because a share does not exist until it has been properly and fully paid for. Directors cannot issue shares where the statutory requirements have not been fulfilled and any attempt to issue shares before full consideration has been paid will fail.

These two authorities were not put to me in the course of the hearing but they indicate a consistent view of the way in which the corporate law should be construed. I regret that I cannot have the benefit of hearing full legal argument by opposing counsel for both parties in this appeal. If the appellant had been represented by counsel, I would have asked the parties to come back and argue the provisions of the corporate law under which Calgroup was incorporated in order to determine how many of the 25,000 optioned shares were in fact and in law issued by Calgroup and therefore "acquired" by the appellant within the meaning of paragraph 7(1)(a) of the Act.

Left to myself on this question, I try to imagine what would appear on the audited balance sheet of Calgroup as at December 31, 1985 with respect to the 25,000 shares which were optioned to the appellant. I am inclined to the view that, if the applicable corporate law contained provisions like section 25 of the CBCA, the balance sheet would show only 9,700 shares as having been issued out of the 25,000 shares which were optioned to the appellant and the increase in paid-up capital or stated capital with respect to those 9,7000 would be only $19,885. If the balance sheet were to show more than 9,700 shares as having been issued out of the appellant's 25,000 optioned shares with an increase in paid-up capital or stated capital exceeding $19,885, then the same balance sheet would have to show a receivable from the appellant in the amount of such excess; and the existence of such a receivable would appear to deny that more than 9,700 shares had been issued according to subsection 25(5) of the CBCA or similar legislation. If only 9,700 shares were issued, then only 9,700 shares were acquired within the meaning of paragraph 7(1)(a).

There is other evidence which leads me to conclude that only 9,700 shares were issued. Calgroup does not appear to have been a “blue chip” corpora- tion. The cease trading order in September, 1985 and the subsequent permanent suspension of trading in the shares of Calgroup lead to an inference of at least negligence on the part of Calgroup, its officers or directors with respect to corporate conduct or public disclosure. If Calgroup had commenced an action against the appellant for the option price ($31,365 at $2.05 per share) of the remaining 15,300 shares, the appellant probably would have counter- claimed for damages relying on the facts which led to the suspension in the trading of shares. When this appeal was heard in August 1992, no claim had been made against the appellant by Calgroup for the balance of the option price.

There appears to be an inconsistency between the corporate law concerning the issue of new shares and the provisions of the Income Tax Act because paragraph 7(1)(a) of the Act refers to the benefit deemed to have been received by an employee with respect to the value of the shares and "the amount paid or to be paid to the corporation” for the shares (emphasis added). If the relevant corporate law requires payment for shares before they can be validly issued, then payment for the shares may be a condition precedent for the application of paragraph 7(1)(a). I prefer not to reach any general conclusion in this area because, as stated above, I have not had the benefit of full legal argument. There could be circumstances in which a share certificate is delivered to an employee who would then sell some of the shares before they were paid for; and his inability to return the shares to the corporate employer may trigger a benefit under paragraph 7(1)(a) without regard to whether the shares were validly issued.

In my opinion, the appellant acquired only 9,700 shares of Calgroup under his employee stock option and, under subsection 7(1) of the Income Tax Act, he is deemed to have received a benefit of $25,220 computed as follows:

The appeal is allowed and the assessment for 1985 is referred back to the Minister of National Revenue for reconsideration and assessment in accordance with the above reasons.

Appeal allowed.