Amirault v. MNR, 90 DTC 1330, [1990] 1 CTC 2432 (TCC)

Rip, T.C.J.:—The question before the Court in this appeal by John A. Amirault, the appellant, from an assessment of income tax for 1986, is whether Mr. Amirault ("Amirault") is entitled to the deduction provided for in paragraph 110(1) (d) of the Income Tax Act ("Act").

At all relevant times Amirault, who was trained as a mining engineer, carried on his profession in Nova Scotia and in June, 1985 was elected as a director of Seabright Resources Inc. ("Seabright"), a company having its head office in Halifax. In 1984 Seabright's shares commenced to be traded on the Toronto Stock Exchange. Amirault commenced doing work for Seabright in 1981 or 1982 when the company was a junior resource company looking for mining prospects in Nova Scotia but aside from being a director was never otherwise an employee of Seabright.

Mr. Amirault was approached by Seabright officials to be director during the Spring of 1985. He believes he was “probably advised" a stock option plan was “in the works" and he "would be eligible to participate in the plan”.

By letter dated September 16, 1985, from Seabright, Amirault was informed that on June 25, 1985 he had been granted an option in accordance with the stock option plan ("plan") to acquire 15,000 Class A shares ("shares") of the company at a purchase price of $2.07, being ten per cent below the market price of $2.30 as at the close of business on that day; the option could not be exercised prior to June 26, 1986 and no more than 5,000 shares could be purchased under the plan in any one year.

On September 10, 1986, the option was amended by the mutual consent of Seabright and Amirault to make the exercise price of the option $2.30 per share, so as to equal the quoted price of the shares of the company at the close of business on June 25, 1985.

Mr. Kenneth MacDonald (“MacDonald”), a chartered accountant, who had been Vice President, Finance of Seabright during the period 1985 to 1988, also testified at trial. Prior to 1985 MacDonald was an audit manager of Thorne Riddell, Chartered Accountants in Halifax and Seabright was one of the firm’s clients. While with Thorne Riddell, MacDonald was involved in Seabright becoming a public offering corporation in 1984 and was aware of the directors' desire to create a pension plan as an incentive to obtain the services of "good people”. Before he left Thorne Riddell for Seabright he was told he would be eligible to participate in the plan. The plan had been prepared by a law firm on instructions of the Board of Directors and although MacDonald was aware of the plan, he was not involved in its preparation.

When he joined Seabright in 1985, MacDonald thought everything, including tax implications, had been considered by the lawyers in preparing the plan. He understood that any benefit from the plan would include an income component and a non-income component as far as tax was concerned. Only when he received a formal notification of his eligibility in the plan did he realize a discount was in play. In March, 1986, an employee who was a participant in the plan was leaving Seabright and wished to exercise his options. He asked MacDonald "what the situation was”. MacDonald told the Court he had assumed the participants were eligible for the deduction permitted by paragraph 110(1)(d) of the Act but nevertheless referred the question to a tax specialist at Thorne Riddell and "she identified the potential problem" with respect to subparagraph 110(1)(d)(iii) in that the exercise price was below the market value of the shares at the time the option was granted. Legal counsel was contacted, stated MacDonald, and an opinion was requested.

In August, 1986, an opinion was received from legal counsel together with a recommendation the option be amended retroactive to June 25, 1985. After consultation with legal counsel MacDonald spoke to the Chairperson of the Pension Plan Committee who, on September 9, 1986, wrote Amirault (and presumably each other participant in the plan) to inform him of the problem and advise him that Seabright was prepared to amend the terms of the option so that the exercise price of his option would be $2.30, the closing price of the shares on the stock exchange on June 25, 1985. Amirault, as director, was expecting his letter and was aware of the tax considerations for the amendment. Amirault agreed to amend the option. The agreement ("amending agreement") reads as follows:

SEABRIGHT RESOURCES INC., a body

corporate having an office in Halifax,

Nova Scotia ("Company")

OF THE SECOND PART

WHEREAS pursuant to the Employee Stock Option Plan of the Company the Employee Stock Option Committee recommended that an option be granted to the Optionee to purchase 15,000 Class A Shares of the Company at Two Dollars and Seven Cents ($2.07) per share being Ten Percent (10%) below the closing price of Class A Shares on June 25, 1985 ('Option');

AND WHEREAS the Board of Directors of the Company confirmed the granting of this Option at a meeting of the Board of Directors held on June 26, 1985;

AND WHEREAS the Optionee and the Company wish to amend the Option; NOW THEREFORE THIS AGREEMENT WITNESSETH that for and in consideration of the sum of One Dollar ($1.00) and other good and valuable consideration (the receipt and sufficiency of which is hereby acknowledged by the parties), the parties agree as follows:

1. The Exercise Price of the Option is hereby amended as and from the day of the grant of the Option to Two Dollars and Thirty Cents ($2.30) being the market price of Class A Shares of the Company as at the close of business on June 25, 1985.

2. The parties hereby confirm all other terms and conditions of the Option as granted.

IN WITNESS WHEREOF the parties have hereunto set their hand and seal the day and year first above written.

SIGNED, SEALED AND DELIVERED

)

in the presence of: )

) ) )

) JOHN A. AMIRAULT

) ) )

) SEABRIGHT RESOURCES INC. ) )

) Per:

) ) )

Prior to the revision of the option, no participant in the plan had exercised his rights. Amirault executed the amending agreement September 10, 1986 and exercised his rights on September 18 by purchasing 5,000 shares of Seabright for $2.30 each. When he exercised his rights the market value of a share was $6.25.

According to Amirault and MacDonald, the option was amended “solely to reflect the intent of what was intended at the time” it was made on June 25, 1985. MacDonald admitted that his option agreement was also amended and as a result of his exercise of the options, the respondent has assessed him for the same reasons he assessed the appellant.

In filing his tax return for 1986, Amirault considered that the provisions of paragraph 110(1)(d) had been fulfilled and he computed accordingly the taxable portion of the benefit from the exercise of his stock option rights. The respondent denied the deduction.

The respondent is of the view the condition of subparagraph 110(1)(d)(iii) had not been satisfied as the amount payable ($2.07) by the appellant to acquire the shares under the option was less than the fair market value of the shares at the time the option was made. The respondent also submitted the amending agreement was a fundamental change to the option and represented a new contract between the appellant and Seabright since it altered the exercise price of the rights in the option.

The appellant is of the view that the amending agreement simply varied the option, that the amended term (the new exercise price) related back to and formed part of the option and the shares were acquired under or by virtue of the option, that is, the agreement of June 25, 1985, as amended. The exercise price was not less than the fair market value of the shares at the time the option was made.

The issue, then, is whether the agreement of September 16, 1986, the amending agreement, rescinded and replaced the option or simply varied it.

Paragraph 110(1)(d) of the Act reads:

For the purpose of computing the taxable income of a taxpayer for a taxation year, there may be deducted such of the following amounts as are applicable:

(d) where, after February 15, 1984,

(i) a corporation has agreed to sell or issue a share of its capital stock, or of another corporation with which it does not deal at arm's length, to the taxpayer,

(ii) the share is a prescribed share at the time of its sale or issue, as the case may be,

(iii) the amount payable by the taxpayer to acquire the share under the agreement is not less than the fair market value of the share at the time the agreement was made, and

(iv) at the time immediately after the agreement was made the taxpayer was dealing at arm's length with the corporation, the other corporation and the corporation of which he is an employee,

an amount equal to one-half of the amount of the benefit deemed by subsection 7(1) to have been received by the taxpayer in the year in respect of the share or the transfer or other disposition of the rights under the agreement.

The determination of whether a subsequent agreement has effected a rescission, as opposed to a simple variation, of an earlier agreement depends on the intention of the parties to be gathered from an examination of the subsequent agreement and from all the surrounding circumstances: United Dominion Trust (Jamaica) Ltd. and Michael Mitri Shoucair, [1969] 1 A.C. 340, at page 348.

In British and Beningtons, Limited and North Western Cachar Tea Company, Limited et al., [1923] A.C. 48, Lord Atkinson stated, at page 62:

A written contract may be rescinded by parol either expressly or by the parties entering into a parol contract entirely inconsistent with the written one, or, if not entirely inconsistent with it, inconsistent with it to an extent that goes to the very root of it: Morris v. Baron & Co. [1918] A.C. 1; Hunt v. South Eastern Ry. Co., (1875) 45 L.J. (Q.B.) 87; and Thornhill v. Neats (1860) 8 C.B. (N.S.) 831.

See also Lord Sumner's comments at pages 68 and 69.

What will constitute a change that goes to the very root of a contract so as to create a rescission depends on the facts of each case. In Morris v. Baron, [1918] A.C. 1, Viscount Haldane, stated, at page 19, that what is essential to cause a rescission:

. . . is that there should have been made manifest the intention in any event of a complete extinction of the first and formal contract, and not merely the desire of an alteration, however sweeping, in terms which still leave it subsisting.

In the appeal at bar only one term of the option was varied by the amending agreement, the exercise price. A clause in a contract dealing with price is an important term of the contract. However did the amendment go to the very root of the option in that it represented a fundamental alteration to the option?

The Federal Court of Appeal held that radical changes to share option agreements were inconsistent with the continuing existence of the agreements and represented new agreements: Wiebe et al. v. The Queen, [1987] 1 C.T.C. 145; 87 D.T.C. 5068. In Wiebe, two taxpayers, when they were hired, were each given an informal option to purchase five shares of their employer corporation at the price of $1 per share. The taxpayer Bastien commenced his employment in 1972 while the taxpayer Wiebe was hired in 1973. The taxpayers, however, did not actually acquire the shares until 1978. The informal option placed no restrictions on the use of the shares by employees. In 1977, however, two other employee-shareholders left the company to set up a competing business and the company was able to reacquire the shares only after difficult and bitter negotiations. A new policy was implemented by the employer which included, among other things, a requirement that the employee-shareholders sign a buysell agreement with respect to the shares upon termination of employment and a requirement that they guarantee the company's indebtedness to the extent of $20,000. The taxpayers signed the buy-sell agreements and the guarantees in 1978 after the shares had been transferred to them. The respondent took the position that the taxpayers had received taxable benefits when they exercised their employee stock options. The taxpayers appealed contending that new agreements were entered into in 1978 and that the benefit provision did not apply by virtue of an exemption in respect of certain employee stock options granted after March 31, 1977.

The conditions in the subsequent agreements, namely the guarantee and the requirement to execute a buy-sell agreement, in the Court's view, represented:

. . . fundamental changes in any rights which the appellants might have had to acquire shares . . . . (p. 146 (D.T.C. 5069))

Mr. Justice Hugessen stated, at page 147 (D.T.C. 5070):

What is important is that these were new conditions which attached to the appellants' becoming shareholders of the company at the time they acquired their shares. They were conditions which substantially affected the “basic elements" of any earlier purported stock option agreement. In particular, they affected the consideration to be paid by adding the important requirement of a personal guarantee with the bank to the extent of $20,000; they also drastically affected the terms upon which each appellant became a shareholder by requiring the concurrent execution of a buy-back agreement. Changes as fundamental as this are inconsistent with the continuing existence of the alleged prior stock option agreement; rather they represent a whole new agreement.

The appeal in Wiebe was therefore allowed.

However, a simple price variation is not always a fundamental change to an agreement nor does it go to the very root of the agreement. In Gable Construction Co., Ltd. v. Inland Revenue Commissioners, [1968] 1 W.L.R. 1426 the Chancery Division held that a deed of variation in which the parties agreed to increase the rents payable under an existing lease did not operate as a surrender of the existing lease and its replacement by a new one. The Court followed the decision of Inchiquin (Lord) v. Lyons (1881), 20 L.R.Ir. 474. Goff, J. found no intention in Gable Construction to create a new tenancy, "rather the reverse" (page 1434).

Halsbury [1] offers the following example:

The distinction here between variation and rescission [. . .] may be a fine one, but it is vital; thus, if on 1st January A agrees to buy B's car for £500 for delivery and payment on 3rd January, but on 2nd January B agrees to accept £400; [.. . .] Whether the transaction was a rescission or a variation would depend upon the intention of the parties.

The letter of September 9, 1986, described in laymen's terms the applicable paragraph of section 7 of the Act with an example as to how it may affect the appellant. The writer also explained how the taxable benefit in section 7 may be reduced by the application of paragraph 110(1)(d). The letter set out the deficiency in the option and informed the appellant that Seabright was prepared to amend the option to remedy the problem, if the appellant wished to do so. It was for Amirault to decide whether to amend the option. The amending agreement amended the exercise price but otherwise ratified the terms of the option. In fact what transpired is that Seabright realized the option could cause an unnecessary tax cost to the appellant (and other participants in the plan), advised the appellant it was prepared to correct the problem by amending the option and the appellant agreed.

In my view there was no intent to cancel or rescind the option but only to vary an otherwise important element of the agreement. The purpose of the plan was to grant certain employees the right to purchase shares in Seabright at a cost less than market value. The variance in price was not fundamental to Seabright's consideration in continuing the option for the benefit of the appellant. The variance in exercise price of the option was at the discretion of the appellant. The plan and option would continue for the benefit of the appellant regardless of any alteration in the exercise price of the option. The change in exercise price could not therefore be said to be fundamental to the option as in Wiebe. In Wiebe the changes in the options altered radically the consideration to be paid by the taxpayers to exercise their rights; the corporation insisted on the changes and the taxpayers, if they wished to participate in the plan, had to accept the changes as required by the corporation. In the case at bar, Seabright suggested the change for the convenience of its employees in order to ensure the continuation of the plan; the appellant could accept or reject the suggestion and the plan and option would continue. The new exercise price did not add anything to the option which fundamentally changed the terms of the option as in Wiebe, supra.

An agreement which is subsequently varied continues to exist in a varied form: British and Beningtons, Ltd., supra, at pages 68 and 69. Once the variation of the exercise price was incorporated into the option it became an integral part of the option as at the date that option was granted. Had the appellant sought to enforce his stock option rights in a court of law he could not have done so by relying on the amending agreement alone since the fundamentals of his rights were in the option: See Morris, supra, page 26. The appellant acquired the shares on September 19, 1986 under the option agreement, as amended, made on June 25, 1985.

The appeal is allowed with costs.

Appeal allowed.