Aylward v. R., 97 DTC 1097, [1997] 2 CTC 2748 (TCC)

Margeson T.C J .:

It was agreed at the outset that evidence given in one case would be considered in the other where relevant.

Exhibit A-1, Appellants’ Documents, was introduced by consent of the parties subject to weight.

Exhibit R-l, the Respondent’s Pre-Hearing Submissions, were filed by consent.

It was agreed that there was no argument about the non-arm’s length issue.

An order for exclusion of witnesses was made.

The Minister of National Revenue (the Minister) issued a reassessment of the income tax liability of the Appellant Ronald Aylward for the 1988 taxation year, notice of which was dated November 8, 1991. The Minister had included in the taxpayer’s income a deemed dividend in the amount of $437,063 with respect to shares acquired by the Appellant from Aylward’s Limited through a stock option arrangement.

The Appellant, Ronald Aylward filed an appeal to the reassessment in question arguing that the deeming of the dividend was incorrect and contradictory to the Income Tax Act (the Act).

The Appellant, Dorothy Aylward was assessed for the 1988 taxation year, notice of which is dated November 8, 1991 in which she was denied the Child Tax Credit in the amount of $182.45 as a result of the reassessment of the Appellant Ronald Aylward.

She filed a notice of appeal to this reassessment arguing that it was incorrect and that she was entitled to the Child Tax Credit for the 1988 taxation year.

Ronald Aylward commenced work with Aylward’s Ltd., (the company) in 1968. He was in charge of the food, hardware operations, hotel operations and construction operations of the company. He described these overall operations as “a one man show”. This operation was very successful and expanded by “leaps and bounds”. He was involved in all aspects of the expansion. He considered himself to have been the “general manager of operations”.

He considered himself to have been very important to the company. He was 22 years of age at the time he was hired and considered his contributions to have been on “par” with those of Fabian Aylward, the owner of the controlling shares in the company who was also his uncle.

The Appellant was paid a salary at this time.

After three years Ronald Aylward and Fabian Aylward talked about making Ronald Aylward a shareholder at some time in the future to the extent of 10 - 15 % and the wages paid to him would be the same as those paid to Fabian Aylward.

The Appellant considered this undertaking as “a promise to issue the shares to him.”

He was referred to Exhibit A-l, Tab 1 which was an undated, handwritten document prepared by Ronald Aylward. Fabian Aylward had approached him in 1985 and asked him if he was interested in forming a company and taking over some of the operations. The Appellant agreed to this proposal providing he receive shares “in the company” and could then go to the bank and borrow money to operate the three stores that he would take over.

At that time the “company” operated four hardware stores and had invested approximately $800,000 into their operation. The company had over- expanded and was experiencing some bank pressure. If the Appellant Ronald Aylward took over the three stores, Fabian Aylward would have been able to recover a large portion of his investment in the home hardware stores.

The document at Tab 1 was a proposal by Ronald Aylward as to what he believed was the value of his interest in the company. It represented from a 10% interest to a 12 1/2% interest.

Fabian Aylward considered this proposal to be “outrageous” but in the Fall of 1985 they had agreed that the value of his interest was $350,000. The Appellant said that he and Fabian Aylward were prepared in the Fall of 1985 to go ahead with the share issue on that basis but they did not.

The $350,000 figure was agreed upon in conjunction with the needs of the Appellant Ronald Aylward and his partners who had to come up with an estimated $425,000 to commence the operation of their new company.

Aylward’s (1986) Limited., the “new company” was formed and it operated three of the home hardware stores upon terms that were agreed upon. Aylwards (1975) Ltd. was to own the real estate and the fixtures for the three stores. The Appellant, Ronald Aylward, Jacob Weymouth and Frederick Forsey were to be three of the shareholders of the “new company” along with Aylward’s Ltd. (the company). The meeting was attended by these three people and on the other side was Fabian Aylward, his lawyer and one other person. The company was to keep the home hardware store at St. Lawrence. Ronald Aylward was to be the President and the majority shareholder of the “new company”. Jacob Weymouth and Frederick Forsey were former employees of Aylward’s Limited.

Tab 2 of Exhibit A-l was a letter from The Bank of Nova Scotia to the “new company” setting out credit arrangements in the amount of $1,000,000 and it indicated the required security to be provided. This letter was dated October 30, 1986. After it was in place the parties proceeded with their arrangement and tried to put the deal in place but by October 30, 1986 Fabian Aylward had still not completed the deal. By that time he had been able to recover his investment from the home hardware operations, the Appellant Ronald Aylward said that his position hardened and he procrastinated in completing the deal. It was not signed until the document at Tab 3 was signed. It was dated the 4th day of February, 1987 although the affidavits of execution refer to the (blank) day of July, 1987.

Ronald Aylward agreed that it was signed later than February 4, 1987. The witness said that they took over in February 1987. The demand noninterest bearing promissory note in the amount of $350,000 was the amount earlier referred to as the agreed value of Ronald Aylward’s interest in the company.

Tab 4 of Exhibit A-l contained the shareholders’ agreement signed by the shareholders and the “new company”. It also included a buy-back clause in favour of Ronald Aylward, Frederick Forsey and Jacob Weymouth for the shares owned by Aylward’s Limited. The shareholders’ agreement also referred to the above referred to note.

The agreements were eventually signed but not without much controversy and with complaints going back and forth between the parties. There were many drafts of the agreement. Finally, on July 17, 1987, the purchasers sent a letter to Aylward’s Limited setting out the items still in dispute and setting a deadline of July 31, 1987. Fabian Aylward responded to the letter of complaint by letter dated July 22, 1987 in which he generally denied that he was responsible for the delay and indicating that if the Appellant did not want to proceed with the deal then it was his choice and his responsibility but at the same time indicating that they should meet and finalize the matter.

By February 18, 1988 it still had not closed but documentation was sent to Ronald Aylward by W. Gary Rowe, the solicitor for Fabian Aylward and the matter closed shortly thereafter.

The Appellant said that his share acquisition was related to Fabian Aylward’s commitment (Agreement) to issue the shares. The shares were not issued until December of 1988.

The amount of $350,000 was the major part of what the “new company” needed to obtain the financing. That was the amount that the Appellant said that he was owed.

The Appellant said that when he took over the hardware stores he went off of the payroll of Aylward’s Limited and he did not know if he was back on but it was talked about. According to the payroll book, he was paid $125 in 1988 and $75 in 1989. A T-4 slip was issued for 1988 to him for $125 from Aylward’s Limited.

The Appellant admitted that he had seen a draft letter concerning the stock option which was unsigned. The redemption price was $350,000. This tied the repayment of the note to the redemption value of the shares. If the note was not repaid they would not get the redemption value of the shares.

The Appellant said that the issuing of the shares was to compensate him for the work that he had done for Aylward’s Limited for 17 years and represented shares that he was promised. The shares were never redeemed and the money is still in the company. The note was non-interest bearing.

In cross-examination he would not agree that the issuing of the shares was all part and parcel of the purchase by Aylward’s (1986) Limited of the stores and that he could not redeem the shares unless Aylward’s (1986) Limited paid back the money to Aylward’s Limited. That is not what he understood the agreement to be. It was never considered that the $350,000 would ever be paid back.

He said that there was never any discussion that the $350,000 worth of preferred shares represented payment for past service. He did not know if the bank knew that the $350,000 note would never be repaid.

He was told by the accountants that there would be no tax implications on the $350,000 note. He would not agree that he did not care how he would receive the $350,000 worth of preferred shares.

He agreed that he was not working for the company when he was paid the $125 in 1988. He did not know if he had received the amount or not. He was not a shareholder or officer of Aylward’s Limited.

He had no input as to how the 350 shares were to be dealt with in the books of Aylward’s Limited but it was agreed that there would be no tax implications.

He agreed that his company had paid too much for the stores and in the end they were almost forced into the deal and it “overwhelmed them”. The first four years were good but during the last two years they lost money.

Jacob Weymonth was a C.G.A. He knew the Appellant since 1975. He is the financial controller of Aylward’s (1986) Limited and a shareholder. He knew Fabian Aylward and said that he made all the major decisions for Aylward’s Limited although the day-to-day operations were conducted by the managers. He was involved with the sale to Aylward’s (1986) Limited.

They decided to proceed in September or October 1985, started work on the matter in December 1985, they took over in February 1987 and the final agreement was signed in January 1988.

The witness described the nature of the negotiations as being very rough and being worse over time. He alleged that Fabian Aylward changed the deals constantly. Ronald Aylward and himself did most of the negotiations. Fabian Aylward was on bad terms with one or another of them most of the time. The relationships were worse after they took over the stores. There were difficulties with the terms of the lease, minimum rental and the price of the fixtures. This witness gave up hope in 1987 of ever completing the deal although they were operating stores at that time. They were forced into deals which they did not want.

This witness was familiar with the financing and knew that Fabian Aylward and Ronald Aylward had discussions about Ronald’s interest in Aylward’s Limited. This made it possible for Ronald to get involved in the “new company”. Without it, there would have been no discussions about taking over.

The note for $350,000 was the same amount as Ronald’s interest in Aylward’s Limited. It was never to be enforced.

This witness confirmed the financial arrangements as per the agreement at Tab 4 of the Appellants’ Documents. He said that the $350,000 note was never paid. Eventually the share certificates were redeemed after rentals were withheld.

In cross-examination this witness said that he considered that the Appellants’ interest in the “new company” included the $350,000 and for this reason his shareholdings were greater than those of the other shareholders.

W. Gary Rowe was the solicitor for Aylward’s Limited and was involved with the negotiations for the sale of the stores from January 1987 to February 1988. He was also familiar with the protracted negotiations and the difficulties already referred to. He had prepared many drafts of documents. He was also involved with the continuation of Aylward’s Limited under the new legislation in the province of Newfoundland. He said that the $350,000 figure was set early and did not change.

In cross-examination he said that an option did not exist until December 5, 1988. He understood that the Appellant was to be given a stock option for long service. He would not agree that he was not concerned about the tax implications. He did remember writing a letter that there should be no tax implications to Aylward’s Limited or to Ronald Aylward. This was in 1988 and it was written to Doane Raymond.

Frank Kelly was a chartered accountant with Doane Raymond. During the years in question his firm gave advice to the Aylward group of companies. Fabian Aylward was the controlling shareholder and this witness dealt with him as the Chief Executive Officer of the group of companies. He described him as a “driven man”. He was autocratic, very demanding, impa- tient and tough. He described the Appellant, Ronald Aylward, as a “management employee” for Aylward’s Limited up to 1984.

He noted that there was conflict between the Appellant and Fabian Aylward. There were some business difficulties involving the inability of the supermarkets to support the fixed costs. In 1985 the company made deals to get out of the supermarkets and to lease the premises with the exception of the supermarket in St. Lawrence. Discussion was also had regarding the move out of the home hardware stores. Ronald Aylward and Fabian Aylward discussed the possibility of a management group taking over the home hardware stores. These discussions took place before the Fall of 1985.

By late 1985, a basic agreement was reached to “do the deal”. By November, there was a “co-sensus” to put the deal in place. The first deadline was February 28, 1986. “Discussions were ongoing for a piece of the action for Ron Aylward’s services. By late November 1986, they reached a conclusion about it”.

This witness was familiar with pages 1 and 2 of Tab 1 of Exhibit A-l. He said that Ron Aylward was asked to put his figures on paper about what the deal should be. Ronald Aylward calculated that his equity was $1 to $2 million. Fabian Aylward brought these calculations to this witness for discussion purposes and this witness set out his figures on the same sheet. He indicated that there was a discrepancy between the parties about gross value to the extent of about $3 million. This witness’ figure showed a 12.5% interest to be about $500,000 to $600,000.

He made a notation on November 26, 1985 that Ronald Aylward’s interest was $350,000. There was discussion about a stock option agreement and he was instructed to do a plan for a stock option in that amount. The atmosphere was tense. There was a practical deadline set of February 1986. “It became difficult to package it. The deadline was moved to November 1986”.

By November 1986, the witness believed that they had a deal and it only needed to be put together. They set a new deadline of February 1987.

This witness was familiar with the documents at Tabs 3, 4 and 5 being the agreement between Aylward’s Limited and Aylward’s (1986) Limited, the agreement between Aylward’s Limited, the new shareholders and Aylward’s (1986) Limited and the Grand Bank lease.

By late October or early November 1986 the bank had agreed to the financial arrangements which included the non-interest bearing promissory note for $350,000. It was not just a coincidence that this figure was the same as the stock option price. “We tried to tie them together”. Aylward’s Limited was not prepared to have a stock option out there and then provide a $350,000 guarantee. His position was that the terms of the stock option were settled early on and in essence there were no changes in the terms. It was just a matter of finalizing the words.

He prepared the draft letter concerning the stock option at Tab 12 on April 30, 1987 and sent it to Gary Rowe to enable him to draft the stock option. He said that Aylward’s Limited did not want a note receivable out there for $350,000 and the stock option until they had the money for the inventory. The witness identified the second letter at Tab 12 dated June (blank), 1987 and recognized his notes at the bottom of the page. He was not familiar with the third letter dated June of 1987 but indicated that it spoke quite clearly of reduction of the indebtedness on the promissory note for $350,000 by way of redemption of the preferred shares. He did not know why the option was not executed in January of 1988. The offer was accepted on December 5, 1988.

He referred to the financial statements of Aylward’s Limited for 1987 and 1988 which showed an increase in capital stock of $350,000 in 1988 to reflect the issuing of the option for the preferred shares.

He did not think that the change in the Newfoundland Statute changed the accounting treatment of this item. He was told that the item could not be treated as an expense under the Act. After that he did not give a lot of consideration to the effect of the Act on the item.

In cross-examination he said that he acted for the Aylward group of companies and not for Ronald Aylward except from the income tax point of view where the transaction would have impacted on him.

According to him the $350,000 figure was a negotiated one. The discussions for this figure culminated in November of 1985. He said that during the meetings Gerard was just sitting in. He indicated that the date of December 31, 1988 on the financial statements reflected the exercise of the option and not its creation. The exercise price of $1 was never paid. The whole option was based upon Ronald Aylward’s services to Aylward’s Limited.

He said that he decided that the transaction would qualify under section 7 of the Act as a stock option and would qualify for a deferral until the sale of the shares. To him it was a question of timing insofar as any consequences to Ronald Aylward were concerned.

He said that his indication on page 5a. of the Financial Statements (Tab 18), that the option was granted in 1987, was from his general information that it had been concluded by that time.

He was asked why he believed that the transaction had taken place. He said that possession of the property took place in 1986, the option was granted in 1987 and effected in 1988.

Argument of the Appellant

Counsel for the Appellant submitted that the issues involved were:

1. Whether subsection 84(1) of the Income Tax Act (the “Act”) applied to the issue by Aylward’s Limited to Ronald Aylward (“Ronald”) of preferred shares of Aylward’s Limited in December, 1988;

2. Whether section 7 of the Act applies to this share issue, and, in this connec- tion:-

a) Whether Ronald Aylward was an employee of Aylward’s Limited, or of a corporation with which it did not deal at arm’s length, in the circumstances required for section 7 to apply;

b) If so, whether Ronald was dealing at arm’s length with Aylward’s Limited at the relevant time or times, as required by subsection 7(1.1) of the Act to apply.

Aylward’s Limited was a Canadian-controlled private corporation incorporated and carrying on business in Newfoundland.

Counsel submitted that subsection 84(1) did not apply and that section 7, including subsection 7(1.1) did apply. It was his position that the conclusions were supported by the evidence given which showed that the essence of the deal and the amount had been agreed upon no later than the end of 1985 in spite of the fact that the final version of the option had not been presented to Ronald Aylward until early December of 1988 and he accepted it on December 30, 1988, the same day when articles of continuance of Aylward’s Limited under the Newfoundland Corporations Act, were filed in the Newfoundland Registry of Companies.

However, there was no “haggling” over its terms which had merely been set aside until the transfer documents had been executed because the terms were not in controversy.

At this point Aylward’s Limited issued to Ronald Aylward, preferred shares, conforming to the terms of the stock option and with the terms spelled out in the articles of continuance.

It was counsel’s position that Ronald Aylward was restored to the payroll of Aylward’s Limited in November 1988, that he continued on the payroll until January of 1989 and was paid a very small salary every half month. T-4 Forms were issued to Ronald Aylward by Aylward’s Limited and the amount was reported by him in his income tax returns for the 1988 and 1989 taxation years.

In the financial statements of Aylward’s Limited as of its year end, December 31, 1988 a total of $350,000 was added to “capital stock” to reflect the issue of the preferred shares to Ronald Aylward. This was done without reference to the Newfoundland Corporations Act, what might be the correct tax treatment of the share issue and according to generally accepted accounting principles as Mr. Kelly had testified. However, the manner in which the preferred share capital of Aylward’s Limited was reflected for accounting purposes in its financial statements is not relevant in determining the tax consequences. See Robinson v. Minister of National Revenue, (1993), 93 D.T.C. 254 (T.C.C.) and Prosperous Investments Ltd. v. Minister of National Revenue, (1992), 92 D.T.C. 1163 (T.C.C.).

Counsel argued that Aylward’s Ltd. received benefits from the transactions, including the home hardware money, participation in dividends of Aylward’s (1986) Limited and that real benefits from the leases accrued to Aylward’s Limited. Aylward’s Limited had a large stake in Aylward’s (1986) Limited to protect its 46.9% of the total outstanding shares.

The consideration injected by the Appellant was his past service for Aylward’s Limited. He had no cash in his pocket as a result of the transaction. Redemption was tied to payment of the $350,000 note although he benefited from the equity by convincing the bank to provide financing.

Counsel was of the view that Revenue Canada had concluded under subsection 84(1) that Aylward’s Limited had increased its paid-up capital instead of its stated capital as required by the Newfoundland Corporations Act which was in effect at the time of the issue. Section 52(1) of the Newfoundland Statute stated:

A corporation shall maintain a separate stated capital account for each class and series of shares that it issues.

Counsel argued that there was an increase in the stated capital of Aylward’s Limited of $350,000 and the consideration for it was the past services of the Appellant. This was in compliance with section 50(1) of the Newfoundland Corporations Act providing that it was “the fair equivalent of the money that the corporation would have received had the shares been issued for money”.

Even though the stated capital was increased by $350,000 due to the application of the Newfoundland Statute, subsection 84(1) still did not apply.

The commitment of Aylward’s Limited to compensate the Appellant represented an enforceable liability by Aylward’s Limited to him. This was present and past consideration whether or not it appeared on the balance sheet.

When the early December 1988 commitment was fulfilled there was a corresponding decrease in liability that paralleled the increase in stated capital. Therefore, paragraph 84(l)(b) was fulfilled.

This situation was analogous to that found in Del Grande v. R., (1992), 93 D.T.C. 133 (T.C.C.). As in that case the commitment had already existed.

Alternatively if subsection 84(1) does apply, it is overwhelmed by section 7.

Counsel examined in-depth the provisions of section 7 of the Act, The opening words of subsection 7(1) require that Aylward’s Limited be a corporation that agreed to sell or issue shares of its capital stock to an employee of Aylward’s Limited or of a corporation with which Aylward’s Limited did not deal at arm’s length, at the relevant time.

Counsel’s position was that the Appellant was an employee of Aylward’s Limited for many years and at the time of the sale of the three hardware stores to Aylward’s (1986) Limited, he left the payroll of Aylward’s Limited although he continued to provide services to Aylward’s Limited. In December of 1988 when the final version of the stock option was granted and accepted, he was again on its payroll and was therefore an employee of that company. Therefore, if subsection 7(1) should be interpreted to require him to be an employee at that time it has been fulfilled. He was an employee when the final stock option agreement was offered and accepted.

But it was submitted that a proper interpretation of subsection 7(1) does not require the “simultaneity of the employment and the issuing of the stock option”.

It was argued that subsection 7(4) recognizes that the stock option is a culmination of a process that may unfold over a period of time. The subsection says:

For greater certainty it is hereby declared that, where a person to whom any provision of subsection (1) would otherwise apply has ceased to be an employee before all things have happened that would make that provision applicable, subsection (1) shall continue to apply as though the person were still an employee and as though the employment were still in existence.

The argument was that the subsection really means that the taxpayer need not be an employee at the precise time when the option was granted, so long as he was an employee previously, of the issuing corporation or of a corporation not at arm’s length with it and provided that, in accordance with subsection 7(5) of the Act, “the benefit conferred by the agreement was received in respect of, in the course of, or by virtue of the employment”.

Counsel argued that there was no question that there has been compliance with subsection 7(5). The reason for the granting of the option was clearly by virtue of his previous employment with Aylward’s Limited and the idea of granting the option did not emerge after the Appellant had ceased to be an employee. It was the fulfilment of a long-standing commitment even though the final version of the option and its acceptance occurred sometime later. The nexus between the granting of the option and the employment is clear. Therefore, section 7 applies.

It was further put forward that section 7 does not specify the time as of which the employment relationship must exist. Therefore, there is ambiguity on the specific issue as to whether or not the taxpayer must be an employee at the time the corporation in question “has agreed to sell or issue shares”.

The policy behind section 7 is clearly to have the regime therein provided apply to situations where shares are issued to an individual in compensation for his employment services and therefore the ambiguity should be interpreted in such a way (whether it favours the taxpayer or not) that section 7 applies. “Further, subsection 7(3) and (4) make it clear that providing the basis for the stock option is the employment relationship, section 7 should be given a wide interpretation. See Québec (Communauté urbaine)

c. Notre-Dame de Bonsecours (Corp.), (1994), 95 D.T.C. 5017 (S.C.C.). Further, the term agreed in subsection 7(1) is not clear. It does not refer to agreement in the sense of a contract that has been formed by offer and acceptance because that would not occur until the taxpayer had accepted all or part of the rights conferred. If the taxpayer had to be an employee at that time there would be little scope for subsection 7(4) to apply.”

Counsel referred to Mansfield v. R., (1983), 83 D.T.C. 5136 at 5138 in support of this proposition that under section 7 of the Act:

“Agree” and “agreement” are not terms of art or technical expressions.

Therefore, there need not be a detailed contractual obligation in existence at that time. (See further Amirault v. Minister of National Revenue, (1990), 90 D.T.C. 1330 (T.C.C.) (T.C.C.)).

Counsel argued that at the time of the assessment the Minister treated the amount in question as a dividend and at the time of trial was arguing that it was a “benefit” under subsection 7(1).

Counsel addressed the question of evaluation and he indicated that if the Court should find that subsection 84(1) of the Act did not apply; if subsection 7(1) of the Act did not apply and subsection 7(1.1) did not apply, then the value of the alleged benefit would become an issue in the year 1988 and the matter should be referred back to the Minister of National Revenue for reassessment on the basis of subsection 7(1) instead of subsection 84(1), on the basis of the fair market value of the preferred shares at the time of their issue, with the right to the Appellants to appeal to this Court if they do not agree with the Minister’s evaluation.

Counsel concluded that the appeals should be allowed, with costs.

Argument of the Respondent

Counsel for the Respondent argued that the assessment was based on the position that at the time the shares were issued, the company increased its paid up capital by $350,000. That was not part of a transaction by which assets were increased or liabilities decreased. No other excepting provisions applied so that section 84 applied to deem a dividend paid to the Appellant. The paid up capital was increased by $350,000.

Financial statements cannot be ignored and the financial documents presented by the Appellant, (Tab 18, Exhibit A-l) show that that is what happened. The accountants were concerned by the expense side of the transaction as can be seen by the notation which referred to “an extraordinary item” of $350,000. On the balance sheet this amount was taken out of the retained earnings but there was no liability in the books for that amount. The liabilities were not reduced.

The matter of remuneration was part and parcel of the entire transaction. It cannot be ignored. There was no agreement on the “greater matters” in issue and therefore there was no agreement on “remuneration”. It was not a closed deal in November of 1985, the parties were not getting along. There was no agreement on any point until the contracts were signed.

Counsel asked, “If the whole deal had fallen through would there have been an enforceable agreement with respect to the $350,000 for the shares of Aylward’s Limited?” If it had been enforceable there would have been a reduction in liability. He answered, the first time there was an enforceable agreement was on December 30, 1988 when the option was exercised.

Section 84 of the Act is a very severe section. The important question is not “what did Ron Aylward do, but what did Aylward’s Limited do?”.

No one testified as to why the transaction was recorded in the books as it was. Why was there no liability recorded in the company’s books for the $350,000? If it had been so, section 84 would have applied and there would have been a reduction in liabilities.

The $350,000 note was never to be repaid. There was no liability for $350,000. The shares were to be issued and the money was taken out of paid up capital. It was a deemed dividend.

Section 84 is not a benefit section. There may be a benefit created but there need not be. It assesses a “deemed dividend”. The Appellant did not receive a benefit of $350,000 when the shares were issued. He received something less. The value depended upon the other shareholders. (See subsection 7(3)).

A dividend is not a benefit under section 84. It is something different. What section 84 assesses is not necessarily a benefit because of subsection 15(1). It does not mean that there is a “doubling up”.

Subsection 7(1) has no application to section 84. Section 84 is in respect to a dividend.

Counsel argued that under subsection 7(1) the term “agreement” means just that. Has the corporation agreed to issue shares? Here there was not enough to find that an agreement existed at the time the shares were issued.

Counsel asked: “Did Mr. Aylward have to be an employee at the time the shares were issued? He answered that subsection 7(1) refers to the present tense. The term is “has agreed to sell or issue shares -”.

The Appellant relied upon Québec (Communauté urbaine), supra, in support of this interpretation.

Counsel argued that the corporation must agree to sell shares to an employee not an ex-employee. The Appellant ceased to be an employee as of February 1987. He said that himself. He did not work and he was not an employee. There must be services rendered to be an employee.

If there was an agreement to issue shares it was not made until December 5, 1988 and he was not an employee at that time under subsection 7(1) and therefore subsection 7(4) does not apply.

The subsection merely means that the taxpayer need not be an employee at the time the necessary acts have been concluded but he must have been an employee at the time the December 5, 1988 agreement was made. Subsection 7(4) does not assist the Appellant here.

Subsection 15(1) contemplates that but for paragraph 15(l)(d) you could assess either under section 15 or section 84.

The question in the case at bar is, “Was the assessment under subsection 84(1) incorrect, not whether the taxpayer may have been assessed under another section.” Here the assessment under section 84 was not wrong.

Counsel argued further that if the assessment was incorrect under section 84, the matter could be sent back for assessment under section 6 of the Act because there was an employee benefit although there was an issue as to the quantum.

Counsel argued that the appeals should be dismissed.

Rebuttal

In rebuttal, counsel for the Appellant asked the question, “Were the liabilities decreased?” He answered “Yes”. This answer to that question does not depend upon the financial statements. It is a legal question and not an accounting one. The liabilities were reduced immaterial of the treatment of the transaction under the financial statements.

From an accounting point of view Mr. Kelly considered the amount as an expense for wages. But the company cannot deduct any expense for a stock option because of paragraph 7(3)(b), but it was shown for accounting purposes and an adjustment was made in the return.

It is immaterial as to whether it was shown in the books as a liability if it is not a liability. There was liability when the shares were issued. This was the only relevant time under section 84. Even if it existed only for a moment, the issuing of the shares discharged a liability.

Section 84 is addressing the gratuitous issuance of shares, not those issued as a result of contractual obligations. The financial statements are not relevant but even if they were, the real question is whether or not there was a liability at the time of the issuing of the shares.

All three witnesses understood that as of 1985 and 1986 there was a firm agreement. It was an enforceable agreement in 1985.

The Appellant’s argument does not depend upon an agreement in 1985 but at the time of the issuing of the shares and at that time it was in place.

Section 7 is a specific section designed to operate when shares are issued in an employee context. This is intended to apply over competing sections.

If section 84 overrides section 7, that section has little scope for application and that is contrary to the intent of the Act. It would lead to absurd consequences.

In the case of John A. Amirault, supra, there was only a letter as the form of option. That case is no different than the series of documents that were put forward here.

A technical change that is made so as to comply with the Newfoundland Corporations Act had nothing to do with the agreement having been concluded.

Counsel argued that section 7 does not require the taxpayer to be an employee at the time that the agreement was made, but he was an employee here when the agreement was made. By the end of 1985 the terms had been agreed upon. That meets the requirements of subsection 7(1). Ronald Aylward was still an employee and shares were issued in 1988 pursuant to the agreement.

The issuing of the shares was not just a part of the agreement but it was a fulfilment of a long-standing undertaking. It does not matter that there were outstanding issues. The terms were not at issue.

By January of 1988, the difficult negotiations were at an end. If the Appellant had not effected the issuing of the shares he could have afterward. He could have gone to Court about it.

With respect to the argument on the alternative basis for an assessment, counsel suggested that if section 7 and section 84 do not apply to the facts of the present case, then he would have difficulty on the facts of fitting it under section 6 in light of subsection 6(3).

Analysis and Decision

As indicated, the parties agreed at the conclusion of the evidence that the Appellant was dealing at arm’s length with Aylward’s Limited at the relevant time under subsection 7(1.1) of the Act.

It was not contested that Aylward’s Limited, at the relevant time was a Canadian-controlled private corporation under subsection 7(1.1) of the Act.

The Court will deal firstly with the provisions of subsection 84(1) of the Act. It is true that the Appellant was assessed under the provisions of this section but the Court finds that the respondent is entitled, alternatively, to rely upon its position set out in the Reply and argued in this Court that subsection 7(1) might tax the value of the preferred shares as income from employment if subsection 7(1.1) did not apply to defer recognition for tax purposes of any such taxable benefit.

The real question before the Court is whether the assessment of taxes was correct or not and not whether it was correct under one section rather than another.

The Court finds that in the years in question the Newfoundland Corporations Act applied so that the “stated” capital of Aylward’s Ltd. was increased by reason of the issue of preferred shares to Donald Aylward and the definition of “paid up capital” in subsection 89(1) of the Act included that amount in Aylward’s Ltd. paid-up capital for tax purposes.

it was clear from the financial statements that this was accepted by the accountants for the “company”. In those returns the company added to the “stated capital account” for the preferred shares, the amount of $350,000.

The Court finds that the nominal value of the shares was to be $1 and not $1 per share.

As a result, this transaction triggered a deemed dividend of that amount to the Appellant, Ronald Aylward, unless, under the facts disclosed in this case, the provisions of paragraph 84(1 )(b) apply. The question, under that section, then becomes, were the net assets of the Corporation (that is, assets minus the liabilities) increased by an amount at least equal to the increase in paid-up capital? More particularly, in this case, have the liabilities of the Corporation been reduced by that amount?

Section 50 of the Newfoundland Statute provided that the consideration may take the form of past services and it was argued that such past services were valued by the company at $350,000.

Counsel for the Appellant argued that this commitment amounted to a liability of that amount, which was reflected in the issuance of the stock option to him in early December of 1988 which was taken up at the end of December. This resulted in the converting of the liability into share capital of the Appellant, Ronald Aylward. Therefore, the exception in paragraph 84(l)(b) applies and there was no deemed dividend.

There was undoubtedly some confusion created as a result of the treatment afforded to the preferred share capital of Aylward’s Limited for accounting purposes in the financial statements of the “company” but such treatment is not conclusive of the proper tax treatment to be applied to any transaction. See Robinson v. Minister of National Revenue and Prosperous Investments Ltd. v. Minister of National Revenue, supra.

Some explanation was afforded by the company’s accountants, which although not affording a definitive explanation, at least was some explanation for the treatment afforded this item. It was originally considered to be an expense item, but that was not possible because of the provisions of paragraph 7(3)(3) of the Act so an explanatory note was appended to the return and the adjustment made.

Counsel for the Respondent argued that the financial statements cannot be ignored and that the treatment afforded the item in the financial statements reflected the fact that there was an increase in paid-up capital without any corresponding reduction in liabilities and the item was properly assessed by the Minister.

There was no liability for that amount in the books of the company and if it existed there would have been a reflection of that item in the financial statements.

The Court is satisfied that it cannot disregard the financial treatment afforded to the item here but it must be considered in light of the other evidence. Such treatment does not dictate that this item was or was not a real liability.

Whether or not it was a liability depends upon the Court’s finding as to the legal nature of the so-called “agreement” to issue the preferred shares to Ronald Aylward. Surely it cannot be a liability unless it was enforceable in law. It could not be enforceable in law unless its terms were set including the matter of consideration.

The Court is satisfied that in order for there to have been a “liability” such as to afford the Appellant, Ronald Aylward, the benefit of the exception afforded to him in paragraph 84(1)(b) of the Act, the liability would have to have been based upon “an agreement” containing the essential terms as set out above.

Counsel for the Respondent argued that there was no liability recorded in the company’s books. There was no duty to pay back the $350,000 note. If there had been, there would have been a liability set up in the company’s books for that amount. It was a deemed dividend.

But section 84 does not apply to “deem” a dividend if there was a reduction in liability to the same amount. If there was an enforceable agreement requiring the company to issue the preferred shares for the $350,000 at the time the shares were issued and the value of the work, which was the consideration for the shares was reasonably valued at $350,000, then there was a decrease in liabilities to that extent and the section would not operate so as to create a deemed dividend.

Counsel for the Respondent argued that the real issue was not, “what did Ronald Aylward do, but what did Aylward’s Limited do?” However, the Court finds that the real question is not only what did Aylward’s Limited do, but why did it do it?

The Court is satisfied that the witnesses were all credible, reliable and informed as to the facts of the case. All of the evidence given by the wit- nesses called on behalf of the Appellant testified as to the existence of an undertaking to issue the preferred shares to Ronald Aylward in return for his service to the company. The valuation of these shares (and of the services rendered) was the subject matter of some heated negotiations, earlier disagreements, professional consultations and legal advice. The negotiations were protracted, disagreeable and created a crisis between the company and the Appellant Ronald Aylward, but in the end, the parties did agree that the Appellant Ronald Aylward was to be issued 350 preferred shares at a nominal price of $1 having a fair value of $350,000, being the value of the Appellant Ronald Aylward’s contributions to the company.

That was the nature of the evidence which was unrebutted. It is true that Mr. Fabian Aylward is deceased and the Court has not had the benefit of his input into the actual situation, but there was no evidence introduced which contradicted the evidence of the Appellant and the other informed witnesses that an agreement had been reached on all of the essential elements of the preferred share issue and that all that remained to be done was to commit the agreement to writing.

The Court is satisfied that in the context of the facts disclosed here, the accounting treatment afforded the transaction in the financial statements of the company does not preclude a finding that, at the time of the issue of the preferred shares, there was an existing liability in the amount of $350,000 that was extinguished by the issuing of the shares.

The Court finds, that at the time of the issuing of the preferred shares, there was a binding and enforceable agreement in existence that created a liability of $350,000, in the “company” which was extinguished by the granting of the option.

Therefore the provisions of paragraph 84(l)(b) provided an exception to the general rule under the opening words of subsection 84(1) so that there was no deemed dividend as assessed by the Minister and the assessment cannot stand under that section.

The Court now turns to a consideration of section 7 of the Act,

Counsel were divided on the issue as to whether the term “deemed dividend” under section 84 and the term “benefit” under section 7 were one and the same thing.

Counsel for the Respondent argued that what the Appellant Ronald Aylward received under section 7 was not the same amount as he received under section 84. It was something less due to the interest of the other shareholder.

But the Court is satisfied that what was to be taxed under section 84 and what counsel for the Respondent now argues can be taxed under section 7 was the same amount. It was the amount of the value of the shares issued to Ronald Aylward and that value was for all intents and purposes $350,000. However, the Court is satisfied that none of the sections referred to by counsel for the Appellant, including paragraph 7(3)(a), subsection 15(1) or subsection 4(4) preclude a finding that the Minister could assess the taxpayer alternatively. Counsel for the Respondent said that he could not be assessed under sections 84 and 7 so as to create a “doubling up” to use the expression of counsel for the Respondent.

This does not mean that there might not be a conflict between section 7 and section 84. If the Court had found that section 84 applied to the present transaction and then it should find that the excepting provisions of section 7 applied, then there would have been a conflict between the two sections that would have had to be resolved. If that was the case the Court finds that the provisions of section 7 override any other provisions of the Act, that would otherwise tax the same amount, by virtue of paragraph 7(3)(a). See Minister of National Revenue v. Chrysler Canada Ltd., (1992), 92 D.T.C. 6346 (Fed. T.D.) (F.C.T.D.).

That brings the Court to a consideration as to whether the Appellant Ronald Aylward may be assessed on the basis of section 7 of the Act. The Court finds as a fact that Aylward’s Limited was a corporation that had agreed to sell or issue shares of its capital stock to the Appellant Ronald Aylward. The Court finds that Ronald Aylward was not an employee of the “company” at the time the shares were issued. By his own evidence, “he went off the payroll of Aylward’s Limited when he took over the hardware stores, that was October 30, 1986 or February 1987.” He was not an employee as of November 1988 up to January 1989 as counsel for the Appellant suggested even though he was on the payroll and may have received a nominal salary.

Being on the payroll does not make him an “employee” for purposes of the Act. By his own evidence he did not know if he had received the nominal salary.

However, the Court finds that the Appellant Ronald Aylward need not have been an employee of the “company” at the time of the granting of the stock option or at the time of the exercise of the option.

Counsel for the Respondent argued that subsection 7(1) refers to the present tense and that the Appellant Ronald Aylward was not an employee of the company at the time the agreement was made to issue the shares, being December 5, 1988.

The Court does not agree with this argument.

However, the Court finds that subsection 7(4) would assist the Appellant Ronald Aylward even if the relevant time for him to be an employee was at the time of the signing of the option or at the time of its acceptance.

Only by interpreting this subsection so as to require the Appellant only to have been an employee of the issuing corporation previously, providing of course that the benefit was conferred “in respect of, in the course of, or by virtue of, the employment”, would the subsection have any real meaning.

The granting of a stock option and its ultimate acceptance normally involve a process that might take considerable time, as indeed it did in this case and indeed there might be many reasons why one might have ceased to have been an employee (as in this case). A strict interpretation of this subsection might result in an injustice to such a taxpayer, where the very section appears to be there for the purposes of such a person where the consideration for the option was his employment.

The Court finds as a fact that the stock option in this case was granted to Ronald Aylward, in respect of and by virtue of his previous employment with the “company”. The commitment to grant the option was of a long standing duration although its final form had not been decided upon. The essential terms of the option had been agreed upon for a considerable period of time. The Act does not specify when the employment relationship must exist. If there is still an ambiguity, in light of subsections 7(3) and 7(4) which would seem to imply that the section should apply when the consideration of the stock option is the employment relationship, section 7 should be given a wide application. Such an interpretation would be consistent with Québec (Communauté urbaine), supra,

The argument of counsel for the Respondent that the Appellant, Ronald Aylward, had to be an employee at the time that the agreement (option) was made, December 5, 1988, is not accepted.

The phrase used in subsection 7(1) is:

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

There is no further definition of the term “agreed”. There is nothing to suggest that what is required is a formal contract in the sense of an offer and acceptance. Further, the argument of counsel for the Appellant that if the taxpayer had to be an employee at the time the option was exercised, either in whole or in part, that there would be little scope for subsection 7(4) to apply, is well taken.

In Mansfield v. R., supra, it was held that in section 7 of the Act, “‘agree’ and ‘agreement’ are not terms of art or technical expressions.”

As argued by counsel for the Appellant, the Court finds that the agreement in question “need not be a detailed contractual obligation”. The case of Amirault v. Minister of National Revenue, supra, appears to support this view.

In any event, on the facts of this case, the Court finds that the “company” had agreed to sell or issue the shares to the Appellant Ronald Aylward, upon terms that had been settled by the parties not later than the end of 1986. Therefore, subsection 7(1) applies as modified by subsection 7(1.1), so that even though the exercise of the option by Ronald Aylward left him open to a taxable benefit, that benefit need not be recognized until such time as he disposed of his shares. This had not yet happened.

There is merit in the contention of counsel for the Appellant that section 84 appears to be addressing the gratuitous issuance of shares and not the situation where shares are issued as a result of a contractual obligation. Further, section 7 appears to more specifically deal with the issuance of shares in the employee context and where there is a conflict then section 7 overrides section 84, otherwise there would be little scope for application of this section. That would appear to be contrary to the intent of the Act.

The end result is that the appeals are allowed and the matters referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that subsection 84(1) of the Act did not apply to these transactions but section 7 and subsection 7(1.1) did apply.

The Appellants will have their costs to be taxed.

Appeal allowed.