CORAM: LINDEN J.A.
FREDERICK J. BUCCINI
- and -
HER MAJESTY THE QUEEN
Heard at Calgary, Alberta, on Wednesday, October 11, 2000.
JUDGMENT delivered at Ottawa, Ontario, on November 20, 2000.
REASONS FOR JUDGMENT BY: MALONE J.A.
CONCURRED IN BY: LINDEN J.A.
CORAM: LINDEN J.A.
FREDERICK J. BUCCINI
- and -
HER MAJESTY THE QUEEN
REASONS FOR JUDGMENT
This is an appeal from a judgment of the Tax Court of Canada, dated September 24, 1998,1 dismissing the appellant's appeal against a reassessment issued by the Minister of National Revenue with respect to his 1983 taxation year.
In the reassessment the Minister contended that he properly included $83,900 in the appellant's income pursuant to paragraph 7(1)(b)2of the Income Tax Act3 ("the Act"). The basis for inclusion was that the appellant transferred or otherwise disposed of his rights under a share purchase agreement ("Option Agreement"), receiving $83,900 as consideration. Alternatively, the Minister argued that the payment is taxable under either subsection 6(1) or 6(3) when read with section 5 as an employment benefit.
The Tax Court Judge confirmed the Minister's reassessment ruling that on the evidence presented the funds received were an employment benefit pursuant to paragraph 7(1)(b). He rejected the appellant's contention that the amount was received as damages for a unilateral breach or termination of the Option Agreement giving rise to a cause of action for damages.
One procedural and three substantive issues are raised in this appeal.4 A brief recital of the facts is, accordingly, in order.
The appellant began employment with Canadian Reserve Oil and Gas Ltd. ("Canadian Reserve") in March of 1982. His Option Agreement for Canadian Reserve shares was signed in July of that year but could only be exercised once fully vested after two years of continuous employment.
Canadian Reserve's majority shareholder, Getty Oil Company, decided to merge its Canadian subsidiaries in early1983. Its amalgamation plan was outlined in an Information Circular and Amalgamation Agreement dated June 22, 1983 ( "Amalgamation Agreement"). The new subsidiary was to be wholly owned, with the result there would be no minority shareholders or optionholders.5
Canadian Reserve complied with Article 10.02 of the Amalgamation Agreement by notifying all optionholders in writing that, on the consummation of the amalgamation on July 29, 1983, all outstanding options to purchase stock would be terminated and optionholders' rights would be limited to the rights provided in Article 10.
On July 29, 1983, the shareholders of Canadian Reserve voted to adopt the terms of the Amalgamation Agreement. Optionholders had no vote and the appellant did not take any part in settlement negotiations with management prior to that vote. A certificate of amalgamation was issued immediately to the "new" Canadian Reserve by the Alberta Registrar of Corporations confirming the amalgamation of the Getty subsidiaries.
The appellant did not consent to the termination of his options in accordance with Article 10.03(1) of the Amalgamation Agreement.6 However, on July 29, 1983 the appellant and Canadian Reserve executed a settlement agreement ("Release") which acknowledged that the payment of $83,900 was in full settlement of all claims arising from the employer's unilateral termination of the Option Agreement. This Release was in accordance with Article 10.02(2)7 of the Amalgamation Agreement and was at arms length. The preamble of the Release acknowledges the employers' default in the following words:
| AND WHEREAS pursuant to the Amalgamation Agreement made as of the 22nd day of June, 1983, providing for the amalgamation of the Company and Getty Oil (Canadian Operations), Ltd. ("Getty Canada") the Stock Options shall, on the effective date of the said amalgamation, terminate and cease to exist, and shall not attach to or be exercisable in respect of any shares in the capital of the amalgamated corporation (the "Amalgamated Corporation") resulting from the said amalgamation, which action is acknowledged to constitute a breach of the Stock Options by the Company (the "Unilateral Termination"): [Emphasis added]. |
In filing his return for 1983, the appellant reported his $83,900 release payment as damages for the unilateral breach of the Option Agreement.
In reaching his decision the Tax Court Judge found that the appellant's rights under the Option Agreement were not extinguished by the Amalgamation Agreement, but continued until the Release was signed. He reasoned that, until the Release was signed, the taxpayer had a right to claim his options and to enforce the Option Agreement by an action for breach of contract in damages or for specific performance. In his view, the wording of the Release signed by the taxpayer indicated that, in accepting the payment, the taxpayer was giving up more than just a right to claim damages; thus, whatever the taxpayer received was not damages.
Accordingly, since the right to specific performance remained open until the taxpayer signed the Release, the Release was in essence a disposition of the taxpayer's rights under the Option Agreement, whatever those rights may have been, in consideration for the payment. In the result, the Tax Court Judge concluded that the Minister properly reassessed the appellant under the provision of paragraph 7 (1) (b) of the Act.
Analysis - Continental Bank
The appellant argues that the Minister's original reassessment was based on the false assumption that he had agreed to the cancellation of the option agreement prior to the amalgamation. Fifteen years later, when it was established at trial that he had not agreed to a cancellation of his option rights prior to amalgamation, the Minister advanced a fresh argument that the option rights survived the amalgamation and that the release payment therefore constituted a disposition of rights under the option agreement.
In Continental Bank of Canada v. R,8 the Supreme Court of Canada held that the Minister is precluded from raising any new argument that has the effect of creating a new basis of reassessment after the limitation period expires. The appellant argues that the Minister's contention that the option agreement was not cancelled by the amalgamation is tantamount to a new basis of assessment and therefore the Minister should be precluded from making such an argument.
On my reading of the Continental Bank decision, it states that a taxpayer must always be afforded an adequate opportunity to adduce evidence with which to rebut the Crown's arguments. Thus, the Crown is not permitted to argue on appeal what it did not argue in the first instance. As Bastarache J. states in Continental Bank at page 367:
|Taxpayers must know the basis upon which they are being assessed so that they may advance proper evidence to challenge that assessment. [. . .] To allow the appellant to proceed with its new assessment without the benefit of findings of fact made at trial would require this Court to become a court of first instance with regard to the new claim.9 |
The Continental Bank case merely reasserts an established rule of procedural fairness that requires the Crown to give a taxpayer adequate notice of the basis of reassessment, so that a taxpayer can fairly appeal or respond.
If, in this case, the Minister had advanced a new basis for reassessment then the appellant would be correct in his argument. However, as the evidence shows, the Crown's basis of assessment has always been section 7 and, alternatively, section 6. In arguing that either section 7 or section 6 should apply, the Minister puts forward alternative arguments in support of its basis of assessment that the payment is taxable under the Act as income from employment. While the Crown may have altered its theory of the case, it did not change the basis of the assessment. Thus, there is nothing here that suggests the taxpayer has been denied adequate notice, or is otherwise prejudiced. As such, the Minister is not precluded from arguing that the amalgamation did not cancel the options.
Analysis - Paragraph 7(1)(b)
I am of the view that this part of the appeal must succeed. In my opinion the learned Tax Court Judge erred by failing to apply the word "disposition" in paragraph 7(1)(b) as defined in Reynolds v. The Queen.10 A "disposition" under paragraph 7(1)(b) refers to a transaction in which the taxpayer voluntarily agrees to exchange property rights that have accrued under an employee stock option agreement for some other consideration. Thus, a determination as to whether a disposition has occurred under this section must be confined to the specific tax meaning ascribed to paragraph 7(1)(b).
On my analysis, the Tax Court judge failed to recognize that the amalgamation of Canadian Reserve constituted a unilateral repudiation of the appellant's rights under the Option Agreement by the employer. As a result, the employee cannot be found to have later disposed of these same rights under paragraph 7(1)(b).
Recently, a different panel of this Court reaffirmed the Reynolds decision on facts very similar to those in the case before us. Writing for the Court in Bernier 11 Noël J.A. reasoned as follows:
|As was the case in Reynolds et al v. R, [. . .] this matter involves the unilateral cancellation of an option contract which gave rise to the financial compensation received by the appellant and not an assignment of rights set out in a contract. It follows that the source of the payment is not the contract but rather its unilateral repudiation. [emphasis added] |
The Tax Court Judge's application of paragraph 7(1)(b) rests on his analysis that the appellant still had the right to accept the unilateral repudiation so that the contract was not terminated until the Release was signed. With respect, and following the reasoning in Bernier, the modern view of the law is that the unilateral conduct of Canadian Reserve in repudiating the Option Agreement constituted a fundamental breach of the contract that terminated the contract as of that date, without the need for the appellant to accept the breach.12
Counsel for the Crown acknowledged the difficulty of reconciling Articles 2.02 and 10 of the Amalgamation Agreement,13 arguing that the former suggested a broad continuation of all of the optionholders' rights after the amalgamation, while the latter suggested that the options terminated and ceased to exist.
It is the duty of the Court to avoid interpretations that result in commercial absurdity.14 In my respectful opinion, in circumstances where the amalgamation process, approved by the shareholders, is structured so as ultimately to create a wholly owned subsidiary, it would be unrealistic to suggest an interpretation of the Amalgamation Agreement in which a right of specific performance survived the repudiation.
Article 2.02(a) and (d) do not speak of the continuing rights of optionholders after the amalgamation, but only of existing causes of action being unaffected, that is, causes of action in existence before the amalgamation. In this case, the rights of the optionholders arose as a result of the act of amalgamation pursuant to Article 10.03.
Article 10.02 clearly states that options to purchase will terminate on the effective date of the amalgamation and will be limited thereafter to the rights as provided in Article 10. Article 10.03 speaks only of monetary relief. In my opinion, any interpretation that would include specific performance among the rights under Article 10.03 would lead to commercial absurdity.
This interpretation is bolstered by a close reading of the release document which refers to the payment as damages arising from the unilateral termination. There is no suggestion that this release agreement was in any way a sham.
Analysis - Section 6
The Minister agues that if the payment is not a disposition of rights under the option agreement, then it is taxable as a benefit of employment under section 6. Specifically, the Minister contends that the payment was received as a benefit of employment and therefore is taxable under subsection 6(1). It is, however, well-settled law that damages for breach of a contract of employment are not taxable under section 6 of the Act. This proposition was established in The Queen v. Atkins,15 and remains good law.16 Therefore, the payment received by the taxpayer in this case does not fall within the parameters of subsection 6(1) of the Act.
The sole remaining issue is whether the payment to the taxpayer may reasonably be said to have been "in satisfaction of an obligation arising out of an agreement" made in the course of employment as contemplated by subsection 6(3).17 In my analysis, the payment in issue, made to discharge an employer from liability for breach of an option agreement, cannot reasonably be regarded as having been received in:
|i. return for entering an employment contract, or |
|ii. as remuneration for services rendered under the contract; or |
|iii. as consideration for a covenant in the contract. |
Since the payment that the taxpayer received was not made to satisfy any of the enumerated reasons set out in paragraphs (c), (d) or (e) of subsection 6(3), it is not captured by subsection 6(3). Thus no liability arises out of this provision.
In the result, I agree with the Tax Court Judge that the monies received arose only indirectly from the taxpayer's employment and the inclusion of such an amount was not contemplated by section 6.
I would allow the appeal and would refer the matter back to the Minister of National Revenue for reassessment on the basis that the $83,900 received by the Appellant from the amalgamated Canadian Reserve is not taxable under paragraph 7(1)(b), or paragraph 6(1)(a), or subsection 6(3) when read with section 5 of the Act. The appellant would be entitled to costs both here and below.
John M. Evans
1. Reported at 99 D.T.C. 242 (T.C.C.).
2. Paragraph 7(1)(b) reads as follows:
|(1) Agreement to issue shares to employees -- Subject to subsection (1.1), where a corporation has agreed to sell or issue shares of the of the capital stock of the corporation or of a corporation with which it does not deal at arm's length to an employee of the corporation with which it does not deal at arm's length, || |
(1) Sous réserve du paragraphe (1.1), lorsqu'une corporation a convenu de vendre ou d,attribuer un certain nobre d,actions de son capital-actions, ou des actions d'une corporation avec laquelle elle a un lien de dépendance, à un de ses employés ou à un employé d'une corporation avec laquelle elle a un lien de dépendance,
|(a) ... ||a) ... |
|(b) if the employee has transferred or otherwise disposed of rights under the agreement in respect of some or all of the shares to a person with whom he was dealing at arm's length, a benefit equal to the value of the consideration for the disposition shall be deemed to have been received by the employee by virtue of his employment in the taxation year in which he made the disposition. ||b) si l'employé a transféré des droits prévus par la convention, en ce qui concerne certaines ou la totalité des actions, à une personne avec qui il n'avait aucun lien de dépendance, ou en a par ailleurs disposé en faveur de cette personne, un avantage égal à la valeur de la contrepartie de la disposition, est réputé avoir été reçu par l'employé en raison de son emploi dans l'année d'imposition où il a fait la à disposition; |
3. R.S.C. 1985 , c. 1 (5th Supp.), as amended.
4.. The issues raised are as follows: Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.Error! Main Document Only.. Whether the Minister was entitled to raise as a basis for upholding the reassessment, after the expiration of the statutory assessment period, the position that the amalgamation did not cancel or terminate the appellant's option rights.
Error! Main Document Only.. Whether the Tax Court judge erred by holding that the appellant could have sought specific performance of his option after the amalgamation or in treating the time of termination of the Option Agreement as the time at which the appellant ceased to be in a position to seek specific performance.
Error! Main Document Only.. Whether the judge erred by assuming that the wording of paragraph 7 (1)(b) makes whether a payment is deemed to be a benefit from employment under that provision determined by whether the appellant retained, following the amalgamation, a theoretical right to receive shares for his option.
Error! Main Document Only.. If the appellant retained a right to specific performance as well as a right to damages, as held by the judge, a third issue arises; did the judge err in apportioning the settlement payment solely to the right of specific performance?
5.. Article 2.02(a)(d) and 10 of the Amalgamation Agreement dealt with the treatment to be afforded the resulting rights of the optionholders in the following words:
2.02 On the Effective Date of the Amalgamation:
(a) the Amalgamation of the Amalgamation Corporations and their continuance as one corporation shall become effective;
(d) an existing cause of action, claim or liability to prosecution is unaffected; 10.01 On the Effective Date of the Amalgamation each outstanding option to purchase any shares in the capital of Canadian Reserve shall terminate and cease to exist, and shall not attach to or be exercisable in respect of any shares in the capital of the Amalgamated Corporation, and there shall be paid to . . . each holder of each such outstanding option . . . an amount in cash equal to:
(a) the product of $26.00 times the number of shares in the capital of Canadian Reserve the holder of such option would have received if such option had been fully exercised (whether or not then exercisable) immediately prior to the Effective Date of the Amalgamation; less
(b) the aggregate exercise price the holder of such option would have been required to pay to Canadian Reserve if such option had been so exercised (whether or not then exercisable) immediately prior to the Effective Date of the Amalgamation.
10.02 Canadian Reserve will give notice to all holders of options to purchase shares in the capital of Canadian Reserve that, if the Amalgamation is consummated, their rights as such holders will terminate on the Effective Date of the Amalgamation and will thereafter be limited to the rights provided in this Article . . . .
10.03 Canadian Reserve shall use its best efforts (1) to enter into agreements with each holder of options to purchase shares in the capital of Canadian Reserve whereby such holders shall consent to termination of the option held and accept the amount payable therefor pursuant to this Article, in full satisfaction of their rights under such options, or (2) failing that, in consideration for payment of such amount to obtain releases from such option holders, releasing and discharging Canadian Reserve, Getty Canada and the Amalgamated Corporation from any and all such claims in respect of or relating to the termination of such options pursuant to this Article.
8.  2 S.C.R. 358.
10. 75 D.T.C. 5042 (F.C.T.D.); 75 D.T.C. 5593 (F.C.A.); 77 D.T.C. 5044 (S.C.C.).
11. Bernier v. The Queen (2000), 1 C.T.C. (F.C.A.) 347 at p. 348.
12. J.M. Thompson, "The Effect of a Repudiatory Breach" (1978) 41 Modern Law Review 138.
13. Supra at footnote 5.
14. J.H.L. Fridman, The Law of Contract in Canada (Scarborough: Thompson Canada Limited, 1999) at page 493.
15. The Queen v. Atkins, 76 D.T.C. 6258 (F.C.A.).
16. See The Queen v. Pollock, 84 D.T.C. 6370 (F.C.A.). The Court is aware that Atkins was the subject of criticism in the obiter comments of Pigeon J. in  1 S.C.R. 812">Jack Cewe Ltd v. Jorgenson,  1 S.C.R. 812, at pp. 815-16.
17. Subsection 6(3) of the Act reads as follows:
| (3) Payments by employer to employee - An amount received by one person from another ||(3) Paiements faits par l'employeurs à l'employé. Une somme d'une autre personne, |
| (a) during a period while the payee was an officer of, or in the employment of, the payer, or || (a) pendant une période alors que le bénéficiaire faisait partie des cadres du payeur ou était employé par ce dernier, ou |
| (b) on account, in lieu of payment or in satisfaction of an obligation arising out of an agreement made by the payer with the payee immediately prior to, during or immediately after a period that the payee was an officer of, or in the employment of, the payer, || (b) au titre ou en paiement intégral ou partiel d'une obligation découlant d'une entente intervenue entre le payeur et le bénéficiaire immédiatement avant, pendant or immédiatement après une période où ce bénéficiaire faisait partie des cadres du payeur ou était employé par ce dernier, |
| shall be deemed, for the purposes of section 5, to be remuneration for the payee's services rendered as an officer or during the period of employment, unless it is established that, irrespective of when the agreement, if any, under which the amount was received was made or the form or legal effect thereof, it cannot reasonably be regarded as having been received ||est réputée être, aux fins de l'article 5, une rémunération des services qui le bénéficiaire a rendus à titre de cadre ou pendant sa période d'emploi, sauf s'il est établi que, indépendamment de la date où a été conclue l'entente, si entente il y a, en vertu de laquelle cette somme a été reçue ou de la forme ou des effets juridiques de cette entente, cette somme ne peut pas raisonnablement être considérée comme ayant été reçue |
| (c) as consideration or partial consideration for accepting the office or entering into the contract of employment, || (c) à titre de contrepartie totale ou partielle de l'acceptation de la charge ou de la conclusion du contrat d'emploi, |
| (d) as remuneration or partial consideration for accepting the office or entering into the contract of employment, || (d) à titre de rémunération totale ou partielle des services rendu comme cadre ou conformément au contrat d'emploi, ou |
| (e) in consideration or partial consideration for a covenant with reference to what the officer or employee is, or is not, to do before or after the termination of the employment. || (e) à titre de contrepartie total ou partielle des services rendus comme cadre ou l'employé doit faire, ou ne doit pas faire, avant ou après la cessation de l'emploi. |