Hurd v. The Queen, 81 DTC 5140, [1981] CTC 209 (FCA)

Urie, J:—I have had the advantage of reading the reasons for judgment of Mr Justice Ryan. While I find them persuasive, after the most careful consideration I have concluded, with regret, that I am unable to agree with them and, consequently, with his proposed disposition of the appeal.

There is no necessity for me to repeat the factual background leading to the appeal or the applicable provisions of the Income Tax Act, all of which have been fully canvassed by Mr Justice Ryan. Suffice it to say that I agree with him when he points out that the critical question is whether the benefit the appellant received by exercising his option in 1973 was a benefit from the duties of his employment with the Company performed by him in Canada before he left this country in 1971. I also agree with him and with the learned trial judge that performance of the duties of the employment in Canada during the taxation year in which the benefit sought to be taxed is received is not essential. To suggest otherwise is to ignore the plain wording of subsection 2(3) which provides, in part, that where a person not resident in Canada “was employed in Canada . . . at any time in the year or a previous year, an income tax shall be paid upon his taxable income earned in Canada. . .(Italics added.)

At that point regard must be had to subparagraph 115(1)(a)(i)*, [1] conceded to be the only applicable provision in the circumstances of ths case. Coun- sel for each of the parties agreed that for the assessment to be upheld on the basis of this paragraph alone it would have to be established that the gain derived by the appellant from exercising his stock option arose from the duties of offices and employments in Canada. Counsel also agreed that only if subsections 6(1), 7(1 )(a) and 7(4) are applicable would the appellant be caught in the taxation net cast by subparagraph 115(1)(a)(i).

Appellant’s counsel contended, of course, that nothing in those provisions had the effect of deeming the appellant to have performed duties of an office or employment in Canada in 1973. I do not agree.

Subsection 7(1) applies to the situation where a corporation has agreed to sell or issue shares to one of its employees. If the employee chooses at some later date to acquire the shares, as the appellant did in the case at bar, any resulting benefit by virtue of paragraph (a) shall be deemed to have been received in the year of acquisition “. . . by the employee by virtue of his employment”. That employment in this case must refer to the employment in which the appellant was engaged at the time the option was granted to him in 1967.

Subsection 7(4) covers the situation where a person to whom subsection (1) would apply has ceased to be an employee of the company which entered into the agreement. The subsection says that subsection (1) shall continue to apply “as though the person were still an employee and as though the employment were still in existence--. Thus, if the appellant was granted the option to purchase by virtue of his employment then, in my opinion, he clearly falls within the ambit of subsections 7(1) and (4). That is so because subsection (1) deems the gain made on the acquisition of his shares to have been received in the taxation year in which he acquired the shares and subsection (4) says that this continues to be so notwithstanding that he no longer is an employee of the company which granted the option because subsection 1 continues to apply as though the employment continued. Since subparagraph 115(1)(a)(i) specifically refers to section 3, which is a part of Division B relating to the computation of income of a taxpayer for a taxation year and since section 7 is part of subdivision a of Division B, it is clear to me that for purposes of subparagraph 115(1 )(a)(i) regard must be had to section 7 in the computation of income of a non-resident. It seems, then, that the sole question requiring resolution is whether the benefit received was a benefit arising from the duties of his employment with the company performed by him in Canada before he left this country in 1971.

To determine this question regard must be had to the option agreement and the circumstances which led to its execution. In that respect, it should be noted that the first recital in the agreement dated as of October 4, 1967, between the appellant and his then employer, The British American Oil Company Limited, states that the Company had established “an Incentive

(a) he had no income other than

(i) incomes from the duties of offices and employments performed by him in Canada,

minus the aggregate of such of the deductions from income permitted for the purpose of computing taxable income as may reasonably be considered wholly applicable and of such part of any other of the said deductions as may reasonably be considered applicable.

Stock Option Plan under which certain officers and employees of the Company . . . may be granted options to purchase common shares ... of the Company.” A second recital refers to the approval by the executive committee of the board of directors of the Company of an option to the appellant on the terms set forth in the agreement. The relevant terms of the agreement, for purposes of this appeal, were referred to in the reasons for judgment of my brother Ryan, J so that it is unnecessary for me to repeat them.

The crucial matters, then, to be noted are:

(a) that the appellant at the time that the option was granted was an employee of the Company;

(b) that it is apparent the incentive stock option plan was, as the name implies, set up to provide, inter alia, incentives for employees to continue in the employ of the Company;

(c) that the appellant would not have been granted the option had he not been an employee of the Company in Canada at the time the agreement was entered into; and

(d) that he satisfied one of the conditions imposed by the agreement by remaining in the Company’s employ continuously for more than one year after the date of the agreement.

Bearing all those factors in mind it is abundantly clear to me that the grant of the option arose only because of the appellant’s employment with the Company. It is equally clear that if he had been a Canadian resident when he acquired the shares the benefit derived therefrom would have been taxable in his hands in the year of acquisition by virtue of subsection 7(1), paragraph (a). Moreover, in such a case the benefit would still have been taxable in his hands even if he had left the employ of the Company as a result of the operation of subsection 7(4) because it continues the application of subsection 7(1) as though the appellant were still an employee and as though the employment were still in existence.

I have earlier pointed out that for the reasons there given, I agree with the learned trial judge that performance of the duties of the employment in Canada during the taxation year in which the benefit sought to be taxed is received is not essential. Therefore, I must conclude that the fact that the appellant was not a resident of Canada in 1973 when he acquired the shares does not differentiate his position from that of a resident of Canada who acquired the shares in similar circumstances. For this reason I am of the opinion that the appellant must fail on this branch of his appeal.

Appellant’s second argument was based on his contention that even if his gain on the acquisition of the shares was taxable, only a part thereof fell into that category. As has been pointed out by Mr Justice Ryan, appellant in his 1973 tax return reported as income the sum of $43,606.13 resulting from his exercise of the stock option. The method used by the appellant in calculating this amount was also correctly stated by him. According to appellant’s counsel, the appellant was entitled to calculate his taxable income in his return in this fashion by virtue of the combined effect of subparagraph 115(1)(a)(v)*, [2] and paragraphs 115(2)(c) and (e)(i)f of the Act. In my opinion, subparagraph 115(1)(a)(v) has no application to the appellant because he does not fall within the class of person envisaged by subsection 115(2). Paragraph 115(2)(c), when read together with subparagraph 115(2)(e)(i), indicates to me that the appellant was not covered thereby because he was not in receipt of remuneration from an office or employment in 1973 as that term is understood given its ordinary meaning. To whomever those subsections have application they do not apply to a person in the position of the appellant. The benefit which he received is not remuneration of the kind envisaged by those paragraphs. Moreover, those two subparagraphs are not applicable to the 1973 taxation year except for the sole purpose of applying section 114.1 of the Act in respect of individuals who ceased to be residents in Canada after February 19, 1973. (See: SC 1973-74, c 14, subsection 37(6)). If it is alleged that resort should be had to paragraph 115(2)(c), as it read in 1972, it does not assist the appellant because that paragraph applies only to “an individual on leave of absence from an office or employment in Canada”. The appellant clearly did not fall into that category.

Appellant’s final submission was that if the benefit was found to be properly included in his 1973 taxable income it is exempt from such inclusion by virtue of Article VIII of the Canada-United States Tax Convention which reads as follows:

Article VIII

Gains derived in one of the contracting States from the sale or exchange of capital assets by a resident or a corporation or other entity of the other contracting State shall be exempt from taxation in the former State, provided such resident or corporation or other entity had no permanent establishment in the former State.

The learned trial judge dealt with this submission in the following manner:

Plaintiff submits that the purchase of shares exercised under the option was “an exchange of capital assets”. He claims that at common law the stock option agree-

(a) he had no income other than

(v) in the case of a non-resident person described in subsection (2), the aggregate determined under paragraph (2)(e) in respect of him.

t115(2)(c) and (e)(i)

(2) Where in a taxation year, a non-resident person was

(c) an individual who had, in any previous year, ceased to be resident in Canada and who was, in the taxation year, in receipt of remuneration in respect of an office or employment that was paid to him directly or indirectly by a person resident in Canada,

the following rules apply:

(e) for the purposes of subparagraph (1)(a)(v), the aggregate determined under this paragraph in respect of the non-resident person is the aggregate of

(i) any remuneration in respect of an office or employment that was paid to him directly or indirectly by a person resident in Canada and was received by the non-resident person in the year, except to the extent that such remuneration is attributable to the duties of an office or employment performed by him in a country other than Canada and

(A) is subject to an income or profits tax imposed by the government of that country, or

(B) is paid in respect of a business carried on in that country by the payer or a foreign affiliate of the payer.

ment was a capital asset which he exchanged in 1973 for shares in Gulf Canada Limited.

That submission is not valid. Plaintiff’s transaction was neither a sale nor an exchange of capital assets. He acquired shares at a price previously set under an option and thus benefited from their increased value, a benefit taxable under the Act as having been made by virtue of his employment in Canada. The mere fact that he only exercised his option after he had left Canada does not transform the taxable benefit into something else.

I agree with that conclusion so that this ground of attack also fails.

For all of the foregoing reasons, I would dismiss the appeal with costs.

Kerr, D J:—I agree.

Ryan, J: [Dissenting]:—This is an appeal from a judgment of the Trial Division, dated October 18, 1979, which dismissed an appeal from a decision of the Tax Review Board confirming an assessment by the Minister of National Revenue which included the sum of $77,812.50 in the appellant’s income for his 1973 taxation year.

The issue in this appeal is whether the appellant, a non-resident of Canada during the taxation year in question, was taxable on a benefit received by means of the exercise by him in that year of a stock option he had received from his employer in a previous year while he was residing and working in Canada. The answer depends on the interpretation of certain provisions of the Income Tax Act* [1] relating to the taxation of non-residents.

A non-resident is subject to income tax in the circumstances specified in subsection 2(3) of the Income Tax Act. Paragraph (a) is the relevant paragraph. It reads:

(3) Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada,

at any time in the year or a previous year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

The income tax imposed on a non-resident who falls within paragraph 2(3)(a) is a tax imposed under Part I of the Act. The tax is imposed on a non-resident who performs or has performed in Canada the duties of an office or employmentt [2] and receives income for his performance. The paragraph, as I understand it, does not purport to tax a non-resident on a benefit received merely by virtue of his employments [3] in Canada, that is to say, merely by virtue of his occupying or having occupied a position in Canada in the service of another. And the tax to be imposed is, and is only a tax

. upon his taxable income earned in Canada for the year determined in accordance with Division D”.

In this case, the relevant provision of Division D is subparagraph 115(1 )(a)(i), which reads:

115. (1) For the purposes of this Act, a non-resident person’s taxable income earned in Canada for a taxation year is the amount of his income for the year that would be determined under section 3 if

(a) he had no income other than

(i) incomes from the duties of offices and employments performed by him in Canada,

minus the aggregate of such of the deductions from income permitted for the purpose of computing taxable income as may reasonably be considered wholly applicable and of such part of any other of the said deductions as may reasonably be considered applicable.

The precise question in this appeal is then whether the benefit which the appellant received in 1973 by exercising his stock option was income from the duties of his employment performed by him in Canada. If so, in respect of it, his taxable income earned in Canada for the 1973 taxation year would be the amount of his income for the 1973 year that would be determined under section 3 of the Act minus permissible deductions. If his benefit from the exercise of the stock option was not income from the duties of his employment performed by him in Canada, then, as a non-resident, he would not be taxable.

The facts were set out in an agreed statement of facts. I will summarize those which appear particularly relevant.

The appellant was a resident of Canada from September 1965 to March 31, 1971. Since April 1, 1971, he has been resident in the United States. He has always been a citizen of the United States.

From September 1965 to March 31, 1971, the appellant was an employee of the British American Oil Company Limited (“the Company”). Ther terms of his employment do not appear in the statement of facts.

An option agreement was entered into between the Company and the appellant. It was dated as of October 4, 1967. The agreement recites that the Company had established an “Incentive Stock Option Plan” under which certain officers and employees of the Company and its subsidiary and affiliated companies might be granted options to purchase common shares of the capital stock of the Company. It also recites that the executive committee of the board had approved the granting to the optionee (the appellant) of the option set out in the agreement. The option was granted “. . . in consideration of the optionee fulfilling the conditions . . .” set forth in the agreement. The option was “. . . an option to purchase 2,500 common shares of the capital stock of the Company upon the following terms and conditions . ..” Following are the first four of eleven terms and conditions:

1. The purchase price per share payable in full by the optionee to the Company at the time of the exercise of the option is $37%.

2. Except as provided in paragraphs 5 and 6 this option shall only become exercisable by the optionee after one year’s continuous employment immediately follow- ing the date hereof either with the Company or with a subsidiary or affiliated company or consecutively with any two or more of them.f [4]

3. The transfer of the optionee between the Company and a subsidiary or affiliated company or between any two or more of them shall not void this option which shall continue in good standing subject to the other provisions hereof.

4. This option shall be exercisable by the optionee, except as herein otherwise provided, in whole at any time or in part from time to time within ten years after the date hereof, but not thereafter.

The option was not assignable. And clause 10 of the agreement gave the Company power to rescind the option if the optionee were to engage in any activity in competition with or otherwise prejudicial to the Company or to a subsidiary or affiliated company. Immediately above the signatures of the parties, the option agreement stated: “IN WITNESS WHEREOF the company has hereunto affixed its corporate seal attested by the hands of its duly authorized officers and the optioneee has hereunto set his hand and seal.” The option, executed under seal, was not revocable by the Company during the term of the agreement so long at least as the appellant observed the conditions.

Clause 9 of the agreement provided in part that if the capital stock of the Company were subdivided into a greater number of shares, the number of shares the optionee was entitled to purchase should be increased proportionately and the purchase price adjusted accordingly. Before the exercise of the option by the appellant, each of the common shares of the Company had been split into two shares so that the appellant had become entitled to buy 5,000 shares at $18.69 per share.

On or about April 1, 1971, the appellant moved to the United States. He commenced to be employed by Gulf Oil Exploration, which was an “affiliated company” within the meaning of the option agreement. The agreed statement of facts states: “The plaintiff [the appellant] in fact performed no duties of employment in Canada after March 31, 1971”. It does not, in terms, assert that he in fact performed duties of employment in Canada before that date, but that is a reasonable implication and, I take it, is not contested. And paragraph 9 of the agreed statement does, as noted below, refer to the period during which the appellant was employed in Canada.

On September 26, 1973, the appellant exercised his option under the agreement. He purchased 5,000 common shares in the Company at a price of $18.69 Per share and at a total price of $93,467.50. The amount by which the value on September 26, 1973 of the 5,000 common shares exceeded the price paid by the appellant was $77,812.50.

The appellant filed a Canadian income tax return for 1973. He reported as income from his employment in Canada, resulting from his exercise of the stock option, the sum of $43,606.13. This sum was computed by him, according to the agreed statement of facts, by apportioning the $77,812.50 according to a fraction: the numerator of the fraction was the number of days between the date on which the option was granted and the date the option was exercised, during which the appellant “was employed in Canada”; and the denominator was the total number of days between the two dates. The details of the calculations appear in paragraph 9 of the agreed statement of facts.

In the circumstances of this case, it may not be necessary to decide whether the appellant would have any right to apportionment. That question will arise only if it is decided that the amount sought to be taxed is taxable in whole or in part.

By notice of assessment dated July 3, 1974, the Minister included the full amount of $77,812.50 In the appellant’s income for the taxation year. The appellant filed a notice of objection, but the assessment was confirmed. On March 20, 1978, the Tax Review Board dismissed the appellant’s appeal to it.

It was submitted to us, and I understand it was argued below, that before either subparagraph 115(1)(a)(i) or paragraph 2(3)(a) of the Income Tax Act could become operative, it was necessary that the taxpayer should have performed the duties of his employment in Canada during the taxation year in which the income sought to be taxed was received.

The learned trial judge was of the view that performance of duties of the employment in Canada during the taxation year in which the benefit sought to be taxed is received is not essential. He said that subsection 2(3) of the Act applies to a non-resident who was employed in Canada at any time in the taxation year . . or a previous year”.

I agree. The income of an employee is taxable only when received, and is taxable in and for the year of its receipt. As I read subsection 2(3), a nonresident who receives income in return for duties of his employment performed in Canada is taxable in the year of receipt whether the duties were performed in the taxation year or in a previous year.

The trial judge found that the appellant was taxable on the benefit he received in 1973 by exercising his stock option. He made this finding on the basis of section 7 of the Income Tax Act.

Section 6 of the Act provides in part:

6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:

(a) the value of board, lodging and other benefits of any kind whatever . . . received or enjoyed by him in the year in respect of, in the course of or by virtue of an office or employment;

Section 7, paragraph (1)(a) and subsections (3) and (4) provide in part:

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

(a) if the employee has acquired shares under the agreement, a benefit equal to the amount by which the value of the shares at the time he acquired them exceeds the amount paid or to be paid to the corporation therefor by him shall

be deemed to have been received by the employee by virtue of his employment in the taxation year in which he acquired the shares;

(3) Where a corporation has agreed to sell or issue shares of the capital stock of the corporation . . . to an employee of the corporation . . .,

(a) no benefit shall be deemed to have been received or enjoyed by the employee under or by virtue of the agreement for the purpose of this Part except as provided by this section;

(4) 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.

I agree that the appellant would be taxable if section 7 applied to him. The benefit he received by exercising the option would be deemed to have been received by him by virtue of his employment in the taxation year in which he acquired the shares. Any problem that might have been presented by his having ceased to be an employee of the Company would be resolved by subsection 7(4), by virtue of which subsection (1) would continue to apply to him as though he were still an employee and as though his employment were still in existence. I take it that “employment” here would refer to his employment with the Company; and “employment”, as used in the subsection, should, of course, be interpreted in the light of the definition of “employment” in subsection 248(1) of the Act. This would mean (and would mean no more than) that subsection (1) would continue to apply as though he were still in the service of the Company. I would observe that, contrary to a submission by counsel for the respondent, I would not interpret subsection 7(4) as having the effect of deeming that the appellant performed any of the duties of his employment in Canada in 1973. It is significant, having in mind the definition of “employed” in subsection 248(1), that subsection 7(4) uses the words “as though the employment were still in existence” and not the words “as though he were still employed”.

My problem with section 7 is in getting through to it. Subparagraph 115(1)(a)(i), when considered together with paragraph 2(3)(a), has the effect, as I read it, of providing that the appellant’s taxable income, earned in Canada, for his 1973 taxation year was the amount of his income for the year that would be determined under section 3 of the Act if, but only if, he had no income other than income from the duties of his employment performed in Canada in 1973 or in a previous year. The critical question thus becomes whether the benefit the appellant received by exercising his option in 1973 was a benefit for duties of his employment with the Company performed by him in Canada before he left Canada in 1971*. [5]

Obviously the benefit sought to be taxed is not the option agreement made between the appellant and the Company in 1967. The benefit is the difference between the value of the shares when acquired and the price paid for them. Was this a benefit from the duties of the appellant’s employment performed by him in Canada?

The benefit was received as a consequence of the purchase of the Company’s shares at a favourable price. The shares were purchased by the appellant by exercising the option provided by the option agreement. The option itself consisted in a power vested in the appellant to accept the Company’s standing offer to sell shares at the price stipulated in the agreement. It was this power that was exercised in 1973.

The benefit sought to be taxed was thus a benefit received by the appellant by virtue of his exercise of a right that had matured earlier: it became exercisable on completion of the one-year period of employment specified in clause 2 of the option agreement. The benefit received cannot, in my opinion, property be described as a benefit received in return for the performance in Canada of the duties of the appellant’s employment in Canada. I find some support for this conclusion in a passage from the speech of Lord Radcliffe in Abbott v Philbin, [1961] AC 352. That was a case in which an employee who had obtained a stock option in 1954 exercised it in 1956; the option was not transferable and was to last for ten years if the optionee remained in his employer’s service for that period [6] t. The passage I wish to quote appears at 379:

The claim to tax the advantage obtained in the year 1955-56 is not claimed by the Revenue if the right view is that the option itself was taxable in 1954-55. Even if there were no taxable subject in the earlier years I should regard the 1955-56 claim as failing on its own terms. The advantage which arose by the exercise of the option, say £166, was not a prerequisite or profit from the office during the year of assessment: it was an advantage which accrued to the appellant as the holder of a legal right which he had obtained in an earlier year, and which he exercised as option holder against the company. . . .

If section 7 of the Act applied, the deeming provisions of the section would, of course, have cleared the way to taxing the appellant’s benefit realized from exercise of the option. But, because of the wording of subparagraph 115(1 )(a)(i) of the Act, it does not in my opinion apply to the appellant, a non-resident, in the circumstances of this case.

I would allow the appeal with costs here and below and I would vacate the Minister’s assessment for the 1973 taxation year.