Steen v. The Queen, 86 DTC 6498, [1986] 2 CTC 394 (FCTD), aff'd 88 DTC 6171, [1988] 1 CTC 256 (FCA)

Rouleau, J.:—This is an appeal by the plaintiff against an income tax reassessment dated May 15, 1979 and confirmed on December 10, 1979 with respect to the 1976 and 1977 taxation years wherein the Minister of National Revenue added to the plaintiff’s income the amounts of $24,060 and $8,905, respectively, as deemed benefits arising out of the exercise of an employee stock option plan, all this pursuant to paragraph 7(1)(a) of the Income Tax Act (the “Act”).

The plaintiff is an employee of British Columbia Forest Products Limited (“BCFP”), a Canadian corporation whose common and preferred shares are traded on the Vancouver, Montreal and Toronto Stock Exchanges.

On December 15, 1959 the board of directors of BCFP resolved to establish a non-transferable Share Option Incentive Plan (the “Plan”) under which certain key employees of BCFP would be granted options to purchase from time to time common shares without nominal or par value of the authorized but unissued capital of the company. Each option granted was to be exercisable not less than one year, nor more than ten years, after the date on which the option was granted. Finally, the provisions of the resolution stipulated the following:

9. (c) An option may be exercised at the applicable times and in the applicable amounts by giving to the Company written notice of exercise signed by the optionee specifying the number of shares to be purchased and accompanied by full payment for the shares to be purchased in cash or by cheque certified by a Canadian chartered bank.

12. No optionee shall have any rights as a shareholder in respect of the shares covered by his option unless and until the issue of shares to him thereunder after its exercise.

By an amendment dated September 28, 1961 the board resolved that shares were to be purchased at a price not less than the last sale price for a board lot as reported on the Toronto Stock Exchange at its close on the business day next preceding the date on which the option was granted. If there had been no such sale on that date then the purchase price was to be not less than the sale price on the last date preceding the granting of the option on which such a sale was reported.

Pursuant to the Plan and by an agreement dated December 15, 1972, in consideration of $1 the plaintiff was granted an option to purchase common shares of BCFP at a price of $21.63 per share. This price was determined in accordance with the established formula. According to the agreement BCFP reserved for allotment 2700 common shares without par value of the Company's treasury stock. The option would be exercisable in installments of 270 shares per annum over the period 1973 to 1982, inclusive.

On February 23, 1973 and again for a consideration of $1 the plaintiff was granted an option to purchase 600 additional common shares at a price of $33 per share. Again, the price was determined in accordance with the Plan formula and available for allotment in installments of 60 shares per annum over the period 1974 to 1983, inclusive,

By a notice dated May 14, 1973, the plaintiff was informed that the common sahres of BCFP were split on a two for one basis effective April 19, 1973. Accordingly, he was advised that the two for one division reduced the option price per share to $10.815 and doubled the number of shares to 5,400; they could be purchased in installments of 540 shares per annum over the period 1973 to 1982 inclusive. He was also informed that, pursuant to the second agreement dated February 23, 1973, the stock split reduced the option price per share to $16.50 and increased the number of shares allocated under option to 1,200 — the shares were now purchasable in installments of 120 shares per annum over the period 1974 to 1983 inclusive.

Pursuant to the agreements the plaintiff notified the secretary of BCFP on May 3, 1976, February 10, 1977 and March 7, 1977 of his wish to exercise his options for the purchase of BCFP common shares. In compliance with the December 1959 resolution plaintiff enclosed a certified cheque with each notice covering the full payment of the shares to be purchased.

The plaintiff's exercise of the 1972 and 1973 options may be summarized as follows:

It should be noted that the last sale price of BCFP common shares on the Toronto Stock Exchange on May 3, 1976 was $24 per share. Similarly BCFP common shares were trading at $25.13 per share and $26 per share on February 10, 1977 and March 7, 1977, respectively.

On May 3, 1976, February 10, 1977 and March 7, 1977 the secretary to the Chairman of BCFP notified the Montreal, Vancouver and Toronto Stock Exchanges of plaintiff’s exercise of his options and of BCFP’s corresponding issuance of shares to the plaintiff from Treasury (Exhibit “A” Tab 17).

On May 6, 1976, February 10, 1977 and on March 7,1977 plaintiff sold the BCFP shares acquired pursuant to the exercise of the Plan agreements as follows:

Plaintiff filed his income tax returns for the years 1976 and 1977 reporting as a capital gain in each case the difference between the cost of the shares acquired and the proceeds of disposition less the expenses of disposition. Plaintiff's calculations are reproduced as follows:

However, the Minister of National Revenue (the "Minister”) determined that plaintiff's exercise of the Plan agreements fell within the parameters of paragraph 7(1 )(a) of the Act and that plaintiff was deemed to have received a benefit of $24,060 (being the difference between the market price on May 3, 1976 and the Plan cost of the 1980 shares ($47,520 - $23,460)) and $8,905 ($16,725 - $7,820) in the 1976 and 1977 taxation years, respectively.

Defendant submits that the Minister properly applied paragraph 7(1 )(a) of the Act to the case at bar. The defendant's position is that the paragraph applies where an employee acquires shares pursuant to a share option incentive plan at a price substantially less than the fair market value of those shares at the time of their acquisition. Defendant contends that plaintiff acquired the shares when the stock was trading at a fixed price and thus had a fair market value substantially higher than the cost incurred by the plaintiff.

Plaintiff submits that the exercise of the Plan agreements did not create a taxable benefit within the meaning of paragraph 7(1 )(a) of the Act.

Initially, he argued that the Minister erred in using the Toronto Stock Exchange trading quotations on the dates of acquisition in order to fix the value of the BCFP shares in determining whether plaintiff had received a benefit within the meaning of paragraph 7(1)(a) of the Act. He submits that nothing in section 7 of the Act requires that the value of the shares acquired be assessed at market value or fair market value.

Plaintiff contends that, pursuant to Part 3 of the Articles of BCFP and paragraph 41 (2)(a) of the British Columbia Companies Act,* [1] (R.S.B.C. 1979,

c. 59), the price per share of BCFP common was determinable by the board of directors in their absolute discretion. The price set by the board and paid by the plaintiff was, in the circumstances of this particular case, equal to the value of the shares at the time that they were acquired; that the predetermined price paid for these shares was equal to their value and paragraph 7(1)(a) was rendered inapplicable.

In making this submission plaintiff states that, at the time of their acquisition, the BCFP shares existed in Treasury and were not part of the trading block of shares in the company; plaintiff was the only person who could acquire these particular shares.

Plaintiff also contends that the facts in the case at bar are consistent with administrative practice as set forth in paragraph 1 of Interpretation Bulletin IT-113.Î [2] According to this provision of the Bulletin, paragraph 7(1 )(a) of the Act is triggered when an “employee is entitled to acquire shares . . . at less than fair market value”; at the time the plaintiff became entitled to acquire the shares under the Plan agreements they were not less than fair market value and therefore fell outside the charging provisions of paragraph 7(1 )(a) of the Act.

The issue to be decided in this case is whether plaintiff received a benefit within the meaning of paragraph 7(1)(a) of the Act when he exercised his option to purchase treasury stock of a "public” company in a taxation year in which the market price for those shares was substantially higher than the option price, notwithstanding the fact that the board of directors of the company had set the option price in reference to fair market value at the time the option was granted.

The resolution of this issue will depend upon a determination as to when the benefit arose; that is, on what date were the shares "acquired” as that term is contemplated by paragraph 7(1 )(a) of the Act. The two alternatives in this case are the dates on which the plaintiff was granted the options to purchase BCFP shares and the dates on which the plaintiff exercised his options for the purchase of the BCFP common shares. In addition, a determination must be made as to the value of these shares at the time they were acquired. This will depend upon the interpretation accorded to the word “value” as it appears in paragraph 7(1)(a) of the Act.

Prior to the March 31, 1977 amendments to the Act, the English and French texts of paragraph 7(1)(a) read as follows:

7. (1) Where a corporation has agreed to sell or issue shares 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 or of a corporation with which it does not deal at arm's length,

(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;

7. (1) Lorsqu'une corporation a convenu de vendre ou d’attribuer un certain nombre 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) si l'employé a acquis des actions en vertu de la convention, un avantage, égal à la fraction de la valeur des actions qui, au moment où il les a acquises, était en sus de la somme qu’il a payée ou devra payer pour es actions à la corporation, est réputé avoir été reçu par l'employé en raison de son emploi dans l’année d'imposition où il a acquis les actions;

Thus, when a corporation with whom an individual is employed has agreed to issue shares of its capital stock to that employee, paragraph 7(1 )(a) will deem that employee as having received a benefit, if any, in the taxation year in which he acquired the corporation's shares. In fact the phrase "a benefit equal to the amount by which the value of the shares at the time he acquired them” and, more explicitly, its French counterpart “un avantage, égal à la fraction de la valeur des actions qui, au moment où il les a acquises" convey the direction that the benefit is to be assessed at that instance in time in which the shares are acquired. Contrary to plaintiff’s analysis of paragraph 1 of IT-113, the triggering event in paragraph 7(1 )(a) of the Act is the acquisition of shares at a price less than their value as determined as of the date of their acquisition.

The meaning of the word “acquired” in paragraph 7(1)(a) of the Act has been the subject of judicial comment. In the case of Anderson et al. v. The Queen, [1975] C.T.C. 85; 75 D.T.C. 5042 (F.C.T.D.), Mr. Justice Gibson, in obiter, commented on those situations that would trigger the operation of section 85A of the I.T.A. (section 7 of the I.T.A., S.C. 1970-71-72 c. 63, as amended). He noted the following (at 87 (D.T.C. 5044)):

Section 85A of the Income Tax Act deals specifically with benefits to employees of a company who acquire options, contracts or other agreements to purchase shares or to have issued to them shares of companies. Paragraph 85A(1)(a) [7(1)(a)] refers to the situation where the employee has exercised his option to purchase shares from a corporation. Paragraphs 85A(1)(b), (c) or (d) refer to situations where the employee transfers or otherwise disposes of his option to purchase shares to a third person or persons who subsequently acquires such employee's rights under a contract option. [Emphasis added. ]

Thus it would appear that according to Gibson, J. an employee acquires shares pursuant to a stock option agreement at the time he exercises his option to purchase shares from his corporate employer.

A similar conclusion was reached by Cardin, T.C.J. in Gesser Estate v. M.N.R., [1984] C.T.C. 2751; 84 D.T.C. 1570 (T.C.C.). In that case, the taxpayer's estate unsuccessfully argued that the taxpayer had acquired shares under an agreement of purchase and sale in 1970 within the meaning of Articles 1025, 1026, 1027 and 1472 of the Quebec Civil Code. The Court held that as the taxpayer was not obligated under the agreement of purchase and sale to pay for any shares, the agreement was in substance a stock option. Further, the Court held that the taxpayer did not acquire and become the legal owner of the shares offered under the 1970 stock option agreement until that option was exercised in 1972.

The relationship between acquisition of shares and the establishment of legal title in and to those shares was examined in Grant v. The Queen, [1974] C.T.C. 332; 74 D.T.C. 6252 (F.C.T.D.). In that case plaintiff, pursuant to a share option purchase plan, purchased on credit on July 25,1968 shares of his corporate employer at their then market value. Plaintiff repaid the debt one year later when the market price of the shares had doubled. It was only at that point that the plaintiff’s share certificates were issued. Mr. Justice Bastin held that the plaintiff had acquired shares in the corporation on July 25, 1968. In reaching this conclusion, Bastin, J. reasoned that the plaintiff's subscription for the shares on that date, and the board of directors' acceptance of that subscription on that same date, as evidenced by its confirmation of the share option plan, constituted a binding enforceable agreement for the sale of the shares in question.

Thus the key factor that Mr. Justice Bastin considered in ascertaining the date of acquisition was not the date on which the shares were fully paid nor the date on which the share certificates were issued but the date on which the taxpayer established a binding proprietary right in the legal ownership of the shares.

Similarly in Van Wielingen v. M.N.R., [1976] C.T.C. 2238; 76 D.T.C. 1182 (T.R.B.) taxpayer was given an option in January 1970 pursuant to a shareholder resolution dated December 30, 1969 to subscribe for shares of a company at the then fair market value. Notwithstanding the fact that the plaintiff subscribed for the shares on January 1, 1970, he did not pay the purchase price until December 31, 1970 when the fair market value of the shares had appreciated considerably. A key provision of the December 1969 resolution was that shares would be issued only when they became fully paid and that only upon such issuance would the subscriber have any rights of a shareholder in respect of those shares. Mr. Taylor, C.A., held on the basis of the particular provision that, as the taxpayer did not have any rights as a shareholder in the subscribed shares until December 31, 1970, he acquired those shares only at that date.

In conclusion, after an examination of the scheme of paragraph 7(1)(a) of the Act and of the relevant jurisprudence, I am satisfied that a taxpayer is deemed to have received a benefit, if any, at the moment he obtains legal ownership or the incidence of legal ownership in and to the shares subscribed.

Applying this principle to these facts it is clear that plaintiff acquired shares of BCFP on May 3, 1976, February 10, 1977 and March 7, 1977. The available evidence indicates: (i) that the shares obtained were fully paid on those dates; (ii) that the shares purchased were issued on those dates; and (iii) that, pursuant to the terms of the December 1959 resolution, the plaintiff on those dates acquired rights as a shareholder in respect of the purchased shares upon the exercise of the option.

Although I have briefly reviewed the legal principles which have developed from judicial consideration of when shares are actually deemed to have been acquired pursuant to paragraph 7(1 )(a) of the Act, I also wish to note that counsel for the plaintiff conceded in the course of the hearing before me that the shares were acquired at the time the plaintiff exercised his option to purchase them. The plaintiff's principal argument is that at the time the plaintiff exercised his option to purchase, the shares existed in the treasury of the company and the directors of the company had set a price for them. It is the plaintiff’s position that it is that price, rather than the fair market value of the shares which represents the “value" of the shares.

Paragraph 7(1 )(a) of the Act provides a formula for the calculation of the deemed benefit arising from the acquisition of shares pursuant to the exercise of a share option purchase plan. For convenience, that formula reads as follows:

. . . 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 .. .

The problem which has most often arisen in relation to this legislative provision involves the interpretation of the word “value’’. As a general rule, the value of listed securities has generally been held to be the stock market price of the day. This is because “value" as it is used in paragraph 7(1)(a) is normally considered to import the concept of fair market value — that which a willing buyer would pay a willing seller in an open market.

The plaintiff argued before me that because the word “value” is used in paragraph 7(1 )(a) rather than the term “fair market value”, which is used in several other provisions of the Act, some difference in meaning was intended by the legislators. However, for most purposes concerning provisions of the Act the term value has been held to mean “market value” or “fair market value”. In Untermyer Estate v. A.G. for British Columbia, [1929] S.C.R. 84 the issue before the Court was the value to be attributed to certain shares held by the appellant at the time of his death for succession duty purposes. Speaking for the Court, Mignault, J. stated at 91:

We were favoured by counsel with several suggested definitions of the words “fair market value”. The dominant word here is evidently “value”, in determining which the price that can be secured on the market — if there be a market for the property (and there is a market for shares listed on the stock exchange) — is the best guide. It may, perhaps, be open to question whether the expression “fair” adds anything to the meaning of the words “market value”, except possibly to this extent that the market price must have some consistency and not be the effect of a transient boom or a sudden panic on the market. The value with which we are concerned here is the value at Untermyer’s death, that is to say, the then value of every advantage which is properly possessed, for these advantages, as they stood, would naturally have an effect on the market price. Many factors undoubtedly influence the market price of shares in financial or commercial companies, not the least potent of which is what may be called the investment value created by the fact — or the prospect as it then exists — of large returns by way of dividends, and the likelihood of their continuance or increase, or again by the feeling of security induced by the financial strength or the prudent management of a company. The sum of all these advantages controls the market price, which, if it be not spasmotic or ephemeral, is the best test of the fair market value of property of this description.

I therefore think that the market price, in a case like that under consideration, where it is shown to have been consistent, determines the fair market value of the shares. [Emphasis added.]

In Montreal Island Power Company v. The Town of Laval Des Rapides, [1935] S.C.R. 304, in analyzing the propriety of an assessment of the actual value of a parcel of submerged land for taxation purposes, Duff, C.J.C. noted the following at 305:

[. . .] The meaning of “actual value,” when used in a legal instrument, subject, of course, to any controlling context, is indicated by the following passage from the judgment of Lord MacLaren in Lord Advocate v. Earl of Home (1891) 28 Sc. L.R. 289, at 293:

Now, the word “value” may have different meanings, like many other words in common use, according as it is used in pure literature, or in a business communication or in conversation. But I think that “value” when it occurs in a contract has a perfectly definite and known meaning unless there be something in the contract itself to suggest a meaning different from the ordinary meaning. It means exchangeable value — the price which the subject will bring when exposed to the test of competition.

When used for the purpose of defining the valuation of property for taxation purposes, the courts have, in this country, and, generally speaking, on this continent, accepted this view of the term “value.” [Emphasis added.]

In Busby v. The Queen, [1986] 1 C.T.C. 147; 86 D.T.C. 6018 (F.C.T.D.), Mr. Justice McNair, in commenting in obiter on paragraph 7(1)(a) and subsection 7(5) of the Act (the latter being a provision which limits the applicability of paragraph 7(1 )(a) to situations where the benefit is conferred by virtue of the employment), made the following observation at 151 (D.T.C. 6020):

In my opinion, the purpose of these provisions is to tax as income any benefit derived by an employee by virtue of a stock option plan or similar agreement that enables the employee to purchase or acquire shares of an employer corporation or of a corporation with which it does not deal at arm's length at a price less than the market value of the shares, whereby the difference between that and the amount paid therefor is deemed to have been received as income; provided that it was received in respect of, in the course of, or by virtue of the employment. If the benefit is attributable to something other than employment then it is not taxable under this section. [Emphasis added.]

Similar comment as to the meaning of the word “value” within the context of paragraph 7(1)(a) of the Act has been advanced by several income taxation authorities (see generally Ward, D.A., ed., Ward's Tax Law and Planning Vol. 1, 1983 pp. 3-54 et seq.; Stikeman, H.H., ed., Canada Tax Service Vol. 1, pp. 7-11 to 7-27).

Given that a taxpayer is deemed to have received a benefit, equal to the difference between the fair market value of shares at that point in time when he acquires legal ownership in those shares and the price paid, I am of the opinion that plaintiff’s argument must fail.

The uncontradicted evidence of Mr. Aldridge, C.G.S., C.B.V., as to the fair market value of BCFP common shares on the Toronto Stock Exchange as of May 3, 1976, February 10, 1977 and March 7, 1977, was that such shares traded at the price of $24 per share, $25.13 per share and $26 per share. That such price quotations are a reflection of the fair market value of those shares is supported by the observations of Mr. Justice Ryan in Henderson Estate v. M.N.R., [1975] C.T.C. 485; 75 D.T.C. 5332 (F.C.A.) wherein he noted (at 492 (D.T.C. 5337)) the following:

[. . .] Given a consistent market in the sense of a market that is not “the effect of a transient boom or a sudden panic" or that is “not spasmodic or ephemeral", to adopt the terms used by Mignault, J. in the Untermyer case, the stock market is the best evidence of fair market value.

Indeed the plaintiff sold these shares on the market on May 6, 1976, February 10, 1977 and March 7, 1977 at substantially the same prices.

Furthermore there is no clog on the disposal of plaintiff's shares that would justify a discount from the market price quotation nor is it necessary to take into account plaintiff's minority position in BCFP in view of the fact that stock market prices of shares in a company listed on a public stock exchange, widely distributed and regularly traded in, as is the case at bar, will reflect a minority discount given that the stock exchange is a market of minority interest (Re Domglas Inc.; Domglas Inc. v. Jarislowsky, [1980] C.S. 925 (Que.); aff'd 138 D.L.R. (3d) 521).

In conclusion, therefore, there is no evidence to warrant a variation in the Minister’s assessment. Accordingly, the plaintiff's appeal is dismissed with costs.

Appeal dismissed.