Rip T.C.J.:
The appellant Owen Ward appeals an assessment from income tax for 1994 on the basis that no amount ought to be included in his income from employment pursuant to subsection 5(1) or paragraph 7(1 )(Z?) of the Income Tax Act (“Act”) due to his acquisition of shares of Biorem Technologies Inc. (“Biorem”). He claims that he was an employee of Biorem at time of acquisition and at all relevant times he dealt at arm’s length with Biorem. Accordingly, it is only in the year he disposes of the shares that any amount ought to be included in his income: subsection 7(1.1). The Minister of National Revenue (“Minister”) assessed Professor Ward pursuant to subsection 5(1) of the Act on the basis that in 1994 he received shares of Biorem having a value of $50,000 for no consideration.
The appellant acted on his own behalf at trial.
At all relevant times, including the hearing of this appeal, Owen Ward was employed by the University of Waterloo as a research professor of microbiology. His research included developing microbiology processes and in 1990 Biorem was incorporated to continue the development of a process, originally started at the University, to clean up contaminated soil. Biorem and the University agreed that Biorem would “approach” the University to negotiate research contracts to do investigative or experimental research in the area of biodegradation of organic toxic components and Biorem would contract the services of Professor Ward to do the work.
Canadian Venture Funds Management Ltd. (“Venture”), a venture capital corporation, initially owned 70% of the shares of Biorem, the University of Waterloo owned 5% of the shares and the appellant owned 25% of the shares.
The appellant was director of Biorem and its Vice-President of Research and Technology. Professor Ward was also engaged by Biorem as a consultant for which he received fees. He received no remuneration or stipend as director.
In 1994 Biorem was a Canadian-controlled private corporation, as defined in subsection 248(1) of the Act.
Biorem started small, said Professor Ward, and carried on some commercial activity in 1994. Professor Ward said he was paid when the company could afford to pay him. In the early years Professor Ward was paid $2,600 monthly and by the end of 1993 the payments increased to $5,200 per month. However he was not paid each month, but perhaps every three to four months “as the company had money”; sometimes he would receive several cheques in a month. For example, Biorem did not pay Professor Ward for services rendered in 1993 but paid him for these services in early 1994 when it was in a cash position. Later in 1994 there was insufficient cash on hand to pay salaries and the appellant agreed to a reduction of 20% from amounts owed to him on the understanding he would receive the balance when Biorem received money from Innovation Ontario (“Innovation”), a provincially funded venture capital investor. Salaries of other employees were also deferred.
The General Ledger of Biorem for its financial year ending on September 30, 1994 reflects a debit of $5,200 payable, but not paid, to Professor Ward for his work as a consultant in October 1993 and for each of the months of January to August 1994, inclusive; the total amount so accrued was $46,800. The amount of $46,800 payable to Professor Ward was “written off’ by Biorem on September 30, 1994. Professor Ward testified the amount was written off since “the company could not afford the accrual”. He believes that the sum of $46,800 was not part of the amount due to directors and officers in Biorem’s balance sheet as at September 30, 1994.
In 1994 Biorem’s directors had arranged for additional financing. It obtained funds from Innovation. As part of Innovation’s investment, Professor Ward testified, he was given the option by agreement of September 16, 1994 to acquire $50,000 worth of shares of Biorem, that is, 27,472 shares, for no monetary consideration. The agreement was not produced by Professor Ward.
Professor Ward had on-going discussions with Biorem’s accountants and Biorem during the summer of 1994 in an attempt to find a way to acquire the shares with no or little tax exposure. Professor Ward did not have the financial ability to invest $50,000. By letter dated August 8, 1994 the accountants recommended to Professor Ward and another person in a similar position, Mr. Brian Herner, that their investments be treated as an employee stock option. In exchange for amounts owing to them by Biorem, they would accept common shares. So long as Biorem maintained its status as a Canadian-controlled private corporation and Professor Ward and Mr. Herner were employees of Biorem the difference between the current fair market of the common shares and the actual price paid for the shares may be deferred, the accountants wrote, until the shares are sold or exchanged. This would eliminate the need for Biorem to provide cash to Professor Ward as equivalent compensation and would allow Professor Ward to defer the recognition of tax. Obviously the accountants hoped to utilize the provisions of subsection 7(1.1) of the Act. Therefore, their letter continued, “it is imperative that both of you are considered employees of the company effective January 1, 1994. The employee stock option benefit can only be provided to employees dealing at arm’s length with the company”.
The accountants also stated that Biorem and Professor Ward and Mr. Herner acknowledge “that pre-determined salaries would only be conditional upon cash-flow and meeting certain business targets. Therefore, stock options may have to be substituted in exchange for cash remuneration”. They also advised that Innovation must agree with the scheme.
By an agreement “made as at the 1st day of January 1994” but negotiated subsequent to January 1994, apparently during the summer of 1994, and executed on or about September 15, 1994, Biorem engaged Professor Ward as an employee, specifically as Vice-President - Research and Technology, for a salary of $5,200 per month (plus other benefits) commencing January 1, 1994. Although Professor Ward testified there was an understanding between Biorem and him that salary was payable only if Biorem had the ability to pay, the employment agreement does not provide that payment of salary is subject to any cash-flow or business targets. The directors of Biorem approved the agreement on September 15, 1994. On September 16, 1994 Biorem allotted Professor Ward 27,472 common shares in the capital stock of the company for no consideration. Also, on September 16, 1994 Brian Herner, who was still a consultant, subscribed for 10,989 common shares for consideration of $10,000 and Venture subscribed for 16,484 common shares for consideration of $30,000. These shares are recorded on the shareholders’ register of Biorem; no directors’ resolution authorizing the issue of the shares was produced at trial.
Biorem placed Professor Ward on its employee payroll starting October 1, 1994. The summary of the payroll register for the period ending December 31, 1994 indicates Professor Ward’s salary to that date was $12,400.3 The corporation sent him an income tax T4 form, a statement of remuneration paid, stating his employment income for 1994 was $12,400.
The Minister’s position, quite simply, is that Biorem owed Professor Ward $46,800 in September 1994 on account of consulting fees not paid and in return for writing off the debt Biorem issued Professor Ward 27,472 common shares in its capital stock. The shares had a value of $50,000, according to the Minister. Professor Ward received the shares not because he was an employee but to satisfy the debt owed to him for services he provided to Biorem as a consultant.
Professor Ward submitted that he was assessed as an employee: Revenue Canada added the sum of $50,000 to his employment income in the notice of explanation of changes to the assessment for 1994 (Form T7W-C) sent to him by the Minister with his notice of assessment for the year. Therefore, in his view, he was an employee at all relevant times.
Subsequent to the hearing of the appeal and upon reviewing the evidence, I thought it would be in the interests of justice that I consider reopening the evidence. Accordingly, I instructed the trial co-ordinator to arrange a telephone conference call between the appellant, the respondent’s counsel, Ms. Tataryn, and me. The call was made on March 27, 1998 at which time I suggested to Professor Ward that he attend at the offices of Biorem and its solicitors to obtain any documentation, among other things, to confirm that he was an employee of Biorem in September 1994 and any corporate resolutions authorizing the issue of shares to him. On or about April 5, 1998, Professor Ward forwarded a book containing more documents to the Registrar of the Court and to Ms. Tataryn.
The information contained in the book of documents of April 5, 1998 unfortunately does not assist the appellant. A draft working paper setting out the terms of the employment contract is dated August 10, 1994. Copies of payroll records, for example, do not show Professor Ward to be an employee of Biorem until October 1994, when he was paid $2,000 for the month.
Another conference call was held between Professor Ward, Ms. Tataryn and myself on June 30, 1998 at which time Professor Ward indicated there was no other documentation available and Ms. Tataryn agreed I may refer to the material sent to the Court on April 5, 1998.4
I am prepared to find that Professor Ward dealt at arm’s length with Biorem both at the time the company agreed to issue the shares and immediately after he agreed to acquire and did acquire the 27,472 shares of Biorem on September 16, 1994. Professor Ward was a minority shareholder in Biorem. On September 16, 1994, Biorem was controlled by Venture. Venture is a venture capital corporation and it and Professor Ward do not necessarily share the same interests in Biorem. Venture and Biorem were not related and they were not part of the same control group.
However, there is no evidence to even suggest that at the time the shares were issued by Biorem to the appellant, the appellant was an employee of Biorem notwithstanding he was a director of the company. Indeed, the evidence is that he was not an employee at the time. Therefore the benefits of subsection 7(1.1) is not available to him.
Subsection 5(1) states that a taxpayer’s income for a taxation year from an office or employment is the salary wages and other remuneration the taxpayer received in the year. An officer is a person who holds an office, that is, the position entitling the individual to a fixed or ascertainable stipend or remuneration and includes the position of a corporate director: subsection 248(1).
It is not necessary that an individual be an employee at the time he or she receives income for that income to be income from employment. Subsection 6(3) provides that:
An amount received by one person from another
(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,
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
(d) as remuneration or partial remuneration for services as an officer or under the contract of employment,
If the shares were received by Professor Ward for something other than as remuneration or partial remuneration for services as an officer or under the contract of employment, then he received the shares as remuneration for services rendered to Biorem as a consultant. The value of the shares was at least equal to the amount Biorem owed and had not paid. Biorem was freed of the obligation to make the payment of the money owed to Professor Ward at or about the same time as it issued the shares to Professor Ward.
The amount of $50,000 is to be included in Professor Ward’s income either as employment income under subsection 5(1) or as business income under sections 3 and 9 of the Act. I cannot find that Professor Ward’s forgiveness of the amount Biorem owed to him and the issue of the shares were two different and distinct transactions. I am not satisfied one would not have occurred without the other. The appellant’s reason for forgiving the amount owed to him - because Biorem did not have the money to pay him - has no basis. Any other person subscribing for shares at the time paid some consideration. Professor Ward did not, unless the forgiveness of the debt was the consideration.
Notwithstanding what I have stated, it appears to me that the shares of Biorem acquired by Professor Ward may not have a value of $50,000. It is fairly certain that he could not have disposed of the shares for that amount. However this issue was not raised in the pleadings and there is no evidence as to the value of the 27,472 shares. There is no consistency of value in the shares issued by Biorem on September 16, 1994. The unit book price of shares acquired by Mr. Herner and Venture are not the same: Herner paid $0.91 per share and Venture paid $1.82 per share. I believe that in the peculiar circumstances of this appeal it is best to allow the appeal without costs and refer the assessment back to the Minister to reconsider the value of the 27,472 shares of Biorem issued to Professor Ward and reassess on the basis of that value.
Appeal allowed.
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