Date: 20111110
Docket: A-35-11
Citation: 2011 FCA 308
CORAM: NADON
J.A.
SHARLOW
J.A.
DAWSON J.A.
BETWEEN:
IMPERIAL TOBACCO CANADA LIMITED
(Successor by Amalgamation to Imasco
Limited)
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1]
The issue
in this case is whether Imasco Limited (“Imasco”), in computing its income for
income tax purposes, is entitled to deduct payments made to its own employees
and employees of its subsidiaries for surrendering options to acquire Imasco
shares. Imasco made such payments in its 1999 and 2000 taxation years, and
claimed deductions for the payments on the basis that they were employee
compensation. The Minister, relying on paragraph 18(1)(b) of the Income
Tax Act, R.S.C. 1985, c. 1 (5th Supp.), reassessed Imasco to
disallow the deductions on the basis that the payments were on account of
capital. Imasco (represented by the appellant Imperial Tobacco Canada Limited,
its successor by amalgamation) appealed to the Tax Court of Canada. Justice
Bowie dismissed the appeal for reasons reported as Imperial Tobacco Canada
Ltd. v. Canada, 2010 TCC 648. Imperial now appeals to this Court. For the
reasons that follow, I would dismiss the appeal.
Standard of review
[2]
This case
involves a dispute as to whether certain payments are on account of capital or
income. The resolution of the dispute requires the application of legal
principles to the facts, which is a question of mixed fact and law (Canada
v. Johns-Manville Corp., [1985] 2 S.C.R. 46, at page 62). Therefore, this
Court cannot intervene in the absence of a palpable and overriding error or an “extricable
error in principle with respect to the characterization of the standard or its
application, in which case the error may amount to an error of law” (Housen
v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235, at paragraph 37).
[3]
The
relevant facts are undisputed. The case in the Tax Court proceeded on the basis
of a statement of agreed facts supplemented by passages read into the record
from the pre-trial examinations for discovery of both parties. There was no
oral testimony. Imasco’s argument essentially is that Justice Bowie erred in
applying the principles derived from the jurisprudence.
Facts
[4]
During
Imasco’s taxation years ending December 31, 1999 and February 1, 2000, it was a
public corporation and a taxable Canadian corporation. Imasco and its
subsidiaries were active in a number of businesses. On May 11, 1983, Imasco
instituted an employee stock option plan under which employees of Imasco and
its subsidiaries could be granted the right to purchase Imasco shares for their
fair market value as of the date of the grant of the option. At the time of the
transactions relevant to this case, options issued under the Imasco employee
stock option plan represented rights to acquire approximately 5 million Imasco
shares (slightly over 1% of the shares then outstanding).
[5]
According
to the terms of the employee stock option plan, an option would “vest” 2 years
after being granted (meaning that it could not be exercised within 2 years of
its grant). An unexercised option would expire 10 years after being granted or
upon the termination of the option holder’s employment (otherwise than by
retirement under an approved retirement plan). Options were not transferable or
assignable except by will or pursuant to the laws of succession.
[6]
By virtue
of a 1995 amendment to the stock option plan, Imasco had the right to offer an option
holder the right to surrender the option for cash equal to the amount by which
the market value of the Imasco shares that could be acquired by exercising the
option exceeded the exercise price. An option holder who was granted that right
and exercised it would be in the same financial position as if the stock option
had been exercised and the shares immediately sold (disregarding income tax
considerations and transaction costs, if any). There is evidence that, even
before the 1995 amendment, Imasco occasionally paid cash to an employee as
consideration for the surrender of a stock option, and that the 1995 amendment
merely formalized what was already being done from time to time.
[7]
In March
of 1999, British American Tobacco p.l.c. (“BAT”) approached Imasco to discuss a
proposal for a “going private transaction” under which BAT would acquire,
directly or indirectly, all of the Imasco shares held by public shareholders. It
is not clear from the record how many shares that represented in March of 1999,
but on December 14, 1999, BAT indirectly owned 42.5% of the Imasco shares then
outstanding. The acquisition proposal was the subject of a press release on
June 7, 1999.
[8]
On June 9,
1999, the Imasco board of directors passed a resolution to amend section 10 of
the employee stock option plan to give all option holders the right to
surrender their options for cash. The effect of that amendment was that the discretion
to initiate the surrender of an option for cash rested with each option holder,
rather than Imasco.
[9]
It is
reasonable to infer, as Justice Bowie did at paragraph 12 of his reasons, that
this amendment was one of the steps taken by Imasco to facilitate the going
private transaction. Imasco contended that the amendment was made to ensure
that option holders were treated fairly if the going private transaction was
completed. That is also consistent with the documentary evidence. I see no
conflict between the objective of facilitating the going private transaction
and the objective of treating option holders fairly.
[10]
In July of
1999, British American Tobacco (Canada)
Limited (“Bidco”) was incorporated as an indirect wholly owned subsidiary of
BAT to acquire the Imasco shares.
[11]
On August
2, 1999, an agreement entitled “Transaction Proposal Agreement” was entered into
by BAT, Bidco, and Imasco dealing with the going private transactions. It also
contemplated a number of other transactions, including the disposition of certain
Imasco assets that BAT did not wish to acquire. Those dispositions were to
precede the going private transaction. After the going private transaction, Bidco
and Imasco were to be amalgamated.
[12]
Article 5
of the Transaction Proposal Agreement is entitled “The Going Private
Transaction and Related Transactions”. Article 5.2 indicates that the parties
agreed that certain internal reorganization transactions (referred to as the “reorganization”)
would occur once all parties were satisfied that certain contractual conditions
had been met. The reorganization involved essentially amending the terms of the
Imasco shares so that the transfer of the Imasco shares to Bidco could be triggered
by a direction from Imasco. That ensured that the transfer of the Imasco shares
would be automatic once the agreed conditions to the going private transaction
were met.
[13]
Article
5.8 of the Transaction Proposal Agreement is entitled “Outstanding Stock
Options and Employment Arrangements of Imasco”. In that provision, Imasco agreed
that its board of directors would unanimously resolve to encourage all holders
of employee stock options to exercise them or surrender them immediately prior
to the completion of the reorganization. Imasco also agreed that, subject to
regulatory and stock exchange approvals, its board of directors would take the
steps required to ensure that all employee stock options would vest before the
reorganization so that they could be exercised prior to the completion of the
reorganization. That was done, but the immediate vesting of the employee stock
options above was subject to the condition that if certain closing steps of the
reorganization were not completed, the immediate vesting would be deemed never
to have occurred.
[14]
The
acceleration of the vesting of employee stock options, coupled with the
provision for the surrender of stock options for cash at the election of option
holders, would ensure that Imasco had taken all possible steps to ensure that Bidco
would be a position, after the reorganization, to acquire all Imasco shares. Of
course it was possible that some option holders would choose not to surrender
their options or to exercise them. As events unfolded, however, that did not
occur.
[15]
On
November 18, 1999, the Transaction Proposal Agreement was amended. Among other
things, the amendment set the purchase price of the Imasco shares at $41.60 per
share. It also included a favourable recommendation from Imasco’s board of
directors. A special meeting of the Imasco shareholders was called for January
28, 2000 to consider the going private transaction. The transaction was
approved by the shareholders on that date and completed on February 1, 2000.
[16]
Prior to
the closing, employees holding in aggregate options to acquire 4,848,600 Imasco
shares elected to surrender their options for cash equal to the difference
between $41.60 per share and the exercise price. The surrender payments
totalled approximately $118 million. A small number of options (62,800) were
not surrendered. They were exercised before the closing, and the shares issued
as a result were acquired by Bidco on the closing date. The result was that
after the going private transaction, Imasco had no further obligations under
the Imasco stock option plan.
[17]
The surrender
payments included an additional amount intended to compensate employees who
surrendered their options for cash and who, for that reason, might not be
entitled to a deduction under paragraph 110(1)(d) of the Income Tax
Act. That deduction would be available to those who exercised their options
and sold the shares. Neither party suggests that this top-up is relevant to the
deductibility of the payments Imasco made to employees who surrendered their
options.
Statutory provisions and
jurisprudence
[18]
Subsection
9(1) of the Income Tax Act is the general rule for determining, for
income tax purposes, a taxpayer’s income from a business or property. It reads
as follows:
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9.
(1) Subject to this Part, a taxpayer’s income for a taxation year from a
business or property is the taxpayer’s profit from that business or property
for the year.
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9.
(1) Sous réserve des autres dispositions de la présente partie, le revenu
qu’un contribuable tire d’une entreprise ou d’un bien pour une année
d’imposition est le bénéfice qu’il en tire pour cette année.
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The word “profit” in subsection 9(1) generally is taken to mean
profit as determined under well accepted business principles, subject to the
established case law and provisions of the Income Tax Act (Canderel
Ltd. v. Canada, [1998] 1 S.C.R. 147, at paragraph 53).
[19]
It appears
that the surrender payments were deducted by Imasco in determining its profit for
income tax purposes and for its financial reporting purposes. The Crown did not
allege that the deduction was not appropriate under well accepted accounting
principles, and there is no evidence on that point. However, that is of no
assistance to Imasco. The computation of profit as described in section 9 is
stated to be “subject to this Part”. That qualifying phrase refers to the many detailed
rules in Part I of the Income Tax Act for determining profit for income
tax purposes. Section 18 is one of those provisions. It limits or prohibits the
deduction of certain amounts. The Crown’s position that the surrender payments
are not deductible is based on section 18 – specifically paragraph 18(1)(b).
If the Crown is correct, then it does not matter whether well accepted
accounting principles would have permitted the deduction for financial
reporting purposes.
[20]
Paragraph
18(1)(b) reads as follows (my emphasis):
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18.
(1) In computing the income of a taxpayer from a business or property no
deduction shall be made in respect of
|
18.
(1) Dans le calcul du revenu du contribuable tiré d’une entreprise ou d’un
bien, les éléments suivants ne sont pas déductibles :
|
|
…
|
[…]
|
|
(b)
an outlay, loss or replacement of capital, a payment on account of capital
or an allowance in respect of depreciation, obsolescence or depletion except
as expressly permitted by this Part….
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b)
une dépense en capital, une perte en capital ou un remplacement de capital, un
paiement à titre de capital ou une provision pour amortissement,
désuétude ou épuisement, sauf ce qui est expressément permis par la présente
partie […].
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[21]
The
statutory prohibition on the deduction of a payment on account of capital
requires consideration of the principles for distinguishing capital and income.
The determination is driven primarily by the facts of the particular case, with
the cases providing guidance on the factors to be taken into account. That is well
expressed in Minister of National Revenue v. Algoma Central Railway,
[1968] S.C.R. 447, at page 449-50 (my emphasis):
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Parliament did not define the expressions "outlay ... of
capital" or "payment on account of capital". There being no
statutory criterion, the application or non-application of these expressions
to any particular expenditures must depend upon the facts of the particular
case. We do not think that any single test applies in making that
determination and agree with the view expressed, in a recent decision of the
Privy Council, B.P. Australia Ltd. v. Commissioner of Taxation of the
Commonwealth of Australia [[1966] A.C. 224], by Lord Pearce. In referring
to the matter of determining whether an expenditure was of a capital or an
income nature, he said, at p. 264:
The solution to the problem is not to be found by any
rigid test or description. It has to be derived from many aspects of the
whole set of circumstances some of which may point in one direction, some in
the other. One consideration may point so clearly that it dominates other and
vaguer indications in the contrary direction. It is a commonsense
appreciation of all the guiding features which must provide the ultimate
answer.
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[22]
One
of the most frequently cited passages on the issue that arises in this case is
found in the decision of Viscount
Cave L.C. in British Insulated and
Helsby Cables v. Atherton, [1926] A.C. 205 (H.L.),
at pages 213-14:
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… when an expenditure is made, not only once and for all, but with
a view to bringing into existence an asset or an advantage for the enduring
benefit of a trade, I think there is very good reason (in the absence of
special circumstances leading to an opposite conclusion) for treating such an
expenditure as properly attributable not to revenue but to capital.
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[23]
As
ubiquitous as this passage is, it is not a bright line test. Rather, it is
useful guide for identifying some of the factors that may be relevant.
[24]
Johns-Manville (cited above) confirms that,
despite the many cases that have resulted in useful catch phrases, there is no
single legal test for distinguishing payments on income account from payments
on capital account. Johns-Manville is also helpful in identifying some factors
that may be considered in determining whether a payment is on account of
capital. The taxpayer in Johns-Manville was the operator of an open pit
mine. It sought current deductions for amounts paid to buy land around the pit
which was needed to maintain the slope of the sides of the pit. After a lengthy
review of the facts and the jurisprudence, Estey J. (writing for the Court)
held that the expenditures were not on account of capital. It appears to me
that what was particularly important was that the expenditures were not made to
acquire assets of intrinsic or enduring value. Rather, they were an easily
discernible and relatively constant part of the taxpayer’s operating costs, which
would be consumed in the course of the taxpayer’s operations.
Application of the principles to the
facts of this case
[25]
In this
case, the Crown argues that the
payments in issue are expenditures on capital account because they were made in
the context of a reorganization of the capital of Imasco and extinguished all
of the outstanding obligations of Imasco to issue shares. As I understand the
reasons of Justice Bowie, this is essentially the basis upon which he concluded
that the payments in issue were on account of capital.
[26]
Imasco argues
that the payments in issue are best characterized as employee compensation, and
therefore deductible as an ordinary business expenses. This argument relies on Imperial
Tobacco Canada Ltd. v. Canada, 2007 TCC 636 (referred to as “Shoppers
Drug Mart”), and in particular on the following statement at paragraph 22
(footnote omitted):
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I
start from the premise that in the ordinary course a payment made by an employer
to an employee for the surrender of his or her option under a stock option
plan to acquire shares of the company is a deductible expense to the company.
This conclusion is not based on any specific provision of the Income Tax
Act. It is simply part of employee compensation and is therefore a cost
of doing business under section 9.
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[27]
Shoppers
Drug Mart dealt
with another aspect of the going private transaction considered in this case.
It involved the deductibility of a payment made by Shoppers Drug Mart Limited
(“SDM”) to Imasco, then its parent corporation, as a reimbursement of payments
made by Imasco upon the surrender by employees of SDM of stock options issued
to them under the Imasco stock option plan. The decision of this Court in Kaiser
Petroleum Ltd. v. Minister of National Revenue (1990), 116 N.R. 209; [1990]
2 C.T.C. 439; 90 D.T.C. 6603 (F.C.A.) (“Kaiser”) involving similar facts
was distinguished on the basis that the payment by SDM involved no capital
restructuring of SMN and no enduring benefit to SDM. That left only the premise
quoted above, which led the judge to conclude that the payment was deductible
as employee compensation.
[28]
It is
arguable that a payment made by a corporation on the surrender of an employee
stock option is employee compensation, and therefore deductible by the
corporation, if it is one of a number of like transactions undertaken as part
of the day to day interaction of the corporation with its employees (perhaps by
analogy to Johns-Manville). I doubt that I would have concluded that
this fairly describes the payment in issue in the Shoppers Drug Mart
case, but I need not express a final opinion on that point. What is in issue
here is whether there is merit to Imasco’s position that Justice Bowie erred in
failing to characterize the payments in issue in this case as employee
compensation.
[29]
The
specific question is whether Justice Bowie’s conclusion in this case was based on
an error in his understanding or application of the relevant jurisprudence. A
careful review of Justice Bowie’s reasons discloses no such error. In my view, there
are three factors that point to the conclusion that the payments in issue were
on capital account. First, they coincided with a reorganization of the capital
of Imasco (the going private transaction and amalgamation). Second, the
arrangements put in place for making the payments facilitated and were intended
to facilitate the capital reorganization. Third, the payments were intended to
and did end all future obligations of Imasco to deal with its own shares, which
can fairly be described as a once and for all payment that resulted in a
benefit to Imasco of an enduring nature.
[30]
There are two
factors that arguably could favour the position of Imasco. First, the employee
stock option plan itself was entered into to provide a form of employee
compensation and the plan had, at least since 1995, contemplated periodic
surrenders of options for cash, albeit at the option of Imasco. Second, the
shares represented by the surrendered options represented only a small portion
of the Imasco issued shares.
[31]
Justice Bowie
was clearly aware of these facts, and just as clearly he did not consider them to
be of sufficient weight to overcome the factors that supported the conclusion
that the payments in issue were outlays on account of capital. In finding as he
did, Justice Bowie relied on Kaiser (cited above) which he found to be
indistinguishable on its facts. The payments in issue in Kaiser were
held to be on account of capital because their immediate result was to
“eliminate extraneous shares or share possibilities”, which was characterized
as a form of capital restructuring. Imasco argues that Kaiser is
distinguishable for a number of reasons. It is true that there are some factual
differences. They are listed at paragraph 10 of Justice Bowie’s reasons.
However, he concluded that these were “distinctions without a difference”. I
agree with Justice Bowie that the facts are sufficiently similar to merit a
similar outcome.
[32]
Imasco
suggests that Kaiser is wrong in principle and should not be followed (Miller
v. Canada (Attorney General), 2002 FCA 370). This argument
seems to be based on the notion that Kaiser is not in step with current
economic realities because it is more common now for a corporation to adopt an
employee stock option as part of the ordinary compensation package for
employees at all levels. I see no reason to conclude that the greater use of
employee stock option plans, in and by itself, should mean that a transaction
like the one considered in Kaiser is not on capital account.
[33]
In my
view, Justice Bowie’s conclusion is consistent with the evidence and the
applicable legal principles. I can discern no error that would justify the
intervention of this Court.
Conclusion
[34]
I would
dismiss the appeal with costs.
“K. Sharlow”
“I
agree.
M.
Nadon J.A.”
“I
agree.
Eleanor
R. Dawson J.A.”
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