Markin v. The Queen, 96 DTC 6483, [1996] 3 CTC 212 (FCTD)

Gibson J.: — This action arises out of a reassessment made by the Minister of National Revenue (the “Minister”) on 20 March, 1985 in respect of the plaintiff’s 1982 taxation year. The plaintiff appealed the Minister’s reassessment to the Tax Court of Canada. The Tax Court of Canada dismissed the plaintiff's appeal by judgment dated 18 April, 1988. This action is, in effect, an appeal from the decision of the Tax Court of Canada by way of trial de novo of the appeal from the Minister’s reassessment.

The parties filed an Agreed Statement of Facts and listed exhibits with the Court on 25 June 1996. The Agreed Statement of Facts, with references to exhibits deleted, reads as follows:

1. Allan P. Markin (the “Plaintiff’) is an individual resident in the City of Calgary, Alberta.

2. Between the years 1975 through 1982, the Plaintiff was employed by Merland Explorations Limited and certain affiliated corporations (“Merland”).

3. In 1978, Merland instituted an incentive program for its executive employees. Under the incentive program, Merland granted certain of its employees, including the Plaintiff, a contractual right to receive one-half of one percent of the “net profits” of Merland from its ownership and operation of certain properties which constituted “Canadian resource properties” for the purposes of paragraph 66(15)(c) of the Act (“the subject properties”). In respect of the Plaintiff, the subject properties constituted all “Canadian Resources Properties” which were acquired by Merland during the term of the Agreement. The term of the initial Agreement was one year, being the 1978 calendar year. (The initial Agreement, together with each subsequent Agreement by which the Plaintiff was granted a right to receive a portion of the profits of Merland, together with all amendments thereto, will be referred to herein collectively as “the Agreements” ...).

4. By letter dated March 25, 1980, Merland confirmed to the Plaintiff that identical Agreements for the calendar years commencing January 1st, 1979 and January 1st, 1980 had orally been entered into. This was confirmed by the Plaintiff. ...

5. The Plaintiff and Merland entered into a further agreement on January 1st, 1981, embodying substantially the same terms and conditions as had been contained in the Agreements which then subsisted for the 1978, 1979 and 1980 calendar years, as amended. The term of the Agreement dated January 1st, 1981 was for the 1981 calendar year. ...

6. By agreement dated March 12, 1981, Merland and the Plaintiff agreed to amend certain provisions of the Agreements then subsisting for the 1978, 1979 and 1980 calendar years to provide for the staggered vesting of the rights granted to the Plaintiff thereunder if he were terminated from his employment with Merland. ...

7. By agreement dated December 1st, 1981, the Agreements which subsisted for 1978, 1979, 1980 and 1981, as amended, were further amended to essentially delete the provisions in the March 12, 1981 agreement as to the Plaintiff’s termination and to replace these provisions with further provisions which enlarged the previous rights of the Plaintiff to require Merland to purchase the Plaintiff’s rights under the Agreements upon death, and thereby permit the Plaintiff to require the purchase of those rights in circumstances of the termination of the Plaintiff’s employment with Merland. ...

8. Merland and the Plaintiff entered into another Agreement as of January 1, 1982. ...

9. The Plaintiff acquired his rights under the Agreements by virtue of his employment with Merland.

10. The Plaintiff terminated his employment with Merland in 1982.

11. On January 14, 1982 the Plaintiff secured a valuation of his rights under the Agreements.

12. On January 25, 1982 the Plaintiff, in accordance with the Agreements, exercised his option to require Merland to purchase, and thereby cancel, his rights under the Agreements. ...

13. On the basis of having acquired his rights under the Agreements at no cost, the Plaintiff reported that he had realized a capital gain in the amount of $389,760.00 in the 1982 taxation year, being the entire proceeds received upon the cancellation of his rights under the Agreements.

14. The Minister of National Revenue does not dispute the amount received by the Plaintiff in respect of the disposition of his rights under the Agreements during the Plaintiff s 1982 taxation year.

15. On March 20, 1985, the Plaintiff was reassessed by the Minister. The Minister disallowed the Plaintiffs claim that he incurred a capital gain in respect of the disposition of his rights under the Agreements, but rather assessed on the basis that he had received an amount which should be included in the Plaintiffs income under paragraph 6(1 )(g) of the Act as a payment under an employee benefit plan.

16. The Plaintiff filed a Notice of Objection dated June 11, 1985 disputing the Minister’s reassessment. ...

17. The Minister accepted the Plaintiffs submission in respect of the legal basis of its original assessment but confirmed the amount of the assessment on the basis that the disposition of the Plaintiffs rights under the Agreements constituted a disposition of a “Canadian resource property” and therefore included the amount received by the Plaintiff in his income pursuant to Sections 3 and 66.2 of the Acct. ...

18. The Plaintiff appealed from the Notice of Confirmation to the Tax Court of Canada. The appeal was dismissed.

The Plaintiff appeals from the decision of the Tax Court of Canada.

The relief claimed by the Plaintiff in his Statement of Claim is that the Court allow his appeal and vacate the reassessment of the Minister or, in the alternative, that the Court refer the reassessment back to the Minister for reconsideration and reassessment.

The issue before the Court can be simply stated. It is whether the amount received by the Plaintiff in 1982 pursuant to the Agreements referred to in the Agreed Statement of Facts, in the amount of $389,760.00, is taxable on income or capital account. As indicated in paragraph 13 of the Agreed Statement of Facts, the Plaintiff reported the amount as a capital gain realized in his 1982 taxation year. The Minister reassessed the Plaintiff in respect of his 1982 taxation year, first on the basis that the amount was income from employment and later on the basis that it was income from the disposition of a “Canadian resource property”.

At the relevant time, “Canadian resource property” was defined in paragraph 66(15)(c) of the Income Tax Act [1] (the “Act”) in the following

terms:

(c) “Canadian resource property” of a taxpayer means any property acquired by him after 1971 that is

(i) any right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada,

(ii) any right, licence or privilege to (A) store underground petroleum, natural gas or related hydrocarbons in Canada, or (B) prospect, explore, drill or mine for minerals in a mineral resource in Canada,

(iii) any oil or gas well in Canada,

(iv) any rental or royalty computed by reference to the amount or value of production from an oil or gas well in Canada,

(v) any rental or royalty computed by reference to the amount or value of production from a mineral resource in Canada,

(vi) any real property in Canada the principal value of which depends upon its mineral resource content (but not including any depreciable property used or to be used in connection with the extraction or removal of minerals therefrom), or

(vii) any right to or interest in any property (other than property of a trust) described in any of subparagraphs (i) to (vi) (including a right to receive proceeds of disposition in respect of a disposition thereof);

It was not disputed before me that the Plaintiffs rights under the Agreements at issue (the “Agreements”) was a property interest acquired by virtue of his employment with Merland Explorations Limited and certain affiliated corporations (“Merland”). The rights or property were or was in the nature of a net profits interest granted, in the 1978 agreement, in the following terms:

2. Grant of net profits interest

The Company hereby grants to the Employee an undivided one- half of one (1/2 of 1 per cent) per cent of the net profits, calculated as hereinafter provided, attributable to the interest of the Company in oil and gas properties. [The calculation of “Net Profits” is then defined.] [2]

Central to a determination of whether or not the Plaintiffs property interest was a “Canadian resource property” is a determination of whether or not the property was a “...royalty computed by reference to the amount or value of production from an oil or gas well in Canada...” within the terms of subparagraph (iv) of the definition “Canadian resource property” quoted above. Although counsel for the defendant argued that the property might well fall within other elements of the definition “Canadian resource property”, I am satisfied by reference to the terms of the Agreements that that is not the case.

“Royalty” was not a defined term in the Act at the relevant time. In Vauban Productions v. R. [3] Mr. Justice Addy stated, at page 513:

The term “royalties” normally refers to a share in the profits or a share or percentage of a profit based on user or the number of units, copies or articles sold, rented or used. When referring to a right, the amount of the royalty is related in some way to the degree of use of that right. This is evident from the various dictionary definitions of the word “Royalty” when used in connection with a sum payable. Royalties, which are akin to rental payments, have invariably been considered as income since they are based either on the degree of use of the right or on the duration of the use, while a lump sum payment for the absolute transfer of a right, without regard to the use to be made of it, is of its nature considered a capital payment, although it may of course be taxable as income in the hands of the recipient if it is part of that taxpayer’s regular business.

By reference to the Agreements and more particularly to the provisions thereof regarding the calculation of net profits from which the Plaintiff’s net profits interest was determined, I conclude that certain of the elements comprising “net profits” might reasonably be regarded as royalties “...computed by reference to the amount or value of production from an oil or gas well in Canada”. On the other hand, it is clear that certain of the other elements entering into the calculation of net profits were not in the nature of royalties. Unfortunately, no evidence was before the Court as to what were the actual contributing elements to net profits giving rise to the Plaintiff’s net profits interest on which the payment made to him in 1982 was based. This weakness in the evidence could reasonably lead the Court to conclude that the grant of the net profits interest to the Plaintiff under the Agreements was in the nature of a royalty computed by reference to the amount or value of production from an oil or gas well in Canada, given the burden of proof on the Plaintiff. [4] However, I do not propose to decide this matter on this ground.

I turn then to the issue of whether or not the amount received by the Plaintiff in 1982, the characterization of which is here in dispute, constituted income from an office or employment. The relevant provisions of the Act at the relevant time read as follows:

5(1) Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by him in the year.

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, except any benefit

(3) An amount received by one person from another

(a) during a period while the payee was an officer of, or in the employment of, the payer, or

(b) on account or in lieu of payment of, 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

(c) as consideration or partial consideration for accepting the office or entering into the contract of employment,

(d) as remuneration or partial remuneration for services as an officer or under the contract of employment, or

(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.

In R. v. Savage, [5] Mr. Justice Dickson, as he then was, referring to the words of paragraph 6(1 )(a) quoted above, stated:

The meaning of “benefit of whatever kind” is clearly quite broad; in the present case the cash payment of $300 easily falls within the category of “benefit”. Further, our Act speaks of a benefit “in respect of” an office or employment. In Nowegijick v. R. ((sub nom. Nowegijick v. The Queen), [1983] 1 S.C.R. 29, [1983] C.T.C. 20, 83 D.T.C. 5041, this Court said, at page 5045 that:

The words “in respect of’ are, in my opinion, words of the widest possible scope. They import such meanings as “in relation to”, “with reference to” or “in connection with”. The phrase “in respect of’ is probably the widest of any expression intended to convey some connection between two related subject matters.

By paragraph 9 of the Agreed Statement of Facts, it is acknowledged that the Plaintiff acquired his rights under the Agreements by virtue of his employment with Merland. Given this acknowledgement, I fail to see how it can be effectively argued on the facts before the Court that the rights under the Agreements, leading as they did to a payment to the Plaintiff of $389,760.00 in his 1982 taxation year in return for the cancellation of his rights under the Agreements, amounted to anything less than a benefit in that amount in respect of the Plaintiff’s office or employment as the rights were acquired by the Plaintiff at no cost to him. I reach this conclusion notwithstanding clause 7 of the Agreements which is in the following terms:

It is expressly understood and agreed that the net profits interest hereinbefore granted is in the nature of a discretionary payment only and under no circumstances whatsoever is it to be treated as part of the salary, wage or other regular employment income of the Participant.

It is trite law that parties cannot, by agreement between them, affect the application of the Act in respect of them.

Counsel for the Plaintiff argued that, if I were to conclude, as I have, that the amount at issue was income of the Plaintiff from an office or employment for a taxation year or years, then I should conclude that it was income in the taxation year in which it accrued and not in the taxation year in which it was actually received. I reject this argument. In Robertson v. Æ. [6] Mr. Justice Marceau, in examining a case where an employee exercised certain stock options received from his employer, found, at page 120:

Thus, in my view, there are two economic benefits, both arising from employment, but only the second is quantifiable as only that one is realized by a flow of money or money’s worth from the employer to the employee. Nothing flows from the employer on the granting of the option: while the employer retains the shares, votes them, collects dividends for his own account and may dispose of them, the employee only acquires a possibility to eventually obtain a proprietary interest in those shares and realize a profit thereform. In my view, individual taxation on employment-source income is based on the flow of money or money's worth from the employer to the employee. Only the second benefit, the quantifiable one,falls within the scope of paragraph 6(1 )(a) of the Act.

[Emphasis added.]

Similarly in this case, the flow of money from the employer to the employee occurred when the Plaintiff exercised his rights under the Agreements in 1982, and the income is therefore taxable in that year, the year of receipt.

Further, I conclude that the amount at issue was also income of the Plaintiff from an office or employment in 1982 under subsection 6(3) of the Act. In Blanchard v. R. [7] the Court stated, at pages 268-69:

Paraphrasing paragraph 6(3)(b) and paragraph 6(3)(c), where an amount is received by a person in satisfaction of an obligation arising out of an agreement made by that person and the payor immediately prior to, during or immediately after a period when the person was employed by the payor, that payment is deemed to be remuneration during the period of employment subject to this exception: if it is established that the amount received cannot reasonably be regarded as consideration or partial consideration for entering the contract of employment, it will not be deemed to be remuneration. This is a very broadly aimed provision that covers the present circumstances. Eugene Blanchard received a $7,240. payment while in the employ of the payor. This payment was made in satisfaction of an obligation arising out of an agreement entered into between Blanchard and the payor either at the time or before the period of employment. This original agreement was clearly intended to induce and did induce Blanchard to accept the employment. It has not been established that this payment “cannot reasonably be regarded as having been received as consideration or a partial consideration for ... entering into the contract of employment”. On the contrary, it is clear that the payment arising from the satisfaction of the obligation that arose under this agreement was received as “consideration or partial consideration” for entering into the contract of employment. It is, therefore, remuneration and is taxable.

The same reasoning applies on the facts before me in respect of paragraphs 6(3)(b) and 6(3)(d). The amount received by the Plaintiff in 1982 was received by him in satisfaction of an obligation arising out of the Agreements made by the Plaintiff and Merland during the Plaintiffs employment by Merland. Thus, the payment is deemed to be remuneration during the period of employment as it can reasonably be regarded as remuneration or partial remuneration for services as an officer or under the contract of employment. The payment here at issue was made in satisfaction of an obligation arising out of the Agreements between the Plaintiff and Merland during the course of the Plaintiffs employment by Merland. I conclude that it is clear that the payment arising from the satisfaction of the obligation that arose under the Agreements was received as “remuneration or partial remuneration” for services by the Plaintiff as an officer or under a contract of employment with Merland. It is, therefore, remuneration and is taxable as such in the year in which it was received.

For the foregoing reasons, I conclude that the Plaintiffs appeal by way of trial de novo must be dismissed, with costs.

Appeal dismissed.