Robertson v. The Queen, 90 DTC 6070, [1990] 1 CTC 114 (FCA)

Marceau, J.A.:—This appeal relates to a tax assessment under the Income Tax Act. In reassessing the appellant for his 1980 taxation year, the Minister of National Revenue added to his income, as a taxable benefit, the sum of $235,500. This sum corresponded to the amount by which the fair market value of a public company's shares, acquired by the appellant in 1980 pursuant to an option which had been granted to him some years previously, exceeded the purchase price paid by him. The appellant brought an action in the Trial Division disputing the validity of this assessment. The action was dismissed, so he reiterated his attack before this Court. The issue, as will be seen, is only about the year of assessment, but it is as difficult as it is of consequence, and I could arrive at the conclusion which I adopt in these reasons only after much hesitation.

The facts may be summarized briefly. In 1974, the appellant was employed as a ranch manager supervising the ranching operations of a Mr. Jack M. Pierce. Mr. Pierce was also the president and a shareholder of an oil company, Ranger Oil (Canada) Ltd. As an inducement to the appellant to stay on as ranch manager, Pierce granted the appellant, by agreement signed October 9, 1974, an option to purchase up to 2,500 common shares he owned in Ranger Oil at $15 per share, which price approximated their fair market value at the time. The option was to become exercisable at the rate of 500 shares per year, over the next five years, subject to certain conditions, the main condition being that the appellant continue his employment.

Five years later the appellant was still Pierce's ranch manager and he had not yet exercised the greatest portion of the option. In the interim, there had been a split of the common shares of Ranger Oil, entitling him, under the agreement, to purchase 6,000 shares at a price of $3.75 per share. On September 15, 1980, he called for the shares at the aggregate price of $22,500. On that date, the 6,000 shares had a fair market value of $258,000.

There are provisions in the Income Tax Act dealing specifically with agreements to issue shares to employees. They are to be found in section 7 which reads in part as follows:

7. Subject to subsection (1.1), 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;

These special provisions, however, had no application to the case of the appellant, since his employer was not a corporation, and the Minister could not refer to them in support of his reassessment. The Minister invoked the general provisions of subsection 5(1) and paragraph 6(1)(a) of the Act, which read:

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

(i) derived from his employer's contributions to or under a registered pension fund or plan, group sickness or accident insurance plan, private health services plan, supplementary unemployment benefit plan, deferred profit sharing plan or group term life insurance policy,

(ii) under a retirement compensation arrangement, an employee benefit plan or an employee trust, or

(iii) that was a benefit in relation to the use of an automobile, except to the

extent that it related to the operation of the automobile; . . .

Two propositions were naturally implicit in the position taken by the Minister: first, that the stock option agreement had conferred on the appellant benefits constituting remuneration for his services as ranch manager; second, that these taxable benefits had accrued to him in 1980 when he had exercised the greatest part of his option and acquired the 6,000 shares.

The appellant does not take issue with the first proposition. He concedes that it can find support in the broad meaning of the words used by the legislation, especially the phrases "benefits of whatever kind” and "in respect of, in the course of, or by virtue of", which have always been seen by the courts as giving the provisions a particularly far-reaching scope (cf. The Queen v. Savage, [1983] 2 S.C.R. 428; [1983] C.T.C. 393; 83 D.T.C. 5409). He does not dispute that he received, through the agreement, benefits which were part of his remuneration and were, as such, subject to tax under subsection 5(1) and paragraph 6(1)(a) of the Act. If there is an issue there, it is not before the Court.

It is the second proposition which, in the view of the appellant, would be unsound. It is not in 1980 that the benefits were taxable, he says, it is either in 1974, the year the agreement was signed, or in each of the five following years pro tanto as the right to purchase shares accrued [1] . His submission is that when a stock option is given to an employee, and the specific provisions of section 7 of the Act do not apply, a benefit from employment is "received or enjoyed" within the meaning of paragraph 6(1)(a) of the Act when the employee first becomes legally entitled to purchase shares, and not in any subsequent taxation year during which the shares would be actually purchased by him. And the reason for that would be the one given by the majority judgment of the House of Lords in Abbott v. Philbin, [1960] 2 All E.R. 763, namely that the right to purchase the property, conveyed by the option, is in itself a valuable asset and is the only benefit related directly to the employment.

The trial judge rejected the appellant's argument. He agreed with the Minister that any taxation prior to the acquisition of the shares would have breached the basic rule that employment income be taxed in the year of receipt. Besides, he added, until the shares were actually acquired, the appellant's "right was always conditional upon the continuation of his employment", and that made taxation at any earlier date precluded by the "principle of income recognition that an amount must not be taxed as income until uncertainty about the taxpayer's entitlement to it has been removed”. As to the reference to the majority judgment in Abbott v. Philbin, the trial judge wrote as follows:

I do not consider Abbott v. Philbin to be authority for the proposition that in Canada such benefits would be taxable in the year the option was awarded and not in the year in which the option has been exercised. This 1960 House of Lords decision is based upon the wording of an English Statute which is different from the language of paragraph 6(1)(a) of the Canadian Income Tax Act. Secondly, such an interpretation is incompatible with the interpretation of the words “in respect of” by the Supreme Court of Canada in its 1983 Savage decision which gives them "the widest possible scope". Thirdly, the English decision is subject to two dissenting judgments, including Lord Denning’s and his famous pronouncement (at page 777) that “a bird in the hand is taxable, but a bird in the bush is not". Fourthly, the House of Lords in a more recent decision (1978) Tyrer v. Smart held that the gain which accrued to a taxpayer between the date of his application for shares and his acquisition of the shares was attributable to his employment and not to "numerous factors which have no relation to the office of the employee, or to his employment in it" as said by Viscount Simonds in Abbott v. Philbin.

I have reservations about the reasons given by the trial judge in support of his conclusion. First, albeit the option conferred on the appellant by the agreement was subject to certain conditions (namely: that the appellant continue in his employment and that the transfer of the shares not violate any regulations of any securities commissions, stock exchanges, or other regulatory authorities), these conditions never operated to prevent the appellant from acquiring, on the day the agreement was signed and at the end of each of the five following years thereafter, rights that were legally enforceable. There was no uncertainty about the existence of such rights. Second, the time at which an elected benefit will be seen to arise for tax purposes is not as directly and necessarily associated with the payment of money or money's worth as it is for revenue. The accounting distinction between the cash method and the accrual method is easy to apply in the area of monetary remuneration, but when non-pecuniary benefits are concerned, the distinction can become inapplicable. Third, it is true that the language of the British Income Tax Act is different from that of the Canadian Income Tax Act. Indeed, the English provision corresponding to paragraph 6(1)(a) of our Act reads as follows:

Tax under Schedule E shall be annually charged on every person having or exercising an office or employment mentioned in Schedule E, or to whom any annuity, pension or stipend chargeable under that Schedule is payable, in respect of all salaries, fees, wages, perquisites or profits whatsoever therefrom for the year of assessment after deducting the amount of duties or other sums payable or chargeable on the same by virtue of any Act of Parliament, where the same have been really and bona fide paid and borne by the party to be charged.

It should be noted particulary (as I will come back to that later) that the use of the phrase "for the year of assessment" may be of significance when it comes to the problem of relating the profits to be taxed to the services rendered by the taxpayer as an employee. I doubt, however, that the difference of language would, in itself, justify an immediate repudiation of the reasoning followed by the majority in Abbott v. Philbin, supra. As to the Tyrer v. Smart case, [1979] 1 All E.R. 321, while its disposition may be difficult to reconcile with the views of the majority in Abbott v. Philbin, it cannot be seen as having overruled the earlier decision, because it did not address the same issue. The proceedings, started before the High Court by way of stated case, posed two questions: (a) whether the benefit which had accrued to the taxpayer from a preferential right to apply for shares of his employercompany constituted an emolument from office or employment, and (b) if so, whether the value of that benefit had been accurately assesed. The lower courts answered the first question in the negative, so that the second, which could have required the consideration of the Abbott v. Philbin judgment, did not arise. When the House of Lords reversed the lower courts on the first question, the second had to be settled, but it was answered in a rather perfunctory manner:

On the question of the value of the emolument, as the commissioners heard evidence as to the value of the shares on the day that they were issued, which was the day before the market opened and was agreed to be the date on which the value of the emolument was to be assessed, their finding was clearly one of fact and I can see no grounds at all for interfering.

[Emphasis added.]

— per Lord Diplock, at page 326

The Abbot v. Philbin judgment was in no way put in question.

Thus, I must say, with respect, that the reasoning of the trial judge does not appear convincing to me. And yet I have finally come to the view that his conclusion must nevertheless be upheld.

As the trial judge quite appropriately remarked, the reasoning of the majority in Abbott v. Philbin is strongly contested by the dissenting speeches of Lord Keith and Lord Denning. For Lord Keith, "the option is an offer to be accepted or not as and when the appellant (employee) pleases, but until it is accepted, the transaction is not complete, nor has any profit been realized”. For Lord Denning, "the offer itself (the option) would not be a perquisite or profit; for it conferred only the expectation of profit, not any profit itself". My views are no different and, with respect, I adopt their reasons. I will nevertheless try to express my thinking in my own words.

The question debated is whether the benefit of an option to purchase shares at a fixed price (assuming that it is a taxable benefit) should be measured and seen to have accrued at the time of its conferral, or at the time of its exercise. In the Abbott v. Philbin case, the judgment of the majority, as I understand it, hinges on two propositions, a basic one and an alternative one. If, say the three learned law lords, a benefit can be said to have been granted at one time, more precisely when the option was given, it is not possible to speak of another benefit being granted later at another time. In any event, adds Lord Reid, even if we can speak of a benefit realized by the exercise of the option, it would not be possible to relate it directly to the employee's office [2] .

My reaction to the main proposition is this. Obviously, double-tier taxation should not be imposed on gains from a single transaction, nor should the same benefit be taxed on two occasions. We certainly cannot have two benefits of a same type, both taxable under paragraph 6(1)(a) of the Act. But, that being said, let me ask why the arrangement should necessarily be seen as conveying only a single benefit. It can hardly be contested, it seems to me, that a first benefit arises upon the employer binding himself, over a period of time, to sell shares at a fixed price, regardless of the appreciation in the market value of such shares, and a second benefit arises if and when the employee makes use of the rights flowing from the first one and exercises the option. The fact is however that while the second benefit can be measured by the discrepancy between the cost of exercising the option and the market value of the shares at the time of the acquisition, the first benefit, although a real one, eludes independent quantification. It might be suggested that the option, although formally non-assignable, could nonetheless be "turned to pecuniary account" via an arrangement between the employee and a willing third party (see the reasons of Lord Reid at page 770). But such an arrangement would not, in itself, accelerate the conferral of the second benefit, any more than borrowing against the award of a bonus could accelerate the time of its assessment from one year to another. More importantly, the measure of the benefit derived from the third-party arrangement should not be taken, or rather mistaken, for the correct measure of the employment benefit itself, which can only be made at the time of receipt of the second benefit.

As to the alternative proposition of Lord Reid, I will simply remark that its strength is linked to the special wording of the English statute and more particularly to the use of the word "for" therein, which, as noted previously, is of consequence when it comes to relating the profits to be taxed with the services rendered as employee. The language of the Canadian Act does not readily allow for the same reasoning. In any event, outside any difficulty of text, I fail to see how one can get around the fact that if the purchase of shares for an amount less than their value is possible, it is only because of the existence of a promise made by the employer to reward the services of his employee. The exercise of the option is inseparable from the signing of the agreement and the employer-employee relationship. We cannot look at the taxpayer who exercises the option as if he had owned the shares all along; the power to acquire the shares should not be confused with ownership of the shares itself. Finally, was it not here a condition of the agreement that the option be exercised before or within a few days after the end of employment: the relation with the services rendered as employee is there too made manifest.

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 therefrom. 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.

The employee who is granted an option to buy shares is in the same situation as the employee who is given the opportunity to purchase his employer’s manufactured goods at variance with their fair market value or the possibility to borrow money from his employer at a lower rate of interest. There is no fixed quantifiable benefit which flows to the first employee until he buys the shares just as there is no quantifiable benefit to the second employee until he purchases the goods or borrows the money. In all three cases, what the employee has is an offer (an offer which may be made irrevocable at will and will then usually be called "option", but remains nevertheless a simple offer), and in none of them does a quantifiable benefit arise until the offer is acted upon. It is only if and when the offer is so acted upon that a benefit may be received by the employee and become taxable as income from employment, regardless of whether the employment relationship is still in existence.

These are the reasons why I agree with the trial judge that the reassessment of the appellant by the Minister is to be upheld.

I would dismiss the appeal with costs.

Appeal dismissed.