Busby v. The Queen, 86 DTC 6018, [1986] 1 CTC 147 (FCTD)

McNair, J.:—This is an appeal by the plaintiff from the Minister’s reassessments with respect to the 1978,1979 and 1980 taxation years whereby benefits received on the exercise of certain stock options were taxed as income in the plaintiff’s hands and gains realized on the sale of the shares so acquired were similarly treated as income. Three statements of claim were filed for each of the taxation years in issue and three statements of defence were entered thereto. An order was made at the commencement of trial, pursuant to agreement of counsel, that the three cases be heard and tried together, based on common evidence.

The issue is twofold — first, whether the difference between the option exercise price and the fair market value of the shares of T.R.V. Minerals Corporation and New Minex Resources Ltd. at the time of their acquisition by the plaintiff pursuant to option is taxable as an employee benefit under section 7 of the Income Tax Act and, secondly, whether the amounts received by the plaintiff on the subsequent disposition of these optioned shares is income or capital.

The plaintiff was a Swiss girl who came to Montreal in 1969 with some educational and apprenticeship background in the travel agency business and proficiency in five languages besides her own. She met Mr. Busby and married. They had one son, Oliver. The marriage did not prosper and the spouses eventually separated and became divorced in 1977.

In 1976 the plaintiff was working for a travel agency business in Vancouver. She chanced to meet through a client a German businessman, Wolfgang Rauball, who was also experiencing marital difficulties. They became very fond of each other and developed a close personal relationship. Rauball paid her son's tuition fees, helped her with the mortgage payments on her townhouse, gave her cash and purchased groceries from time to time, bought her a car, and financed several trips to Europe for her. While they did not live under the same roof, they managed to cohabit together until their breakup in February 1980.

Rauball owned a management company known as W.R. Financial Consultants Ltd. He was also a principal shareholder in two resource corporations, T.R.V. Minerals Corporation and New Minex Ltd. In the spring of 1977, Mrs. Busby left the travel agency business to perform part-time secretarial services for W.R. Financial Consultants Ltd., without pay. The work primarily consisted of translating and typing German correspondence and documents for Rauball as occasion required, sometimes averaging two or three hours at a time on a hit or miss basis. It was the plaintiff's way of thanking Rauball for his financial assistance and many kindnesses.

In the latter part of 1976 Rauball needed a Canadian resident director for T.R.V. Minerals and New Minex and prevailed on the plaintiff to fill this role. In the beginning the plaintiff was paid no remuneration whatever for acting in the capacity of nominal director. Her compensation, whether qua director or because of her personal involvement with Rauball, took other forms.

Commencing in 1979 until in or about the month of February 1980, the plaintiff was paid a stipend of $250 a month by each of T.R.V. Minerals and New Minex for director's fee. Through 1977 and 1978 the plaintiff was called upon by Rauball to join with him in personally guaranteeing bank loans of T.R.V. Minerals and to execute a bank guarantee in respect thereof.

In consideration of this and because of their special relationship, Rauball set about to make some money for the plaintiff by way of a series of stock options.

There were three such options. The first emanated from a directors' resolution of December 6, 1977 whereby the plaintiff was granted an option to purchase 12,500 shares of T.R.V. Minerals at specified prices per share, depending on when the option was exercised. The other optionees were Rauball and his brother. The plaintiff exercised her option on December 1,1978 and acquired 12,500 shares of T.R.V. Minerals at the option price of sixty cents per share. On July 30, 1978 these shares were sold for $76,085.

The second option resulted from a directors' resolution of T.R.V. Minerals passed on March 22, 1979. The plaintiff was granted an option to purchase 27,000 shares of the company at a price of $4 per share. There were other optionees for larger numbers of shares. The plaintiff exercised her option on these shares at different times and for varying amounts over the period from October 22, 1979 to February 4, 1980. The net result was 27,000 shares of T.R.V. Minerals acquired at the option price of $4 per share. The plaintiff sold 4,000 of these shares in October 1979 for the approximate price of $39,900. Another 10,000 of these shares were sold in December 1979 for $242,825.

The third option was for the purchase of 10,000 shares of New Minex at a price of forty-six cents per share granted to the plaintiff by virtue of a directors' resolution of April 1, 1978. The resolution granted a like option to four other directors for varying numbers of shares. By resolution of March 13, 1979, 50,000 of the optioned shares were issued and allotted in the proportion of 40,000 to Rauball and 10,000 shares to Verena Busby. The plaintiff sold her New Minex shares in May 1979 for $10,394.

In all these stock options, the optionees were either designated as members of management or directors. All the funds payable on the exercise of the plaintiff's stock options were provided by Rauball to the tune of some $125,000, with one exception. He asked the plaintiff for a cheque in the sum of $52,000 to pay for the 13,000 shares of T.R.V. Minerals acquired under option on February 4, 1980. The resolutions granting the options and the other documentation required for the issue and allotment of shares were prepared by Rauball’s solicitor and submitted to Mrs. Busby for her signature. She had the utmost trust and confidence in Rauball and signed whatever he told her to. Indeed, she was not cognisant of what was transpiring with respect to the share acquisitions and dispositions under the stock option arrangement until she began to inquire about notices and communiqués received from the stockbroker. Rauball then explained that he was doing this to help her out financially.

Late in 1979 Rauball put up $80,000 to enable Mrs. Busby to purchase the assets and goodwill of Reid's Travel. This was accomplished through the medium of a new company, Hasting's Travel, in which the plaintiff and Rauball each held one share. The plaintiff soon began to devote all her attention and energy to this travel agency business. By this time her relationship with Rauball had seriously deteriorated. The final breakdown came in February 1980 and was precipitated by his demand for repayment of the $125,000 he had advanced as loan to enable her to exercise the stock options. She gave him a cheque for that amount on February 28, 1980. Sometime later the plaintiff offered $40,000 to purchase Rauball’s share in Hasting's Travel. He made a counter-offer of $5,000, which she paid. Late in the year or early in 1981, Rauball told the plaintiff that he no longer wanted her as a director of T.R.V. Minerals and New Minex and he implemented this by resorting to a written resignation which she had previously signed.

The Minister reassessed the plaintiff for her 1978, 1979 and 1980 taxation years by revising her taxable income in manner following, viz:

The plaintiff had reported her dispositions of the optioned shares as capital gains. The reassessments were arrived at by adding to her income the employee benefits attributable to the stock options, by deleting certain capital gains, and by including in income the sum of $56,980.16 as the proceeds of disposition of the shares acquired under option.

The case for the taxability of the stock options as employee benefits stands or falls on the application of section 7 of the Income Tax Act and, more particularly, paragraph 7(1)(a) and subsection 7(5) thereof, which read:

7. (1) 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.

(5) This section does not apply if the benefit conferred by the agreement was not received in respect of, in the course of, or by virtue of the employment.

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.

Moreover, it is noteworthy that subsection 7(5) specifically uses the words “the employment" without the usual coupling with the word “office" as in sections 3, 5 and 6 of the Act. In my view, it must be inferred that Parliament intended that the words “the employment" should stand alone on their own feet and without the support benefit of the extended meaning accorded the words “Employed", “Employee", and “Office" by the dictionary of section 248. The dictionary meaning given by the section to the word “employment" is:

“Employment".— “employment" means the position of an individual in the service of some other person (including Her Majesty or a foreign state or sovereign) and “servant" or “employee" means a person holding such a position;

The plaintiff’s argument is reducible to two propositions. First, there was no agreement for the sale and acquisition of shares by way of stock options. Secondly, and even if there was, the benefits thereby conferred were not received in respect of, in the course of, or by virtue of the plaintiff's employment but rather resulted primarily from the special relationship between the plaintiff and the principal shareholder of the companies concerned and secondarily as partial consideration for having guaranteed corporate loans.

In Bernstein v. M.N.R., [1977] C.T.C. 328; 77 D.T.C. 5187 (F.C.A.), the issue was whether the taxpayer was entitled to make an election for a special calculation of tax under section 85A of the former Act in respect of a stock option benefit of $99,800 arising from the redemption of preferred shares. The taxpayer and his colleague were the principal shareholders of their company and both were paid employees. The situation was the converse of the case at bar in that the taxpayer argued that he and the other controlling shareholder were bona fide employees and that the stock option benefit was received by them in respect of, in the course of, or by virtue of their employment within the meaning of subsection 85A(7), and not as shareholders. The subsection is identical to subsection 7(5) of the present Act. The Court held that the taxpayer was not entitled to the election because the benefit was received by him in his capacity as a shareholder and not by virtue of his employment. Hyde, D.J. stated the ratio at 333 (D.T.C. 5189-90) :

As subsection 85A(7) indicates, the exception provided for stock option benefits is that they be received as employees not as shareholders. That an employee may incidentally be a shareholder does not disqualify him but when it is evident, as I believe it has been shown to be the case in this instance, that the options were granted because these employees were shareholders — in fact the only ones — they cannot qualify.

Phaneuf Estate v. M.N.R., [1978] C.T.C. 21; 78 D.T.C. 6001 (F.C.T.D.), held that a benefit conferred by way of testamentary bequest that enabled the taxpayer to purchase the shares of a company at their par value, which was substantially less than the fair market value, was a personal gift conferred on the recipient as a person rather than as an employee, and that it was not a benefit in respect of which the recipient was liable for income tax as income from employment under the provisions of the Income Tax Act. Thurlow, A.C.J. reviewed the authorities comparing the corresponding provisions of the Income Tax Act and the English statute, and stated the following test at 27 (D.T.C. 6005):

. . . Is the payment made “by way of remuneration for his services” or is it “made to him on personal grounds and not by way of payment for his services”? It may be made to an employee but is it made to him as employee or simply as a person?

In The Queen v. Savage, [1983] C.T.C. 393; 83 D.T.C. 5409 (S.C.C.) the issue for determination was whether a monetary award of $300 paid to an employee of a life insurance company for successfully passing several employment-related courses was subject to income tax as a benefit in respect of employment or it was exempt from tax as a prize for achievement within the meaning of paragraph 56(1)(n). The Court held that the award was a benefit in respect of employment by reason that the words “in respect of” were words of the widest possible scope and import. Nonetheless, the Court concluded that the award was exempt from tax as “a prize for achievement in a field of endeavour ordinarily carried on by the taxpayer” and thus came within the exclusion of paragraph 56(1)(n). Dickson, J. alluded to the Phaneuf case, stating at 399 (D.T.C. 5414):

I agree that the appropriate test in Phaneuf was whether the benefit had been conferred on Mr. Phaneuf as an employee or simply as a person. It would seem that Mr. Phaneuf received, as a person, the right to acquire the shares and therefore the case was correctly decided. . . .

Further on the same page, the learned Judge made this significant statement:

. . . Distinguishing this case from Phaneuf, there was no element of gift, personal bounty or of considerations extraneous to Mrs. Savage's employment. [Emphasis added.]

Mrs. Busby would be hard put to escape the taxation net of section 7 if the only opening was restricted to the absence of an agreement. The resolutions and other corporate actions all tend to support the inference of an agreement, although not stated in so many words. The point has come up before. In Mansfield v. The Queen, [1983] C.T.C. 97; 83 D.T.C. 5136, the issue was whether an employee of a private company had obtained a taxable benefit under paragraph 7(1)(a) on the conversion of a convertible deb- enture into common shares, and Mahoney, J. had this to say at 99 (D.T.C. 5138):

“Agree” and “agreement” are not terms of art or technical expressions. I am satisfied that, in purchasing the debentures from his employer, the plaintiff obtained its agreement to convert the debenture to its shares according to its terms.

See also Smith v. M.N.R., [1969] Tax A.B.C. 217 at 220; 69 D.T.C. 192 at 194.

I must therefore approach the matter from the broader standpoint of “employee or not”. I conclude, based on the evidence in its entirety, that the benefits received by the plaintiff from the stock options were not in respect of her employment. Certainly, she was not the employee of T.R.V. Minerals or New Minex but was simply a director in name of those companies. It is true that she was admitted to be an employee, albeit unpaid, of W.R. Financial Consultants Ltd. There is no evidence whatever that the two corporations granting the stock options were not at arm's length with W.R. Financial Consultants Ltd., nor was the point even argued. In the absence of any evidence to the contrary, I am bound to conclude that the relationship between these corporations was one of “arm's length”. There is the further fact that the stock options were not granted to the plaintiff singly but comprehended as well other members of the corporate management. In my view, her employment with W.R. Financial Consultants Ltd. was nothing more than a fortuitous circumstance and not a causative factor. To conclude on this point, it is my opinion that the benefits received by the plaintiff from the stock options were not in respect of her employment but instead were received by her as a person for considerations extraneous to such employment, namely, the guaranteeing of loans and, more particularly, her special relationship with Wolfgang Rauball. The Minister's assessment of the same as employee benefits is incorrect.

The final point concerns the assessment of $56,980.16 as business income from the ultimate sale of the T.R.V. Minerals and New Minex shares.

This raises the controversial question of whether the transaction was “an adventure or concern in the nature of trade”.

The relevant statutory provisions are contained in subsections 9(1) and 248(1) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, which read:

Income from business or property

9.(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

Definitions

248. (1) In this Act,

“business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

In Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346; [1962] C.T.C. 215, 62 D.T.C. 1131 the Supreme Court of Canada, on close division, held that the substantial profit realized by the appellant on the sale of treasury shares purchased from a mining corporation and sold within a few months thereafter was a Capital gain on the realization of an investment and not income from an adventure in the nature of trade.

Martland, J., writing for the majority, put the issue thus at 349 (C.T.C. 217; D.T.C. 1132):

The issue in this appeal is as to whether an isolated purchase of shares from the treasury of a corporation and subsequent sale thereof at a profit, not being a part of the business carried on by the purchaser of the shares, or in any way related to it, constitutes an adventure in the nature of trade so as to render such profit liable to income tax.

He answered the question this way at 351 (C.T.C. 219; D.T.C. 1133):

I cannot agree that the question as to whether or not an isolated transaction in the securities is to constitute an adventure in the nature of trade can be determined solely upon that basis. In my opinion, a person who puts money into a business enterprise by the purchase of the shares of a company on an isolated occasion, and not as a part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at that time, he did not intend to hold the shares indefinitely, but intended, if possible, to sell them at a profit as soon as he reasonably could. I think that there must be clearer indications of “trade” than this before it can be said that there has been an adventure in the nature of trade.

He then pointed to Californian Copper Syndicate v. Harris (1904), 5 T.C. 159 at 165 as illustrative of the point that where the realization of securities is involved, the taxability of enhanced values depends on whether such realization was an act done in the carrying on of a business.

The learned Judge made reference to Leeming v. Jones, and concluded at 355 (C.T.C. 223; D.T.C. 1135):

The only test which was applied in the present case was whether the appellant entered into the transaction with the intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so doing. Is that a sufficient test for determining whether or not this transaction constitutes an adventure in the nature of trade? I do not think that, standing alone, it is sufficient. . . .

. . . There is, however, a general statement of principle by Lord Buckmaster, at p. 420, which aptly applies to the present case, when he says:

an accretion to capital does not become income merely because the original capital was invested in the hope and expectation that it would rise in value; if it does so rise, its realization does not make it income.

In my opinion, therefore, the appeal should be allowed . . .

In arriving at this result, the Court was of the opinion that the transaction in question did not fall within either of the two positive tests which the authorities have suggested should be applied in determining whether a transaction may fairly be called an adventure in the nature of trade. These are: (1) whether the person dealt with the property purchased by him in the same way as a dealer would ordinarily do, and (2) whether the nature and quantity of the subject matter of the transaction exclude the possibility that its sale was the realization of an investment or otherwise of a capital nature, or that it could have been disposed of otherwise than as a trade transaction.

In the recent case of Watts Estate et al. v. The Queen, [1984] C.T.C. 653; 84 D.T.C. 6564 (F.C.T.D.), the Court found on the balance of probabilities that it was the intention of the taxpayers to sell their shares from the beginning, the ground being that the transaction was highly speculative and, although isolated, was truly a venture in the nature of trade.

In the case at bar, counsel for the Crown presses the argument that the stock option aspect viewed in light of the circumstances inevitably “stamps the transaction as a trading venture”. Counsel for the plaintiff submits that there is no broad proposition of law that invests all stock option dealings with the character of speculative trading ventures and he relies strongly on Irrigation Industries Ltd. v. M.N.R., supra.

In my view, the evidence is all to the effect that these relatively isolated stock option transactions were not part of a regular business pattern but rather were of an investment and capital nature, even though made with the hope and expectation of an ultimate realisation of profit. The inference to be drawn from the evidence is that Rauball was the “mastermind” of the scheme. His purpose vis-a-vis the plaintiff was to help her financially because of their special relationship. Neither Rauball nor the plaintiff were in the business of trading in securities. The plaintiff still holds the 13,000 shares of T.R.V. Minerals that she acquired under option and paid for on or about February 4, 1980. The only other shares the plaintiff ever held, apart from the optioned shares, were those of Hasting's Travel. Applying the positive tests of Irrigation Industries Ltd. v. M.N.R., supra, it is my opinion that the plaintiff dealt with the option and the shares acquired thereby in a manner characteristic of and consistent with a capital investment and not in the way of a speculative trading in securities, and that the nature and quantity of the subject matter of the transaction were not such as to exclude the possibility that the sale of the shares was the realisation of an investment. I find therefore on the balance of probability that the gain of $56,980.16 realised on the sale of the shares was of a capital nature and not income. In the result, the taxpayer has met the burden of establishing that the Minister’s assessment was wrong.

For the foregoing reasons, the appeal is allowed with costs and the matter is referred back to the Minister for reassessment accordingly.

Appeal allowed.