REASONS
FOR JUDGMENT
Smith J.
Overview
[1]
This is an appeal from reassessments made by the
Minister of National Revenue (the “Minister”) for the 2010 and 2012 taxation
years, and relates to the calculation of employment benefits received by Natale
Ferlaino (the “Appellant”) following the exercise of employee stock options
denominated in US dollars.
[2]
It is not disputed that the Appellant exercised
the stock options at a profit and that he is deemed to have received an
employment benefit in the taxation years in which they were exercised. It is
also agreed that he is entitled to a deduction equal to one-half of the benefit
for the relevant taxation year.
[3]
While it is also agreed that the Appellant was
required to report the benefit in Canadian dollars, at issue is the calculation
of the benefit in Canadian dollars.
[4]
The Appellant calculated the benefit with reference
to the exercise price of the shares converted into Canadian dollars using the
exchange rate effective the date of the grant of the stock options. The Minister
reassessed the Appellant on the basis that he should have converted the
exercise price of the shares to Canadian dollars effective on the date that the
stock options were finally exercised.
[5]
For reasons set out below, this appeal should be
dismissed on the basis that the Minister properly converted the exercise price
of the shares using the spot rate applicable on the date the stock options were
exercised.
Factual Background
[6]
The material facts are not in dispute. The
Appellant was a senior employee of Pratt & Whitney Canada (“PWC”), a
wholly-owned subsidiary of United Technologies Corporation (“UTC”), a Delaware
corporation whose shares trade on the New York Stock Exchange (“NYSE”). As a
senior employee, he received stock options to purchase shares of UTC (the “shares”
or the “securities”).
[7]
The Appellant was a resident of Quebec.
According to his testimony, he earned a Bachelor of Commerce degree at
Concordia University in 1974 and worked for a number of technology companies
including Nortel, BCE and finally PWC, where he was involved in tax compliance
and planning. He held the position of Director of taxes at PWC until his
retirement in 2012.
[8]
UTC offered stock options to key employees
through an incentive plan designed to attract, retain and motivate senior employees
of UTC and its subsidiaries, which included employees of PWC such as the
Appellant.
[9]
The plan is described in a document entitled
“2005 Long Term Incentive Plan” (the “Plan”), an attachment to a
prospectus filed with the US Securities and Exchange Commission. A copy was
provided to the Court.
[10]
The Plan provides that an “option” entitles a
participant to purchase shares of UTC at a specified price and includes a number
of relevant definitions that I would paraphrase as follows:
“Exercise
Price” - is the price fixed at the time the stock options are granted. It must
be equal to or greater than the fair market value of the UTC shares traded on
the NYSE on that day;
“Term”
- the stock options are valid for a maximum period of 10 years from the date of
the grant (though it may be less in the event of the participant’s death or
termination of employment);
“Vesting”
- an option vests and becomes exercisable at such time or times, or subject to
such terms and conditions, as are set out in the award agreement;
“Method
of Exercise” – a vested option may be exercised in whole or in part at any time
prior to its expiration date by giving notice to UTC followed by payment of the
exercise price. This may be achieved either by:
i) delivery of the UTC shares in exchange for payment of the
exercise price; or
ii) a
broker-assisted transaction in which the designated broker commits to
delivering the proceeds in satisfaction of the exercise price to UTC in
exchange for the shares issuable upon the exercise of the option.
[11]
The Appellant confirmed and it is not disputed
that the stock options that are the subject of this appeal vested after three
years and were subject to expiry after ten years from the date of the grant. In
terms of how the stock options were exercised, the Appellant had a choice
between the two methods noted above.
[12]
On December 1, 2000, he received an award letter
from UTC confirming the grant of 1000 stock options at an exercise price of
$35.25 US dollars per share and on February 4, 2002, he received a second letter
confirming the grant of 500 stock options with an exercise price of $33.495 US
dollars per share.
[13]
As explained by the Appellant during his
testimony, one of the advantages of receiving stock options was that the
exercise price was locked-in from the date of the grant for a period of up to
ten years but he was not required to advance any capital at any time. He viewed
this as the equivalent of an interest-free loan.
[14]
The UTC shares eventually increased in value
and, with the expiry date approaching (in both instances), the Appellant
decided to lock-in his gains.
[15]
Since he preferred not to hold the shares for
investment purposes, he chose to exercise the stock options using the second
method noted above (which he described as a “cashless” exercise), using the
services of the designated broker known as UBS, a Swiss-based investment dealer
with operations in the US.
[16]
The Appellant had access to an online account
and was able to enter trading instructions. The net effect of the cashless
exercise was that a sufficient number of treasury shares were issued by UTC,
delivered to the designated broker and immediately sold according to
instructions given by the Appellant.
[17]
Following the date of settlement of the order,
the designated broker would issue a cheque to UTC representing the “Exercise
Price”, and the balance of the proceeds of sale, net of transaction costs, was forwarded
to the Appellant.
[18]
On April 26, 2010, the Appellant completed a
cashless exercise of 1000 stock options, acquiring UTC shares at $35.25 US
dollars per share and immediately selling them at $75.75 US dollars per share.
[19]
On January 25, 2012, he completed a cashless
exercise of 500 stock options, acquiring UTC shares at $33.495 US dollars per
share and immediately disposing of them in the open market at $78.60 US dollars
per share.
[20]
During cross-examinations, it became apparent
that the Appellant was unable to produce a copy of the cheque or transaction
slip from UBS or to provide any other form of evidence as to the amount
actually received.
[21]
Counsel for the Appellant argued that since the
material facts were not in dispute, there was no need to attempt to obtain and
provide such documentation. I accept this explanation but will provide further
comments below.
[22]
During examination in chief, the Appellant
explained his understanding of the cashless exercise and it was apparent that
he viewed the granting of the stock options as one transaction and the process
of acquiring and selling the shares as another transaction:
Q: Let’s
get back to the tax treatment that you used in terms of essentially declaring
or reporting a benefit, a tax benefit earned under the stock option plan:
A: .
. . So when I exercised my shares, the options, in my opinion, it is a matter
of how do I calculate the employment benefit? Well, the employment benefit is
in Canadian dollars and I must use exchange rates applicable on the exercise
date, which is when I exercised and sold. And we use the term a cashless
exercise, meaning when I went online and I exercised the options, there was no
cheque that I issued for the grant price and everything was done; it was sold. And
then UBS, the broker, issued two cheques, one to UTC for the grant price, and
one to me for the net amount.
. . .
Q: And
as for the tax revenues?
A: .
. . in calculating that employment benefit I compared the selling price of the
shares, as I exercised and sold, in US dollars at the exchange rate on the date
that the shares were sold and exercise, and I compared that to the price or the
cost of acquiring those shares, the options, using the grant price and the
exchange rate on the date that the options were granted.
And to me, that is
critical and it’s important to note that the employment benefit calculation is
in Canadian dollars and must look at – there’s two events, two taxable events,
two tax transactions that we’re talking about. Not one as the Minister has
reassessed me, but two. One is what is my cost? And for purposes of Canada my
cost is in Canadian dollars and the only relevant spot rate is the rate of the
year 2000 when the options were granted. And the second transaction is when I
exercised and sold.
[23]
On the basis of the Appellant’s understanding
that the granting of the stock options was one transaction and the exercise of
the options and sale of the shares was another transaction, he completed his income
tax return for the 2010 taxation year reporting the following transaction:
|
|
Result in US dollars
|
Declared for 2010
|
|
Proceeds of Disposition
|
US$75,750.00
|
CAD$75,682.00*
|
|
Exercise price
|
US$35,250.00
|
CAD$54,124.00**
|
|
Net proceeds of Sale
|
US$40,500.00
|
CAD$21,558.00
|
* @ Exchange rate of 0.9991
** @ Exchange rate of 1.53545
[24]
The Appellant used the same methodology to
complete his income tax return for the 2012 taxation year and reported employment
income calculated as follows:
|
|
Result in US dollars
|
Declared for 2012
|
|
Proceeds of Disposition
|
US$39,300.00
|
CAD$39,821.00*
|
|
Exercise price
|
US$16,747.50
|
CAD$26,695.00**
|
|
Net proceeds of Sale
|
US$22,552.50
|
CAD$13,126.00
|
* @
Exchange rate of 1.0132619
** @ Exchange rate of 1.59401185
[25]
In both instances, he calculated his cost base
with reference to the Canada/US exchange rate in effect on the date the stock
options were granted and his proceeds of sale on the basis of the Canada/US
exchange rate in effect on the date of exercise. The Minister reassessed the Appellant
for both the 2010 and 2012 taxation years on the basis that he was required to
report the actual cost of the securities acquired and converted into Canadian
dollars using the Canada/US exchange rate in effect on the date the stock
options were exercised.
[26]
The Minister took the position that the appropriate
Canada/US exchange rate on April 26, 2010 was 0.9984, resulting in employment income
of $40,435, and the Appellant was reassessed accordingly.
[27]
The Minister also took the position that the appropriate
Canada/US exchange rate on January 25, 2012 was 0.9956, resulting in employment
income of $22,451, and the Appellant was reassessed accordingly.
[28]
In both instances, the Minister was of the view
that the Appellant was entitled to a corresponding deduction equal to one-half
or 50% of the employment benefit, pursuant to paragraph 110(1)(d) of the
Income Tax Act
(the “ITA”).
The Appellant’s position
[29]
The Appellant acknowledges that any gain arising
from the exercise of employee stock options is deemed to be an employment benefit
but he argues that the benefit received on the date of the grant of the stock
options is suspended until such time as they are exercised.
[30]
He argues that his employment gain is to be
calculated as the difference between i) the value of the securities at the time
he exercised his stock options (which refers to the market value of the UTC
shares on the NYSE on the date of exercise) and ii) the amount paid or to be
paid for the securities (which refers to the exercise price) as set out in the
stock option agreement.
[31]
He argues that the amount set out in the option
agreement is fixed in time and that he must ascertain that amount for tax
purposes, using the Canada/US exchange rate effective on the date of the grant.
[32]
The Appellant finds support for this argument in
paragraph 110(1.5)(a), which provides that the exercise price of stock
options “shall be determined without reference to any change in the value of a
currency of a country other than Canada, relative to Canadian currency,
occurring after the agreement was made”. He argues that Parliament has
expressed the view that any changes in the Canada/US exchange rate occurring
after the date of the grant are to be ignored and that this is consistent with his
view that the benefit is suspended until the date of exercise.
[33]
The Appellant acknowledges that he is required
to report his Canadian tax results for the taxation year in Canadian currency. He
finds further support for his position in paragraph 261(2)(b), which
provides that “if a particular amount that is relevant in computing those
Canadian tax results is expressed in a currency other than Canadian currency,
the particular amount is to be converted to an amount expressed in Canadian
currency using the relevant spot rate for the day on the particular amount
arose.”
[34]
The Appellant argues that the time when “the
particular amount arose” is when the stock options were granted and that is the
appropriate time to calculate the cost base of the shares by converting the
exercise price expressed in US dollars to Canadian dollars by referring to the
relevant spot rate on that date.
[35]
The Appellant also refers to the French version
of paragraph 261(2)(b) and the expression “selon le taux de change au
comptant affiché le jour ou elle a pris naissance” to emphasize the point that
he must calculate his Canadian tax results from the time the stock options were
granted.
The Respondent’s position
[36]
The Respondent argues that the relevant date to
determine the cost base of the shares is when the stock options are exercised,
and that this is apparent on the plain reading of paragraph 7(1)(a),
adding that Parliament has expressed the view that until such time as the stock
options are exercised, an employee is deemed neither to have received nor enjoyed
any benefit.
[37]
The Respondent argues that the reference to
Canadian currency in paragraph 110(1.5)(a) and to changes “occurring
after the agreement was made” is simply to ensure that stock options that are
out-of-the-money (where the exercise price is at or above the market value of
the underlying stock) are not found to be in-the-money as a result of currency
exchange fluctuations occurring after the date of the grant (such as when the
Canadian dollar is trading above the US dollar).
[38]
The Respondent adds that employment income,
including employment benefits that may arise from the exercise of employee
stock options, are taxed on a cash basis in the year they are received and not
on an accrual basis.
[39]
Since the expression “Canadian tax results” is defined
in paragraph 261(1)(a) as “the amount of income, taxable income . . . of
the taxpayer for the taxation year”, the Appellant was not required to report
any income relating to the stock options until the taxation year when they were
exercised.
[40]
On the basis of the above, the Respondent argues
that the cost base of the shares must be determined in the taxation year when
the stock options were actually exercised, using the spot rate applicable at
that time.
The Law and Analysis
A. Employee
stock options taxable as an employment benefit
[41]
Sections 5 to 8 (located in Part I, subdivision (a)
of the ITA) deal with the computation of income from an office or employment. While
section 5 refers to “salary, wages and other remuneration including gratuities”,
section 6 provides for the taxation of a broad variety of employments benefits.
[42]
Stock options granted to employees are also
treated as an employment benefit but dealt with separately in section 7. It
provides as follows:
7. (1)
Agreement to issue securities to employees —
Subject to subsection (1.1), where a particular qualifying person has agreed to
sell or issue securities of the particular qualifying person (or of a
qualifying person with which the particular qualifying person does not deal at
arm’s length) to an employee of the particular qualifying person (or of a
qualifying person with which the particular qualifying person does not deal at
arm’s length),
(a) if the employee has acquired securities under the
agreement, a benefit equal to the amount, if any, by which
(i) the value of the securities at the time the employee acquired
them
exceeds the total of
(ii) the amount paid or to be paid to the particular qualifying
person by the employee for the securities, and
(iii) the amount, if any, paid by the employee to acquire the right
to acquire the securities
is deemed to have been received, in the taxation year in which the
employee acquired the securities, by the employee because of the employee’s
employment;
. . .
7. (3)
Special provision — If a particular qualifying
person has agreed to sell or issue securities of the particular person, or of a
qualifying person with which it does not deal at arm’s length, to an employee
of the particular person or of a qualifying person with which it does not deal
at arm’s length,
(a) except as provided by this section, the employee is
deemed to have neither received nor enjoyed any benefit under or because of the
agreement; and
[My
emphasis.]
[43]
As a general rule, employment income and
benefits are taxed on a cash basis and must be reported in the taxation year in
which they are received.
[44]
This is also apparent from a reading of
paragraph 7(1)(a), which begins with the words “if the employee has
acquired securities under the agreement,” followed by a formula for the
calculation of the employment benefit. The word “if” speaks to the timing of
the receipt of the securities following the exercise of the stock options. If
the stock options are not exercised, there is no benefit.
[45]
In other words, section 7 defers the recognition
of the employment benefit derived from the granting of stock options until such
time as it is quantifiable: see Rogers Estate v R., 2014 TCC 348 at
paragraphs 28 and 29.
[46]
Any doubt as to whether an employee has received
a taxable benefit effective the date of the grant of the stock options is
resolved by a reading of paragraph 7(3)(a). It provides that an employee
is “deemed to have neither received nor enjoyed any benefit under or because of
the agreement”. Any perceived economic benefit is to be ignored for tax
purposes.
[47]
This is not to suggest that the Appellant had
not received an economic advantage when the stock options were granted to him. As
acknowledged in his testimony, the stock options provided him with the
opportunity of locking-in the price of the UTC shares for up to ten years
without advancing any capital. There was of course a certain risk (and I use
the word “risk” loosely since it did not involve a loss of invested capital)
that the stock options would not vest (for example, if he left his employment
prior to vesting) or that they would expire worthless if the market value declined
below the exercise price prior to expiry.
[48]
While the Appellant clearly received an economic
advantage when the stock options were granted to him, the question is whether
he received a taxable benefit. The response to this is that Parliament has
decided, for policy reasons, that employee stock options are not taxable as an
employment benefit until such time as they are exercised. As indicated by Hogan
J. in Rogers Estate, supra:
38. . . . A textual, contextual and purposive reading of section 7 of
the Act leads me to conclude that this provision is meant to provide a complete
code for the taxing of benefits arising under or because of a stock option
agreement. The text of paragraph 7(3)(a) is clear and unambiguous: it
deems an employee to have neither received nor enjoyed any benefit under or
because of a stock option agreement, except as provided by that section.
[49]
I agree that section 7 is intended as a complete
code for the taxation of employee stock options. Other cases have similarly
concluded that the benefit that arises under this section is to be calculated
from the moment a taxpayer obtains legal ownership or the incidence of legal
ownership in and to the shares: See Steen v Canada, [1987] 1 FC 139 at
paragraph 29, confirmed on appeal to the Federal Court of Appeal and: Steen
v R., [1988] 1 C.T.C. 256, where Hugessen JA, for the Court stated:
3. The appellant argues that “the value of the shares at
the time he acquired them” is the option price. He is plainly wrong. He acquired
the shares only at the time he exercised the option, not when it was granted. There
is no basis for thinking that their value then was any different from that of
all other outstanding shares of the same class . . . it is the price freely
established on the Exchange on the date of acquisition . . .
[50]
The decision of Mathieu v Canada, 2014
TCC 207 (at paragraphs 48 and 49) cited by the Appellant and the decision of Van
de Velde v Canada, 2007 TCC 533 (at paragraph 11) cited by the Respondent
both support the proposition that the appropriate date to quantify the benefit is
at the date of exercise.
[51]
While the express terms of the stock option
agreement (notably the exercise price, vesting, expiry, method of exercise) are
critical from a contractual point of view, we need to look at the legislation to
determine how the benefit that arises from the exercise of the stock option is
to be calculated for tax purposes.
[52]
In my view, there is nothing in section 7 that
suggests that the cost base of the shares should be established as of the date of
the grant of the stock options. On the contrary, I am of the view that the
words “the amount paid or to be paid . . . for the securities”, as
set out in subparagraph 7(1)(a)(ii), refer to the amount actually paid
to UTC on the date when the stock options were exercised.
[53]
I find that this conclusion is consistent with
the notion that employment income is taxed on a cash basis and not on an
accrual basis. If the cost base of the shares was fixed for tax purposes effective
the date of the grant of the stock options, there would in fact be an accrual
of the benefit from that date.
[54]
The Appellant, while acknowledging that section
7 defers the recognition of the employment gain until the date of exercise, has
argued that there was nonetheless a benefit but that it was suspended until the
date of exercise.
[55]
Before addressing the argument that the benefit
was “suspended” from the date of grant to the date of exercise, a further point
needs to be made to emphasize the distinction between employment income and
capital gains treatment. Where shares are acquired as a result of the exercise
of stock options and retained for investment purposes, the deemed employment
benefit is used to determine the adjusted cost base of the shares for capital
gains purposes.
[56]
Paragraph 53(1)(j) (located in Part I,
subdivision (c) of the ITA, dealing with taxable capital gains and
losses) provides for an adjustment to the adjusted cost base of shares acquired
as a result of the exercise of employee stock options:
53(1)
Adjustments to cost base — In computing the
adjusted cost base to a taxpayer of property at any time, there shall be added
to the cost to the taxpayer of the property such of the following amounts in
respect of the property as are applicable:
. . .
(j) share or fund unit taxed as stock option benefit —
if the property is a security (within the meaning assigned by subsection
7(7)) and, in respect of its acquisition by the taxpayer, a benefit was
deemed by section 7 to have been received in any taxation year that ends
after 1971 and begins before that time by the taxpayer or by a person that did
not deal at arm’s length with the taxpayer or, if the security was acquired
after February 27, 2000, would have been so deemed if section 7 were read without
reference to subsections 7(1.1) and (8), the amount of the benefit that was,
or would have been, so deemed to have been received;
[My
emphasis.]
[57]
Therefore, had the Appellant decided to exercise
his stock options and acquire the UTC shares for investment purposes, the
employment benefit deemed to have been received by virtue of section 7 would have
been added to the exercise price for the computation of the adjusted cost base
of the shares. Were this not the case, the employment benefit, together with any
further increase in the value of the shares following the exercise date, could
be taxed again as a capital gain.
[58]
The Appellant referred the Court to the
so-called “Gaynor principle” derived from the decision of Gaynor v Canada (Minister
of National Revenue),
which dealt with a situation where US shares, acquired in a US dollar account,
were eventually disposed of, triggering a gain. The taxpayer converted the capital
gain (the difference between the cost of the shares and the proceeds of
disposition) using the average Canada/US exchange rate for the taxation year of
disposition and reported a capital gain in Canadian currency on that basis.
[59]
Sarchuk J. held that the cost base of the US
securities was to be determined with reference to the exchange rate at the time
of acquisition rather than the exchange rate at the date of disposition. This
decision was confirmed on appeal by the Federal Court of Appeal in Gaynor v Canada
(FCA),
where Pratte J.A held:
. . . the cost of
the securities to the appellant must be expressed in Canadian currency at the
exchange rate prevailing at the time of their acquisition while the valuation
of the proceeds of disposition of the same securities must be made in the
Canadian currency at the rate of exchange prevailing at the time of
disposition.
[60]
The Appellant has argued that the Gaynor decision
was correctly decided and that it supports his position that the benefit
accrues to him from the date of the grant but that it is suspended until such
time as the stock options are exercised.
[61]
I am far from being convinced that this is a
proper application of the Gaynor principle for the simple reason that, as
indicated above, while the recipient of employee stock options may have
received an economic advantage or benefit on the date of the grant, Parliament has
decided, for policy reasons, that there is a deferral of that benefit until it
is quantifiable; that is, until such time as the stock options are exercised. Any
other benefit is to be ignored for tax purposes.
[62]
The Appellant cannot have his cake and eat it
too. Having reported the gain from the exercise of his stock options as an
employment benefit and claimed the one-half deduction provided for in paragraph
110(1)(d), he cannot then superimpose capital gains treatment by tracking
his adjusted cost base using the exchange rate on the date of the grant as if
he had acquired capital property.
[63]
I would conclude this analysis with the
observation that employee stock options must not be confused with publicly
traded stock options (taxable under section 39 and more specifically under
section 49). Although both are derivative instruments in the sense that their
value is inextricably linked to the value of a publicly traded security, the
latter stock options are actually purchased and their adjusted cost base is
established as of the date of acquisition. While such stock options are valued
on the basis of intrinsic value (whether the exercise price is below the market
value) and time value (the time remaining to expiry), the net effect of paragraph
7(3)(a), consistent with the authorities cited above, is that employee
stock options have no value for tax purposes until they are exercised.
[64]
Even if the Appellant had paid some money to UTC
in exchange for the stock options on the date of the grant, he would still not
be entitled to capital gains treatment, though he would, by virtue of
subparagraph 7(1)(a)(ii), be entitled to deduct that amount in the
calculation of his employment benefit.
B. Does
paragraph 110(1)(d) change anything?
[65]
While the gain arising out of the exercise of employee
stock options is taxed as an employment benefit under section 7, paragraph
110(1)(d) provides a deduction equal to one-half of the gain where
certain conditions are met. It provides as follows:
110 (1)
Deductions permitted — For the purpose of computing
the taxable income of a taxpayer for a taxation year, there may be deducted
such of the following amounts as are applicable
(d) Employee options — an amount
equal to 1/2 of the amount of the benefit deemed by subsection 7(1) to have
been received by the taxpayer in the year in respect of a security that a
particular qualifying person has agreed after February 15, 1984 to sell or
issue under an agreement, or in respect of the transfer or other disposition of
rights under the agreement, if
(i) the security was acquired under the agreement by the taxpayer or
a person not dealing at arm’s length with the taxpayer in circumstances
described in paragraph 7(1)(c),
. . .
(ii) where rights under the agreement were not acquired by the
taxpayer as a result of a disposition of rights to which subsection 7(1.4)
applied,
(A) the amount payable by the taxpayer to acquire the security
under the agreement is not less than the amount by which
(I) the fair market value of the security at the time the
agreement was made
exceeds
(II) the amount, if any, paid by the taxpayer to acquire the right
to acquire the security, and
[My
emphasis.]
[66]
Although a stock option benefit realized as of
the date of exercise is initially taxed as an employment benefit, the net
effect of this provision is that “the stock option benefit is taxed like a
capital gain in terms of its inclusion rate, but it is not characterized as a
capital gain so it is not eligible for the capital gains exemption and it
cannot be offset by a capital loss.”
[67]
As noted above, the availability of this
provision requires that a number of conditions are met (i.e., that the
employee be at arm’s length with the employer, that the shares are prescribed
shares, etc.), one of which is that the market value of the securities is equal
to or greater than the exercise price set out in the stock option agreement at
the time of the grant. I note that the statutory language set out in
subparagraph 110(1)(d)(ii) meshes with the definition of the “Exercise
Price” set out in the Plan, as indicated above.
[68]
Where this condition is met, stock options are
said to be “out-of-the-money” (a term that also applies to publicly traded
options). Absent this condition, there would be nothing to prevent an employer from
granting in‑the‑money stock options (or what are known as “deep” in-the-money
stock options), thus conferring an immediate benefit on an employee.
[69]
The recent case of Fettes v R., 2015 TCC
198, illustrates the point. It dealt with a situation where stock options,
initially priced above market value and thus out-of-the-money, were later
repriced below market value and exercised by the taxpayer prior to his
retirement. Miller J. found that while the taxpayer had realized an employment
benefit pursuant to subsection 7(1), he was not entitled to the capital gains
treatment contemplated by paragraph 110(1)(d).
[70]
Where, as in this case, employee stock options
are denominated in a currency other than Canadian currency, subsection 110(1.5)
provides that:
110 (1.5)
Determination of amounts relating to employee security options —For the purpose of paragraph (1)(d),
(a) the amount payable by a taxpayer to acquire a security
under an agreement referred to in subsection 7(1) shall be determined without
reference to any change in the value of a currency of a country other than
Canada, relative to Canadian currency, occurring after the agreement was made;
[71]
Considering the use of the words “for the
purpose of paragraph (1)(d)”, it is apparent that this provision seeks
to eliminate a situation where, although the exercise price is equal to or below
the market value of the security on the date of the grant, a benefit has
accrued to an employee as a result of currency fluctuations occurring after the
grant of the stock options.
[72]
As a result, I agree with the Respondent that
the deduction of one-half the employment benefit made available under paragraph
110(1)(d) is only available where the exercise price of the stock option
is set at a price that is above the fair market value of the stock at the time
it is granted and that the purpose of paragraph 110(1.5)(a) is to ensure
that stock options that are out-of-the-money when they are granted, are not,
through no fault of the taxpayer, later found to be in-the-money as a result of
currency fluctuations occurring after the date of the grant.
[73]
Moreover, since I have already concluded that
section 7 provides a complete code for the taxing of employment benefits
arising out of the exercise of stock options, there is nothing that compels me
to agree with the Appellant’s suggestion that paragraph 110(1.5)(a)
somehow relates to the expression “the amount paid or to be paid . . . by the
employee for the securities” in subparagraph 7(1)(a)(ii) and suggests
that the exercise price should be converted into Canadian dollars using the
exchange rate effective as of the date of the grant.
[74]
While the Appellant has argued that Parliament
has filled a gap in section 7, which is a situation where securities are
denominated in a currency other than Canadian currency, there is nothing in the
statutory language of paragraph 110(1)(d) to suggest that it needs to be
considered for any other reason than to determine whether the taxpayer is
entitled to the one-half deduction.
[75]
The Appellant referred to Canadian Occidental
U.S. Petroleum Corp v The Queen,
but I do not think that decision is particularly relevant, as it dealt with the
non-binding nature of departmental or technical interpretations and a situation
where the Minister had effectively inserted words into a statutory provision. In
this instance, the Minister has merely calculated the Appellant’s employment
benefit following the plain and ordinary language of paragraph 7(1)(a). No
words have been inserted nor is there any need to do so.
C.
Obligation to report Canadian tax results
[76]
Subsection 261(2) of the ITA requires that any
amount that is expressed in another currency be converted into Canadian dollars
for Canadian income tax purposes. It provides as follows:
261(2)
Canadian currency requirement — In determining the
Canadian tax results of a taxpayer for a particular taxation year,
(a) subject to this section, other than this subsection,
Canadian currency is to be used; and
(b) subject to this section, other than this subsection,
subsection 79(7) and paragraphs 80(2)(k) and 142.7(8)(b), if a
particular amount that is relevant in computing those Canadian tax results is
expressed in a currency other than Canadian currency, the particular amount
is to be converted to an amount expressed in Canadian currency using the
relevant spot rate for the day on which the particular amount arose.
[My
emphasis.]
[77]
Since the Appellant has also referred me to the
French equivalent, I reproduce it here:
261(2) Monnaie
canadienne — exigences Les règles ci-après
s’appliquent au calcul des résultats fiscaux canadiens d’un contribuable pour
une année d’imposition :
a) sous réserve du présent article, à
l’exception du présent paragraphe, la monnaie à utiliser est le dollar
canadien;
b) sous réserve du présent article, à
l’exception du présent paragraphe, du paragraphe 79(7) et des alinéas 80(2)k)
et 142.7(8)b), toute somme prise en compte dans le calcul de ces
résultats qui est exprimée dans une monnaie autre que le dollar canadien est
convertie en son équivalence en dollars canadiens selon le taux de change au
comptant affiché le jour où elle a pris naissance.
[My emphasis.]
[78]
Subsection 261(1) of the ITA also provides the
following definitions:
261 (1)
Definitions — The following definitions apply in
this section.
“Canadian tax
results” of a taxpayer for a taxation year means
(a) the amount of the income, taxable income or taxable
income earned in Canada of the taxpayer for the taxation year;
(b) the amount (other than an amount payable on behalf
of another person under subsection 153(1) or section 215) of tax or
other amount payable under this Act by the taxpayer in respect of the taxation
year;
(c) the amount (other than an amount refundable on behalf of
another person in respect of amounts payable on behalf of that person under
subsection 153(1) or section 215) of tax or other amount refundable under this
Act to the taxpayer in respect of the taxation year; and
(d) any amount that is relevant in determining the amounts
described in respect of the taxpayer under paragraphs (a) to (c).
(résultats fiscaux canadiens)
“relevant spot
rate” for a particular day means, in respect of a
conversion of an amount from a particular currency to another currency,
(a) if the particular currency or the other currency is
Canadian currency, the rate quoted by the Bank of Canada for noon on the
particular day (or, if there is no such rate quoted for the particular day,
the closest preceding day for which such a rate is quoted) for the exchange of
the particular currency for the other currency, or, in applying paragraphs (2)(b)
and (5)(c), another rate of exchange that is acceptable to the Minister;
and
[My
emphasis.]
[79]
Subsection 261(2) refers to a taxpayer’s obligation
to report his or her “Canadian tax results” for a particular taxation year in
Canadian currency but paragraph 261(2)(b) provides that the day on which
the taxable amount arose determines the appropriate exchange rate that should
be used.
[80]
The question is when did the particular amount
arise? The Appellant argues that we need to look back in time to determine the
genesis or source of that amount. He concludes that it was on the date of the grant
of the stock options.
[81]
The Appellant relies on Agnico-Eagle Mines
Limited v The Queen, 2014 TCC 324, a decision of Woods J. In that case, Agnico
had issued convertible debentures with a face value of $1,000 US dollars, convertible
into a fixed number of common shares that traded on the NYSE.
[82]
The debentures were issued on February 15, 2002
and converted into common shares in 2005. The main issue was whether Agnico had
realized currency gains when the debentures were converted into common shares.
[83]
Woods J. reviewed the requirements of subsection
261(2) and the need to translate the amounts into Canadian dollars “using the
relevant spot rate for the day on which the particular amount arose”. She concluded
at paragraph 61 and 62 of her decision that the appropriate date was when the
convertible debentures were issued in 2002 (when the spot rate was 1.588
Canadian dollars) since that reflected the true consideration received.
[84]
The Appellant points out that the Canada/US
exchange rate in effect when the debenture was issued was applied in Agnico even
though the conversion to common shares took place at a later date (in 2005) and
suggests that this supports his position that the appropriate time to determine
the cost base of the stock options is on the date that they were granted.
[85]
I find that this decision does not assist the
Appellant since Agnico had actually received $1,000 US per debenture in
February 2002, whereas in this instance, the Appellant received the stock
options as part of an incentive plan, without advancing any monetary
consideration whatsoever.
[86]
It is clear that there will be situations where
the “particular amount” described in paragraph 261(2)(b) will have
arisen at some point in time that predates the actual taxation year when the
taxpayer is required to determine his “Canadian tax results”. But that is no
different from the principle established in Gaynor, supra, that the
adjusted cost base of a capital property must be tracked in Canadian dollars
from the date of acquisition.
[87]
I conclude that “the day on which the particular
amount arose” for the purposes of paragraph 261(2)(b) was when the
Appellant exercised his stock options, that is, the date on which he acquired
the UTC shares and simultaneously disposed of them. Since the process of a
cashless exercise allowed him to complete both transactions on the same day,
that determines the appropriate spot rate.
Conclusion
[88]
I indicated above that I would comment on the
lack of documentation to confirm the net proceeds of disposition actually
received by the Appellant following the exercise of the stock options.
[89]
While I am tempted to conclude that the Appellant
was simply “caught in the tangled web of complicated tax legislation” (Fettes,
supra, at paragraph 23), I feel compelled to state that I have some
difficulty with the fact that the net proceeds of sale received by him
following the cashless exercise differ materially from the amounts reported for
the taxation years in question. This must have been obvious to the Appellant
and should have raised a red flag.
[90]
I conclude by thanking counsel for their able submissions.
[91]
The Appeals are dismissed without costs.
Signed at Ottawa,
Canada, this 28th day of April 2016.
“Guy Smith”
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