Citation: 2010 TCC 648
Date: 20101221
Docket: 2008-402(IT)G
BETWEEN:
IMPERIAL TOBACCO CANADA LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bowie J.
[1] These appeals are brought from assessments for income
tax for the appellant’s two taxation years ended December 31, 1999 and February
1, 2000. The appeal for the taxation year 2000 is concerned with the
appellant’s claim that it is entitled, in computing its business income for
that year, to deduct amounts aggregating $118,575,528 as employee compensation
paid to satisfy its obligations under an employee stock option plan. The
Minister of National Revenue, in assessing the appellant, has taken the
position that the amounts are not deductible. He says that they are not amounts
paid as employee compensation at all, but rather amounts laid out by the
appellant in the course of the corporate reorganization to rid itself of an
employee stock option plan, the deduction of which is precluded by paragraph
18(1)(b) of the Income Tax Act.
That provision reads as follows:
18(1) In computing the income of a taxpayer
from a business or property no deduction shall be made in respect of
(a) …
(b) an outlay, loss or replacement
of capital, a payment on account of capital or an allowance in respect of
depreciation, obsolescence or depletion except as expressly permitted by this
Part;
[2] The appeal for
the 1999 taxation year arises out of the appellant’s claim to carry back a loss
from 2000. Its success or failure will be determined by the result in the
appeal for the taxation year 2000.
[3] The
circumstances surrounding the payments in question are described in a
comprehensive Statement of Agreed Facts, and the accompanying documents that
are referred to in it, that were filed at the opening of the trial. These were
augmented by read-ins from the examinations for discovery of both parties. Counsel
for the Respondent objected on the basis of relevance to the admissibility of
two documents at Tabs 10 and 11 of the extract from the discovery of the Respondent’s
representative herein. These summarized payments made by the appellant to
employees under various employee incentive plans. I reserved my ruling on this
objection. I have concluded that the documents should be admitted, but only as
proof of the fact that the payments were made and not as to the treatment of
those payments by the Minister, which is irrelevant to the issue before me. Indeed,
they add nothing useful to the facts agreed upon.
[4] I shall
reproduce the Agreed Statement of Facts in its entirety.
STATEMENT OF AGREED FACTS
The parties to this proceeding admit,
for the purposes of this proceeding only, the truth of the following facts:
1. The
Appellant, Imperial Tobacco Canada Limited ("ITCL"), is the successor
by amalgamation to Imasco Limited ("Imasco"). Imasco was a public
corporation and a taxable Canadian corporation for purposes of the Income Tax
Act (Canada) (the
"Act") in its taxation years ended December 31, 1999 and February 1,
2000.
2. During
the relevant period, Imasco and its subsidiaries were active in the financial services,
tobacco, drugstore, and land development industry segments.
3. At
December 14, 1999, British American Tobacco p.l.c. ("BAT") was a
public corporation which was not resident in Canada. BAT indirectly owned
42.5% of the outstanding common shares of Imasco.
4. British
American Tobacco (Canada) Limited ("BAT CAN") was incorporated on July
27, 1999 for the purpose of acquiring all of the common shares of Imasco that
BAT and its subsidiaries did not beneficially own.
5. In or
about December 1998, BAT and the Toronto Dominion Bank ("the TD")
entered into discussions with respect to the acquisition by the TD of shares of
CT Financial Services Inc. ("CTFS") then held by Imasco; the
discussions proposed that the sale of the Imasco CTFS shares to TD would be
cross-conditional with and closed immediately following BAT's acquisition of
all of the shares of Imasco held by public shareholders. These discussions
between BAT and the TD were made known to Imasco.
63 In
March of 1999, British American Tobacco plc ("BAT") approached Imasco
to discuss a proposal that BAT would acquire all of the common shares of Imasco
held by the public shareholders of Imasco.
7. On
June 7, 1999 BAT issued a news release (attached hereto at Tab 1) stating that
it was in discussions with Imasco regarding the possibility of increasing BAT's
interest in Imasco's tobacco business through a cash offer for Imasco's publicly
held common shares, but that the feasibility of such a transaction was uncertain
(including whether it could be accomplished on acceptable terms).
8. The
Imasco SOP was instituted on May 11, 1983. It was a plan under which options to
purchase Imasco shares were granted to officers and key employees of Imasco and
its subsidiaries, ("the Employees"). Article 2 of the Imasco SOP describes
the objective of the Plan as follows:
The Plan has been established to enable
certain Employees
to acquire Shares directly from the
Corporation.
9. Pursuant
to the terms of the Imasco SOP, as amended on October 27, 1995 (the amended
Imasco SOP is attached hereto at Tab 2), holders of vested options could elect
at any time to exercise their options to receive newly issued common shares of
Imasco upon payment of the exercise price. The options were not assignable by
the employees. Further, the exercise of the option was dependent upon the
employee being in the employ of Imasco at the time of exercising the rights.
10. On June
9, 1999, the Board of Directors of Imasco passed a resolution to amend Section
10 of the Imasco SOP (the amended SOP is attached hereto at Tab 3) to permit
the optionee the discretion to elect to surrender an option, in lieu of exercising
same, and to receive upon such surrender a cash payment equal to the amount of
the excess of the then market value of one Imasco common share over the
purchase price per share specified in the option multiplied by the number of shares
purchasable upon the exercise of the option surrendered.
11. On
August 2, 1999, a Transaction Proposal Agreement was entered into by BAT, BAT
CAN and Imasco proposing a revision to the proposal described in paragraph 5
hereof (the Transaction Proposal Agreement as amended and restated is attached
hereto at Tab 4).
12. On
November 18, 1999, Imasco, BAT, and BAT CAN entered into a Amending Agreement
to the Transaction Proposal Agreement (attached hereto at Tab 5) that set the
purchase price per Imasco common share at $41.60, and included a favourable
recommendation from Imasco's board of directors.
13. As
described in section 5.8 of the Transaction Proposal Agreement, Imasco agreed
that its board of directors would resolve to encourage all persons holding options
pursuant to the Imasco SOP to exercise or surrender their options immediately
prior to the completion of the proposed transaction with BAT. Imasco further
agreed that its board of directors would resolve, authorize and direct Imasco
to accelerate the vesting of options under the Imasco SOP such that all
outstanding stock options would become exercisable prior to the completion of the
transaction.
14. On
December 8, 1999, the Toronto Stock Exchange was notified of the accelerated
vesting described in paragraph 13 above and that if certain reorganization closing
steps were not completed, the accelerated vesting would be deemed never to have
occurred (the letter dated December 8, 1999 to the Toronto Stock Exchange is
attached hereto at Tab 6).
15. On
December 14, 1999, Imasco advised its shareholders of a special meeting to vote
on the proposed acquisition by BAT CAN of all of the shares of Imasco not then
owned by the BAT group (the Notice of the Special Meeting together with the
Management Proxy Circular are attached hereto at Tab 7).
16.
On December 14, 1999, Imasco
caused the vesting of those options granted under the Imasco SOP that had not
yet vested to accelerate (as described above in paragraphs 13 and 14) such that
all employee options became exercisable prior to the completion of the proposed
transaction with BAT. Such acceleration was dependent upon the completion of
all reorganization closing steps, and holders of options were encouraged, in
accordance with the Transaction Proposal Agreement, to surrender or exercise
their options on or before January 28, 2000. If the proposed transaction was
not completed, then the stock options which were vested on an accelerated basis
would revert to their former status (letters dated August 3, 1999, December 22,
1999, January 10, 2000 and January 18, 2000 from Denis Faucher to the Employees
are attached hereto at Tab 8).
17. The exercise
or surrender by the Employees of their options as at January 28, 2000 was
conditional upon the completion of the transaction.
18. On
January 28. 2000, holders of Imasco common shares voted to approve the proposed
transaction at a special meeting of shareholders held on that date.
19. In
January of 2000, optionees under the Imasco SOP holding 70,000
options exercised their options and received Imasco common shares.
20. On
January 28, 2000, Imasco employees holding 4,848,600 options in aggregate elected
to surrender their options in exchange for cash payments equal to the difference
between the closing price of Imasco shares on the TSE ($41.40) and the exercise
price of the options (the "Cash Surrender Payments"). Those employees
signed a form (attached hereto at Tab 9) that contained the following condition:
Notwithstanding the foregoing, my
Options shall be deemed never to have been surrendered if Imasco fails to complete
certain internal reorganization transactions in contemplation of the capital reorganization
as provided for in the Transaction Proposal Agreement between Imasco and
British American Tobacco p.l.c.
21. All of
the then outstanding stock options issued under the Imasco SOP were exercised
or surrendered in January of 2000. All surrendered stock options were cancelled.
22. Payments
that reflected the difference between the purchase price per Imasco share
offered by BAT ($41.60) and the TSE
closing price of Imasco shares on the date of surrender ($41.40), grossed-up to
reflect what Imasco understood to be the lack of a paragraph I10(1)(d)
deduction in respect of such payments (the "Make-Up Payments"), were
made to option holders that had elected to surrender their options in exchange
for cash payments. The total of these amounts paid to the Employees was $118 ,575,527.95.
23. Subsequent
to the closing, no more stock options were issued pursuant to Imasco's stock
option plan. There have not been any transactions or activities respecting the
SOP since the closing on February 1, 2000. The parties hereto agree that this
Statement of Agreed Facts does not preclude either party from calling evidence
to supplement the facts agreed to herein, it being accepted that such evidence
may not contradict the facts agreed.
The parties hereto agree that this
Statement of Agreed Facts does not preclude either party from calling evidence
to supplement the facts agreed to herein, it being accepted that such evidence
may not contradict the facts agreed.
[5] The appellant
argues that the payments in question here were simply payments made by Imasco
in the normal course of its business, and more specifically, in the normal
course of administering its employee stock option plan (SOP). As such, the
amounts paid were simply Imasco “settling-up” with its employees, or
“discharging liabilities that had arisen as part of its compensation
arrangements”.
To take this view of the matter one would have to consider the decision to
accelerate the vesting of unvested options, the decision to amend the SOP to
permit the holders of options the discretion to surrender them for cash, and
the cessation of the granting of options all in isolation from the going
private transaction whereby BAT Canada sought to acquire all the outstanding
shares of Imasco. To do that, however, would be to ignore the much-quoted
dictum of Lord Pearce in B.P. Australia Ltd. v. Commissioner of Taxation that the solution to cases
such as this is to be found through “a commonsense appreciation of all the
guiding features” of the case. This passage was quoted with approval (and with
emphasis added) by Estey, J., writing for a unanimous Court, in Johns-Manville
v. The Queen.
[6] In the same
paragraph Lord Pearce went on to adopt the earlier statement of Dixon J. in Hallstroms
Pty. Ltd. v. Federal Commissioner of Taxation that the answer to the
question whether an outlay is to be considered capital or current in nature
depends on
what the expenditure is calculated to effect from a practical and business
point of view rather than upon the juristic classification of the legal rights,
if any, secured, employed or exhausted in the process.
This
passage, too, was cited with approval in Johns-Manville. I am therefore
bound in deciding this case to have regard to all the “guiding features”, or
circumstances, of the case, and to determine from a practical and business
point of view what the payments in question were intended to accomplish. As I
understand it, that is what the Federal Court of Appeal did in deciding Kaiser
Petroleum Ltd. v. Canada,
the case principally relied on by the respondent in this appeal.
[7] In Kaiser,
the Federal Court of Appeal held that a payment made by the taxpayer to
extinguish an employee share option plan was a payment on capital account.
Ashland Oil Canada (AOC) was controlled by Ashland Oil Inc. (AOI), a United States
company which held about 85% of its shares. AOI agreed to sell its interest in
AOC to Kaiser Resources for $33.50 per share. AOC had a share option plan under
which employees of the company held options to purchase a total of 126,370
shares. 108,650 of these options were vested and the rest were not. The
contract for the sale by AOI of its shares to Kaiser required that AOC offer
the holders of the options the opportunity to surrender their options for a
payment of $33.50 less the option price for each option, and that the same
offer be made available to the holders of unvested as well as vested options.
The offer was made, and it resulted in the surrender and cancellation of
120,970 options for payments totaling $2,772,317. Some time later the share
option plan was cancelled. AOC (now renamed Kaiser Petroleum) sought to deduct
the $2,772,317 as employee compensation in computing its income for the year.
[8] The trial judge
held that the amount was correctly characterized as employee compensation, and
so deductible. The Federal Court of Appeal disagreed. Desjardins, J.A., writing
for a unanimous Court, referred to the question asked by Lord Pearce in B.P.
Australia:
Finally, were
these sums expended on the structure within which the profits were to be earned
or were they part of the money-earning process?
The Court went on to conclude that although compensation was the reason for
implementing the stock option plan initially, and compensation was one element
pursued when the plan was terminated:
[n]evertheless,
the compensation was made by means of a reshaping of the capital structure of
the respondent’s organization. This feature, in my view, dominates the whole
set of circumstances revealed by the evidence and constitutes the guiding
element under the test set out in the B.P. Australia Ltd. case cited
above.
[9] The appellant
placed a great deal of reliance on the decision of Bowman, C.J. in Imperial
Tobacco Canada Limited (successor by amalgamation to Shoppers Drug Mart
Limited) v. The Queen
(hereafter Shoppers Drug Mart). That case arose out of the same going private
transaction as the present case. Shoppers Drug Mart (SDM) was a subsidiary of
Imasco, and prior to the transaction in 1999 certain of its employees had
participated in the Imasco SOP. The SDM employees holding options were
encouraged to exercise or surrender their options, just as were the Imasco
employees. In January 2000, employees of SDM exercised 70,000 options. On January
28, 2000 SDM employees holding a total of 2,190,380 options chose to surrender
their options for payments that, in the aggregate, amounted to $54,984,104.
This amount was made up of the difference between the option price and the
Toronto Stock Exchange closing price for each option, plus $0.20 to make the
surrender price the same as the price at which the going private transaction
closed, grossed up by an amount to compensate the option holders for the fact
that the favourable tax treatment under paragraph 110(1)(d) of the Act
was not available to them. These amounts were paid to the SDM employees by
Imasco. SDM made a payment of $54,984,104 to Imasco to reimburse it. Bowman,
C.J. distinguished the Kaiser Petroleum case on the basis that the
payment was not made to reshape the capital structure of SDM, as was the
dominant consideration in Kaiser Petroleum.
In
the case before me, however, it was the capital structure of the taxpayer,
Imasco, that was restructured.
[10] Counsel for the
appellant sought to distinguish Kaiser Petroleum on a number of
bases.
·
The payments in the Kaiser
case were made for the purpose of the capital transaction. Ashland was
required by the purchase agreement to amend its stock option plan, to make an
offer to acquire the outstanding options, and then to cancel the plan. Imasco
only agreed to encourage the surrender or exercise of the options. The payments
were made by Imasco to satisfy obligations to its employees, not to make the
capital transaction possible.
·
In Kaiser the payments were
made to extinguish the stock option plan. Imasco was not required by the
agreement to extinguish the plan, and it has not been formally terminated.
·
In Kaiser the payments were
made to ensure the retention of key employees. In the present case the payments
were not related to employee retention.
·
In Kaiser the obligation of
Ashland to make the payments arose under the purchase agreement. Imasco
incurred and satisfied the obligation to make the payments under the terms of
the SOP.
·
In Kaiser the employees’
right to surrender their options for cash was contingent on the closing of the
capital transaction. Following the amendment of the Imasco SOP employees had
the right to surrender vested options for cash whether the going private
transaction was completed or not.
·
The option holders in Kaiser
were required to surrender their options for cash or have them terminated. The
Imasco option holders had the right to choose whether they would exercise or
surrender their options, or retain them.
·
Ashland was required by the purchase agreement to amend its
SOP to allow early vesting. Imasco’s SOP permitted early vesting and cash
surrender since 1995.
[11] These are all
distinctions without a difference. It is far from clear from the facts put
before me that the reason for making the payments to the holders of options in
this case was, as the appellant would have it, settling-up with its employees,
or discharging an obligation to them. The holders of vested options could have exercised
them, and then sold the shares on the market or tendered them to BAT on
completion of the transaction, if they had wished to do so. The directors of
Imasco might have felt that in light of the impending going private transaction,
fairness to the employees required that Imasco accelerate the vesting of
unvested options, but fairness did not require it to make the redemption
payments. It is clear from the Transaction Proposal Agreement at section 5.8
that the mutual intention of BAT and Imasco was that, so far as it was feasible
to do so, all outstanding options to purchase shares would be eliminated before
the completion of the transaction. If compensation was an element of the
decision to make the payments then nevertheless, as in the Kaiser Petroleum
case, the reshaping of the appellant’s capital structure “dominate[d] the whole
set of circumstances … and constitute[d] the guiding element …”.
[12] The real question
in each case is “what was the expenditure calculated to effect from a practical
and business point of view?” Given the timing of the amendment to the SOP on
June 7, 1999, coincident with the press release the same day by
which BAT announced that discussions were taking place, and followed on August
2, 1999 by the signing of the Transaction Proposal Agreement in which section
5.8 set out the parameters for the elimination, so far as possible, of
outstanding options, there can be no serious doubt as to what the expenditure
was calculated to effect. It was calculated to give BAT some assurance that on
completion of the going private transaction there would be few or no
outstanding options remaining in the hands of Imasco employees. If all that
Imasco intended was to settle up with its employees, as counsel contends, then
it need only have accelerated the vesting of unvested options. Employees could
then have exercised them at will.
[13] It is true that
the Imasco SOP had, since the 1995 amendment, permitted the Corporation to
accelerate the vesting of options. The important fact is that, coincident with
the going private transaction, it took the steps necessary to do so, including
obtaining approval of the Toronto Stock Exchange. It is notable that the early
vesting was conditional on the completion of the transaction, as was the exercise or
surrender by the employees of their options.
While the Imasco SOP has not been formally terminated, it has been inactive
since the closing of the going private transaction, which amounts to the same
thing.
[14] Bowman, C.J.
distinguished the Shoppers Drug Mart case from Kaiser Petroleum
solely on the basis that it was the capital structure of Imasco, not that of
SDM, that was reshaped. That distinction does not apply here, nor is there any
other. Consequently, I am bound to apply the decision in Kaiser Petroleum.
[15] Counsel for the appellant
argued that three recent decisions of this Court dealing with expenditures
arising in connection with corporate reorganizations all militate in favour of
concluding that the payments in this case were on revenue account. All of those
cases deal with situations that are significantly different from the facts of
this case and Kaiser Petroleum. As I am bound by the Federal Court of
Appeal’s decision in Kaiser, it is not necessary for me to consider the
degree to which these cases might otherwise have influenced my decision.
[16] The appeals are
dismissed, with costs to the respondent.
Signed at Ottawa, Canada, this 21st
day of December 2010.
“E.A. Bowie”
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