Michael K. Taylor v. Minister of National Revenue, [1988] 2 CTC 2227, 88 DTC 1571

Rip, T.C.J.:—Michael K. Taylor, the appellant, appeals from notices of reassessment for the 1980 and 1981 taxation years issued by the Minister of National Revenue, the respondent. The respondent assessed on the basis that since the appellant was a director of two corporations the shares he received from the corporations under option agreements were received by him by virtue of his employment in accordance with paragraph 7(1)(a) of the Income Tax Act ("Act"). Furthermore, certain shares (sometimes referred to as "escrowed shares") received from one of the corporations in consideration of mining claims the appellant transferred to it, which shares were held pursuant to an escrow agreement, and the shares in that corporation purchased in accordance with the option agreement with that corporation were determined by the respondent to be identical properties and in computing capital gains and losses realized by Mr. Taylor in 1980 and 1981 the respondent held that the adjusted cost base of all the shares in that corporation were the same.

At all relevant times Mr. Taylor was a petroleum engineer who, through a corporation in which he was sole shareholder, provided consulting services to a number of resource companies, in particular in British Columbia. Two of these companies were Bianca Resources Limited (“Bianca”) and Greenwood Explorations Limited ("Greenwood"). Mr. Taylor subsequently became a director of Bianca on April 27, 1979, and Greenwood on May 28, 1980, and received stock options in each of the two corporations.

Bianca granted him an option on April 27,1979 to acquire 50,000 shares of the company at $2.70 per share on or before April 27, 1980. The appellant exercised his right to purchase 20,000 shares on March 3, 1980, and 30,000 shares on March 10, 1980, the values of each share on those dates were $5.40 and $4.40 respectively.

Greenwood granted the appellant an option to acquire shares on May 28, 1980, which was cancelled on June 30, 1980, and replaced on the same day with another option granting Mr. Taylor the right to acquire 15,000 shares of the company at $3.75 per share on or before June 30, 1982. The appellant exercised this option on January 8, 1981, when the value of each share was $16.50.

In his capacity as a director of each corporation, the appellant attended directors' meetings, voted on resolutions of the Boards and generally performed the duties of his offices, albeit at a minimum level. As a director, Mr. Taylor had statutory responsibilities. Mr. Taylor testified - and there was no evidence or any suggestion to the contrary - that he was appointed to the Board of Directors of each of the two companies because each of Bianca and Greenwood desired to enhance its reputation by being associated with him.

In addition to the share option agreements Mr. Taylor also received 50,000 shares in Bianca from Treasury in consideration for several mining claims which Mr. Taylor owned and transferred to Bianca. These shares were subject to an escrow agreement. The escrow agreement provided, inter alia, that the appellant was prohibited from dealing with the shares in any manner without the consent of the Superintendent of Brokers of British Columbia, although he did retain the rights to vote his shares and receive any non-share dividends accruing thereto. But, more importantly, the escrow agreement also provided that should the company fail to acquire title to the aforementioned mining claims, or should the claims diminish in value, or the company discontinue development of them, then the shares were to be tendered to the company by way of gift. There was, however, no evidence as to the likelihood of this occurring.

Benefits by Virtue of Employment

The respondent submits that he has correctly included the stock option benefits from Bianca by virtue of Mr. Taylor's employment with Bianca and Greenwood respectively in accordance with paragraph 7(1)(a) of the Act. In the respondent's view, Mr. Taylor was director of Bianca and Greenwood and received stock option benefits by virtue of his employment as a director of the corporations. The respondent assumed the appellant received remuneration from the corporations in receiving the stock options.

Paragraph 7(1)(a) reads as follows:

(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.

Any benefit Mr. Taylor may have received "by virtue" of his employment as a result of exercising the option was in the year in which the option was exercised: J. Stuart Robertson v. The Queen, [1988] 1 C.T.C. 111; 88 D.T.C. 6071.

The first requirement of subsection 7(1) is that the taxpayer must be an employee of either corporation or of a corporation with which it does not deal with at arm's length. Accordingly, Mr. Taylor's initial position is that because a corporation does not exercise any control over a director, a director can not be considered an employee and therefore he falls outside the ambit of the Act.

The words "office", "officer" and "employee" are defined in subsection 248(1) as:

“office” means the position of an individual entitling him to a fixed or ascertainable stipend or remuneration and includes a judicial office, the office of a Minister of the Crown, the office of a member of the Senate or House of Commons of Canada, a member of a legislative assembly or a member of a legislative or executive council and any other office, the incumbent of which is elected by popular vote or is elected or appointed in a representative capacity and also includes the position of a corporation director; and "officer" means a person holding such an office . . .

"employee" . . . includes an officer.

Thus a directorship is an office: the holder of an office is an officer, and an officer is an employee. Therefore it would appear for the purposes of the Income Tax Act a director is an employee. However in Busby v. The Queen, [1986] 1 C.T.C. 147; 86 D.T.C. 6018 (F.C.T.D.), under appeal to the Federal Court of Appeal, Mr. Justice McNair stated at page 151 (D.T.C. 6020):

. . . 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.

He then went on to say at page 153(D.T.C. 6021):

Certainly she was not the employee of T.R.V. Minerals or New Minex but was simply a director in name of those companies.

In subsection 7(1) the word "employee" is not coupled with the word "officer". In N.V. Beaumont v. The Queen, [1986] 1 C.T.C. 507; 86 D.T.C. 6264, Mr. Justice Muldoon dealt specifically with subsection 7(1), at page 511 (D.T.C. 6267):

The case of Busby v. The Queen (above) is not relevant here. There, Mr. Justice McNair makes it plain (151 (D.T.C. 6020)) that he is dealing with the meaning of "employment" pursuant to section 248 of the Act, and not "employee". Accordingly, whether the plaintiff was an employee, or only an unpaid officer, of Nortek is not material, since the section defines "employee" to include "officer".

The appellant relied on the decision in The Queen v. Kuhl et al., [1973] C.T.C. 846; 74 D.T.C. 6024 (F.C.T.D.) in support of his submission that to be an employee a person must receive remuneration. In that case, Walsh, J. held, at page 857 (D.T.C. 6031), that:

The defendants herein were not, as stated, entitled to any fixed or ascertainable stipend or remuneration. They had no contract of employment and if the company had suffered a loss would have received no remuneration (although, at the same time, benefiting from the separate existence of the corporation, they would not have been responsible for its debts). I do not believe, therefore, that they come within the exclusion of paragraph 139(1)(e) of the Act (supra) which excludes “an office or employment" from the definition of "business".

Mr. Justice Walsh found that the Kuhls were carrying on a business at the same time as they were performing services for a corporation and the corporation did not pay them in their capacities as officers and directors. Mr. Justice Muldoon in N.V. Beaumont v. The Queen, op cit, stated an unremunerated officer may be an employee for the purposes of section 248. While there is a definite connection between employment and remuneration in that there is a general presumption that employees are entitled to remuneration, the absence of remuneration is not determinative of the nature of the relationship and an individual can be an employee despite the fact that he is not being paid: Archambault v. Desmarteaux, [1945] R.L. 129 (C.S.); Huba v. Schulze and Shaw (1962), 37 W.W.R. 241 (Man. C.A.); Poppe v. Tuttle (1980), 14 C.C.L.T. 115 (B.C.S.C.). [1] For the purposes of subsection 7(1) a director is an employee.

Mr. Taylor was granted the stock options subsequent to his appointments as a director. Accordingly, he received them while he was an employee of the corporations and the Minister's assessment would seem to meet the conditions set out in paragraph 7(1)(a).

The appellant, however, further submits that, even if he was an employee, he did not receive the options "by virtue of his employment", as required by subsection 7(5) of the Act. Subsection 7(5) provides that:

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.

There appear to be two elements to this argument. The first, returning to the dicta in Busby v. The Queen, supra, is that directors, although employees, do not have "employment". Mr. Justice McNair’s comments on the words "the employment" are obiter to the actual judgment. On a closer reading the dicta itself stands not for the proposition that directorships can never constitute a form of employment, but rather that a director is not an employee merely by virtue of the "extended meaning accorded the words employed, employee, and office” by section 248 of the Act. In Busby the benefits received by the taxpayer from stock options were not in respect of any employment but because of her personal relationship with the controlling shareholder of the corporation and in consideration of her guaranteeing bank loans.

Presumably, the appellant seeks to restrict the scope of the word "employment" to that found in subsection 248(1), namely:

"employment" means the position of an individual in the service of some other person (including Her Majesty or a foreign state or sovereign) . . .

Quite clearly, a directorship would not meet this test. But, the definitions provided by section 248 are not necessarily all inclusive, and the possibility still exists that the appellant may fall within some broader definition of the word employment.

"Employment" is defined as follows:

. . . A person's regular occupation or business; a trade or profession . . .

(The Oxford English Dictionary, Vol. Ill)

Act of employing or state of being employed; that which engages or occupies; that which consumes time or attention . . .

(Black’s Law Dictionary, 5th ed.)

These broader definitions are to be preferred to the more narrow statutory one for several reasons. Generally speaking, when an Act says that a word "means" something, it is understood that the legislature has intended to restrict the definition of that word to that set out in the Act: vide: Yellow Cab v. Board of Industrial Relations, [1980] 2 S.C.R. 761, per Ritchie, J., at page 768. But, this rule is only applicable where the particular statutory definition fits the context in which it is used. Where the context of a particular section clearly renders the statutory definition inapplicable, reference must be made to the ordinary meaning of the word: Interpretation Act, R.S.C. 1970,

c. 1-23, s. 14(2)(a). As Davis, J. said, in Regina v. Scory (1965), 51 W.W.R. 447 (Sask. Q.B.):

To hold that the definition is exhaustive and must prevail would do violence to the recognized rules of grammar and would render the subsection meaningless. The law is that if a defined expression is used in the context which the definition will not fit, the context must be allowed to prevail over the “artificial conceptions" of the definition clause and the word must be given its ordinary meaning: Maxwell on Interpretation of Statutes, 11th ed., p. 31; Strathern v. Padden [1926] SC (J) 9.

To this end, implicit in the use of the phrase “by the employee by virtue of his employment" is the presumption that all employees are in employment. Indeed, it is only by accepting this relationship between the words "employee" and "employment" that the provisions of section 7 can have any logical meaning. See also Might v. M.N.R., [1948] Ex. C.R. 382; [1948] C.T.C. 144; (affd. without reasons [1949] 2 D.L.R. 351; [1949] C.T.C. 41 (S.C.C.)) and Carter v. Great West Lumber Company et al., [1919] 3 W.W.R. 901 at 902.

A statute must be expounded “according to the intent of them that make it” and should be interpreted to best ensure the attainment of its objects: Fordyce v. Bridges (1847), 1 H.L.C. 4 (cited in Might v. M.N.R., op cit); Interpretation Act, R.S.C. 1970, C. 1-23, s. 11. The purpose of subsection 7(5) is to exclude from income only the amount of any benefit received for consideration extraneous to a taxpayer's employment. See, for example, The Queen v. Savage, [1983] C.T.C. 393; 83 D.T.C. 5409 (S.C.C.), per Dickson, J., as he then was, at page 399 (D.T.C. 5414). The intent of the Act therefore would require that the word "employment" be given an inclusive, rather than exclusive, interpretation.

The second strand of the appellant's argument was that, even if he was an employee and was in “employment”, he did not receive the stock options by virtue of such employment. In this respect the appellant relied on three cases: Busby v. The Queen, supra; The Queen v. Kuhl et al., supra; and Phaneuf Estate v. M.N.R., [1978] C.T.C. 21; 78 D.T.C. 6001 (F.C.T.D.). In Busby v. The Queen, the appellant taxpayer obtained certain stock options in two companies, of which she was a nominal director. The Court, however, held that the benefit resulting from the stock options was not "received in respect of her employment".

In The Queen v. Kuhl et al., supra, the respondent taxpayers carried on farming operations through a corporation of which they were directors. Although they performed work for the corporation, the appellants didn't have a formal contract of employment and did not bill the company directly for their time. Rather, they seem only to have been responsible to each other for doing their fair share of the work and shared equally in the profits therefrom. The Court held the defendants were not paid for their services in their capacities as officers and directories.

The appellant's greatest reliance for support was the case of Phaneuf Estate v. M.N.R. This case revolved around the question of whether or not a testamentary gift was received by the appellant beneficiary in his personal capacity or qua employee. The testator was the founder and principal shareholder of Charles Ogilvy Limited. By his will he directed that his executors make certain shares in the company available to the employees thereof, at par value. At all times the par value of the shares were considerably less than their fair market value. The appellant employee exercised his rights under the will and the Minister assessed on the basis that the difference between the price paid for the shares and their fair market value was a benefit received by virtue of employment (paragraph 6(1 )(a) of the Act).

The appellant in Phaneuf Estate argued that although being an employee was the cause of the benefit, in order to be received by virtue of employment, the benefit must partake of the character of remuneration for services. The Court held that in order to be taxable, a benefit "must arise from the office or employment in the sense that the services rendered in the employment must be the effective cause of the payment", rather than merely a pretext for it. In similar terms, the Court cited, with approval, the dicta of Noel, J., in Ransom v. M.N.R., [1968] 1 Ex. C.R. 293; [1967] C.T.C. 346, to the effect that:

. . . in order to be taxable as income from an office of employment, money received by an employee must not merely constitute income as distinct from capital, but it must arise from his office or employment. Similar comments were made in Hochstrasser v. Mayes with reference to the English legislation by Viscount Simonds at p. 705 and by Lord Radcliffe, at p. 707. Secondly, the question whether a payment arises from an office or employment depends on its causative relationship to an office or employment, in other words, whether the services in the employment are the effective cause of the payment. I should add here that the question of what was the effective cause of the payment is to be found in the legal source of the payment, and here this source was the agreement which resulted from the open offer of the employer to compensate its employee for his loss and the acceptance by him of such offer. The cause of the payment is not the services rendered, although such services are the occasion of the payment, but the fact that because of the manner in which the services must be rendered or will be rendered, he will incur or have to incur a loss which other employees paying taxes do not have to suffer.

Thus, although there may be a presumption that an employee who receives a benefit does so by virtue of his employment, the Court must look behind the form of the relationship and determine the true substance of the transaction. Unless there is substantive justification for deciding that a benefit accrues to an employee as a direct result of the services which he performs, or performed, as an employee it will not be regarded as having occurred “by virtue of employment”.

Stripped to its essentials, the appellant argues that although he was a director and performed the duties inherent in this office, he, in common with all the other directors, received no remuneration as a consequence. Instead, the benefit which he did receive, namely the options, resulted from the companies' desire to enhance their reputations by virtue of their association with him. Put differently, by becoming a director, the appellant had the effect of increasing the prestige of the companies. This was, however, a benefit that he conferred on the companies, not a service which he performed for them, and thus is not subject to taxation under section 7 of the Act.

Dickson, J., as he then was, in the decision of The Queen v. Savage, supra, cited with approval the following statement of Evans, J.A., in R. v. Poynton, [1972] 3 O.R. 727:

I do not believe the language to be restricted to benefits that are related to the office or employment in the sense that they represent a form of remuneration for services rendered. If it is a material acquisition which confers an economic benefit on the taxpayer and does not constitute an exemption, e.g., loan or gift, then it is within the all-embracing definition of s. 3.

To say that the appellant received the stock options because the companies wished to further their reputations begs the question. Even accepting the appellant's characterization of the matter, the term "services" refers not to the final product or end result of a transaction, but rather to the process by which this is achieved. Just as in the determination of whether an individual is working as an employee or an independent contractor, reference must be made to the way in which the parties structure their relationship. Here, the reputation of the companies was not advanced merely because the appellant's name appeared on a prospectus. Rather, it was because, having agreed to become a director, investors may have logically presumed that Mr. Taylor was performing the duties thereof, to the ultimate benefit of the companies. While the companies themselves may have been more interested in the prestige afforded by the appellant's name than by the manner or competence with which he performed his duties, the former flows directly from the latter.

As well, although it is necessary to relate the benefit received to the services performed, the connection need not be substantial. Subsection 7(5) only exempts those benefits which were not conferred “in respect of, in the course of, or by virtue of the employment”, and as Dickson, J., as he then was, indicated, in Nowegijick v. The Queen, [1983] 1 S.C.R. 29 at 39; [1983] C.T.C. 20 at 25:

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

Ultimately, whatever the companies themselves hoped to gain through their association with the appellant, the bottom line is that he was "hired" as an employee in order, ostensibly at least, to perform as a director with all the statutory responsibilities of that office. Therefore, having structured their relationship in this manner the parties are bound by their choice.

Was Mr. Taylor remunerated by the companies? One may ask as well the question "why did Bianca and Greenwood grant the options to Mr. Taylor?" The evidence leads me to infer the options were granted in consideration of the services Mr. Taylor was to perform as a director and he received the options qua director, an employee of each of the corporations. The benefits he received by the exercise of his rights under the option agreements are taxable pursuant to subsection 7(1) since he received the benefits by virtue of his employment with the corporations.

Value of Escrowed Shares

As a general rule, where an owner of property is not free to deal with the property as owner, the value of such property has been diminished to at least a certain degree. In Steen v. The Queen, [1986] 2 C.T.C. 394; 86 D.T.C. 6498 (F.C.T.D.), Rouleau J. stated, at page 402 (D.T.C. 6504), that:

Furthermore, there is no clog on the disposal of [the] plaintiff's shares that would justify a discount from the market price quotation. . . .

Hence where there is a clog on disposal of shares a discount should be justified.

The principal feature of the escrow agreement is the provision that should the mining claims which the appellant exchanged for the shares prove to be worthless, or should the company discontinue development of the claims, then title to the shares would effectively be lost. On this basis, it is difficult to conclude that the two blocks of shares have an equal value. More accurately, it is difficult to say that the appellant received equal benefit from the block of shares to which he received absolute title and the block of shares to which his ownership was merely conditional. Where the owner of one of two sets of otherwise identical shares is not free to deal with one of the sets of shares as owner, the value of that set of shares is diminished to a certain degree from that set of shares the owner is free to deal with as owner.

It is also useful to make reference to Interpretation Bulletin IT-387. Paragraph 5 states that shares of the capital stock of a corporation which are subject to an escrow agreement and shares of the same class which are not so subject are considered to be identical properties. The Minister viewed the escrowed shares on this basis. The bulletin goes on to say, however, that shares which are merely allocated conditionally would not be identical to free or escrow shares which have been issued. Although administrative policy and interpretation are not determinative, they are entitled to weight and become an important factor in case of doubt about the meaning of legislation: per de Grandpré, J. in Harel v. The Deputy Minister of Revenue of the Province of Quebec, [1978] 1 S.C.R. 851 at 859; [1977] C.T.C. 441 at 448 and Dickson, J. (as he then was) in Nowegijick v. The Queen et al., supra. It appears to me that the two blocks of shares should not be viewed as having equal value for the purposes of the assessment. I have difficulty finding the two properties are of similar value where the owner can not freely deal with one of the properties.

The Court was asked only to rule on whether the escrowed shares were identical property to the other Bianca shares. No evidence was adduced as to the value of the escrowed shares in the event it was determined by the Court that the escrowed shares and the other Bianca shares were not identical property. The obvious solution is to refer the assessments back to the Minister for reconsideration and reassessment on the basis that the properties are not identical. Vide: Kit-Win Holdings (1973) Limited v. The Queen, [1981] C.T.C. 43 at 46; 81 D.T.C. 5030 at 5032.

Conclusion

The appeal of Mr. Taylor will be allowed without costs and the assessments for 1980 and 1981 are referred back to the respondent for reconsideration on the basis that the escrowed Bianca shares and the other Bianca shares are not identical properties.

Appeal allowed in part.