J. Stuart Robertson v. Her Majesty the Queen, [1988] 1 CTC 111, 88 DTC 6071

Dube, J.: —In reassessing the plaintiff for his 1980 taxation year, the Minister of National Revenue added as a taxable benefit the sum of $235,500 being the amount by which the fair market value of 6,000 shares at the date of the plaintiff's acquisition thereof exceeded the purchase price paid therfor by him.

The key facts in this income tax case are quite straightforward and may be briefly summarized as follows. At all material times the plaintiff was employed by Mr. Jack M. Pierce ("Pierce") as ranch manager to supervise his ranching operations. As an inducement to the plaintiff to remain in his employment, Pierce granted the plaintiff an option in 1974 to acquire certain shares which were owned by Pierce in Ranger Oil (Canada) Limited of which Pierce was the president. The option price in respect of the shares was equivalent to or greater than the fair market value thereof at the time the option was granted.

In 1980 the plaintiff exercised his option with respect to a portion of the aforementioned shares. On the date of such exercise, the fair market value of the shares in question exceeded the purchase price paid therefor by the plaintiff in the amount of $235,500. The Minister based his reassessment upon subsection 5(1) and paragraph 6(1)(a) of the Income Tax Act which read as follows:

5. (1) Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by him in the year.

6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:

(a) the value of board, lodging and other benefits of any kind whatever (except the benefit he derives from his employer's contributions to or under a registered pension fund or plan, group sickness or accident insurance plan, private health services plan, supplementary unemployment benefit plan, deferred profit sharing plan or group term life insurance policy) received or enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment;

The Minister contends that the purpose of paragraph 6(1)(a) is to extend the meaning of "income from an office or employment" beyond the normal concept of "salary, wages and other remuneration, including gratuities", by including the value of “benefits of any kind whatever" which an employee receives or enjoys “in respect of, in the course, or by virute of” an office or employment.

In Robert Shorrocks Williams v. M.N.R., [1955] C.T.C. 1; 55 D.T.C. 1006, a 1954 Exchequer Court of Canada decision, Cameron, J. referring to paragraph 5(b)(i), the predecessor to the present 6(1)(a), said as follows at page 3 (D.T.C. 1007):

. . . The purpose of the subsection is to extend the meaning of “income from an office or employment” beyond the normal concept of “salary, wages and other remuneration, including gratuities" by including in that term the value of board, lodging and other benefits which an employee may receive or enjoy in the course of, or by virtue of, his office or employment.

In The Queen v. Savage, [1983] C.T.C. 393; 83 D.T.C. 5409, a 1983 decision, the Supreme Court of Canada dealt with paragraph 6(1)(a) and Dickson, J. (as he then was) emphasized the key words of the paragraph to be “benefits of any kind whatever", “in respect of, in the course of, or by virtue of an office or employment". He said as follows at page 399 (D.T.C. 5414):

. . . The meaning of “benefit of whatever kind” is clearly quite broad; in the present case the cash payment of $300 easily falls within the category of "benefit". Further, our Act speaks of a benefit “in respect of” an office or employment. In Nowegijick v. The Queen, [1983] C.T.C. 20; 83 D.T.C. 5041 this Court said, at 25 [5045], that:

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.

Consequently, the Minister argues that when the plaintiff paid $22,500 for 6,000 common shares with a fair market value of $258,000 during his 1980 taxation year he thus received the benefit of $235,500 during that year. He acquired that benefit by virtue of the inducement of his employer to him to remain in his employment as ranch manager. That benefit was a “benefit of any kind whatever" gained “in respect of” his employment within the wide meaning attributed to those words by the Supreme Court of Canada in the above case.

Several instances of such benefits having been held to be in respect of employment under paragraph 6(1)(a) have been recorded by the jurisprudence in the matter: the cost of preparing employees' income tax returns, [1] the cost of a vacation trip by a supplier, [2] the payment of personal legal expenses, [3] the acquisition of shares for an amount less than their fair market value. [4]

On the other hand, the plaintiff argues that the only income tax provision which would apply to an agreement to issue shares to an employee is section 7. Paragraph 7(1)(a) reads as follows:

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;

The plaintiff alleges that section 7 is clearly inapplicable because the plaintiff's employer is not a corporation. Moreover, the plaintiff is not an employee of a corporation. That allegation is valid. The Minister, however, does not rely on section 7 but on paragraph 6(1)(a).

In the alternative, the plaintiff contends that if paragraph 6(1)(a) is applicable, then the value of any benefit obtained by the plaintiff should have been included in his income for the taxation year during which the option was granted (1974) and not for the taxation year in which the option was exercised (1980). For that proposition he relies mostly on three decisions [5] of Mr. Fordham of the then Income Tax Appeal Board, decisions largely based on Salmon v. Weight, [1935] All E.R. 904, a 1935 House of Lords decision.

In Salmon, the managing director of a company was entitled to a yearly salary and in addition, under resolution each year, was given the privilege to apply for and take up at par, certain unissued shares of the company which were at all times of a value considerably in excess of par. The Court held that the advantage to the director of receiving the allotments was “profits” from "having or exercising an office or employment of profit” within the English Income Tax Act. Thus, in that case, the taxpayer's request to purchase shares at less than the market price was taxable upon receipt of the shares. Lord Atkin said as follows (at page 910):

It is to be observed that while the board have expressed their willingness to entertain an application for these shares, nobody was bound and no right was given and no profit was received of any kind by the appellant until the application had been accepted and the shares in question had been allotted to him. At that moment he received from the company 2,500 shares on which there was no clog whatever and he was entitled to go on the market and sell those shares, for which he had paid £1, and he would at once be in a position to receive £3 or £4 or £5, as the case might be.

In the above case, the Court held that the special privilege to buy shares at a price lower than their market value was clearly given in respect of services rendered by the appellant. The privilege, though in itself not indeed money, was money's worth. The plaintiff contends that in the instant case, the taxpayer was given a legally enforceable right in the nature of a share purchase option as opposed to the simple privilege of purchasing the shares at the discretion of the board of directors as in Salmon: the date of taxation would therefore be determined by the date this legally enforceable right was granted, i.e. the date the share purchase option was granted.

With reference to a legally enforceable right to purchase shares under a stock option, the plaintiff relies on Mr. Fordham's third decision, No. 247 v. M.N.R. In that case the taxpayer received an option in 1951 to purchase shares of his employer's company at a price which was less than the current fair market value of the shares in question. The option was received by the taxpayer prior to the enactment of the predecessor to section 7 of the Income Tax Act. The taxpayer exercised his option in 1952. Mr. Fordham confirmed the Minister’s decision to assess a benefit for the year in which the option was granted (not the year in which the option was exercised).

The plaintiff relies also on Abbott v. Philbin (Inspector of Taxes), [1961] A.C. 352; [1960] 2 All E.R. 763, a decision of the House of Lords wherein the taxpayer received from his employer an option to purchase shares at the existing market price. The option was exercisable within a ten-year period. The taxpayer exercised his option in the subsequent year when the shares in question were worth more than the option price. The majority of the House of Lords held that the exercise of the taxpayer's option did not give rise to a taxable transaction and that the taxable benefit was the value of the option at the date the option was acquired. Viscount Simonds said this (at page 367: All E.R. 767):

. . . But I do not find it easy to say that the increased difference between the option price and the market price in 1956 or, it might be, in 1964 in any sense arises from the office. It will be due to numerous factors which have no relation to the office of the employee, or to his employment in it.

Professor Douglas J. Sherbaniuk in a study for the Royal Commission on Taxation entitled “Specific Types of Personal Income" offered these comments regarding the majority decision in Abbott v. Philbin (at pages 143-44):

Canadian courts, on similar facts, would very likely reach the same result as did the majority. A legally enforceable contractual right would seem clearly to fall within the elastic concept of “benefit” in section 5(1)(a) and, when granted in circumstances similar to those in Abbott v. Philbin, also within the words “in respect of, in the course of or by virtue of the office or employment”. Furthermore, although Canadian courts have not yet come to grips with interpreting these latter phrases, it seems probable that they would follow a line of reasoning similar to that taken by the majority and hold that increases in the value of stock that were attributable to factors such as retention of profits and expansion of business could not be said to have been received “in respect of, in the course of or by virtue of the office or employment". In summary, then, the employee would be taxed in respect of the value of the option, less what he paid for it, in the year of the grant of the option.

Reference is also made to Ward's Tax Law and Planning, Volume 1, wherein it is stated (at page 3-58) :

In the absence of special provisions in the Act relating to stock options, the second type of contract results in taxable income being received by the employee under section 5 or section 6(1)(a) at the time the option is granted rather than at the time of exercise. The measure of the taxable benefit would be the difference between the option price and the fair market value of the stock at the date the option is granted: Salmon v. Weight, [1935] All E.R. 904, 19 T.C. 174 (H.L.); No. 726 v. M.N.R., 53 D.T.C. 419. See also: Abbott v. Philbin, [1960] 2 All E.R. 763, [1961] A.C. 652 (H.L.).

And it is further stated (at page 3-64):

Stock option benefits to which section 7 does not apply (e.g. benefits received under agreements made on or before March 23, 1953) are taxable to the employee in the year in which the option is granted. If the option price is equal to the value of the stock when the option is given, no benefit is considered to be received at that time. With respect to the tax consequences of the exercise of the option, see Abbott v. Philbin, [1960] 2 All E.R. 763, [1961] A.C. 352 (H.L.).

Consequently, the plaintiff in this case argues that he obtained an enforceable right during the 1974 taxation year to purchase shares and the purchase price was equal to or greater than the fair market value of the shares at the time the option was granted. Accordingly, the plaintiff did not receive any benefit within the meaning of paragraph 6(1)(a) by virtue of the initial grant of the option in 1974. However, if the conferral of the option did create a benefit to the plaintiff in 1974, having regard to the fair market value of the option, the benefit in that year was nominal at best, according to the plaintiff's submission.

In conclusion, the plaintiff further submits that there are no charging provisions in the Act which would render him liable to include in income any amount with respect to the exercise of the option during the 1980 taxation year: section 7 is inoperative in this case, and paragraph 6(1)(a) is inapplicable because in view of the Abbott v. Philbin decision, such increase in value was not realized by the plaintiff “in respect of, in the course of or by virtue of” his office or employment during the 1980 taxation year.

In answering to the plaintiff's position the Minister alleges that prior to the plaintiff's 1980 taxation year no portion of the $235,500 benefit had been "received or enjoyed by him in the year" within the meaning of paragraph 6(1)(a) of the Income Tax Act. In support of that proposition the Minister relies on a 1960 Exchequer Court decision, M.N.R. v. Rousseau, [1960] C.T.C. 336; 60 D.T.C. 1236, wherein Fournier, J. said at page 340 (D.T.C. 1238), “As a rule, it is the income paid or received that is taxed."

Fournier, J. held that since the taxpayer did not in fact receive the salaries and rentals credited to him, they were not taxable in that year. He pointed out that if the legislator had wanted to tax amounts receivable it would have said so in clear terms, as otherwise the general rule is that amounts must have been received before they constitute income.

In the instant case, prior to the plaintiff's acquisition of the shares in 1980, his right was always conditional upon the continuation of his employment. In other words, until the plaintiff actually exercised his option in 1980, it could not be ascertained whether that central condition of the agreement

would be fulfilled: it is a principle of income recognition that an amount must not be taxed as income until uncertainty about the taxpayer's entitlement to it has been removed.

In a paper prepared for the Canadian Tax Foundation, entitled “Timing and Income Taxation," [6] Professor B.J. Arnold deals with the principles of income measurement for tax purposes. As a general principle, he states (at page 78) that:

.. . For income tax purposes, taxpayers using the cash method generally report revenue items in the year in which they are actually received.

He further notes (at page 80) that:

The Act requires the use of the case method of accounting with respect to the following types of income: income from office or employment . . .

A notation at the bottom of that page reads as follows:

Subsection 5(1) and paragraph 6(1)(a). Income from employment includes not only salary and wages, but also a wide variety of cash and in-kind fringe benefits.

Under "Income from Office of Employment" (at pages 81 and 82) he notes:

. . . Noncash benefits, such as board and lodging, allowances, director's fees employment bonuses, and payments pursuant to a covenant not to compete, are included in a taxpayer's income only if they are received in the year.

At the bottom of page 82 the following notation appears:

Paragraphs 6(1)(a), 6(1)(b), 6(1)(c) and subsection 6(3). Paragraph 6(1)(a) refers to benefits “received or enjoyed" by the taxpayer in the year.

Further on (at page 84) he deals with the general concept of receipt as follows:

Under the cash method of accounting, an amount is included in the computation of a taxpayer's income only if it is received by the taxpayer and has the quality of income. The mere right to receive an amount does not constitute income.

One final quote bears reproduction (at page 122):

The Act includes many other specific timing provisions. For example, subsection 6(1) requires an officer or employee to include in his income from office or employment only amounts that he has actually received.

In my view, the benefits received by the plaintiff in 1980 are indeed benefits taxable in that year. I do not consider Abbott v. Philbin to be an authority for the proposition that in Canada such benefits would be taxable in the year the option was awarded and not in the year in which the option has been exercised. This 1960 House of Lords decision is based upon the wording of an English Statute which is different [7] from the language of paragraph 6(1)(a) of the Canadian Income Tax Act. Secondly, such an inter- aretation is incompatible with the interpretation of the words "in respect of" by the Supreme Court of Canada in its 1983 Savage decision which gives them "the widest possible scope". Thirdly, the English decision is subject to two dissenting judgments, including Lord Denning's and his famous pronouncement (at page 384; All E.R. 777) that “a bird in the hand is taxable but a bird in the bush is not". Fourthly, the House of Lords in a more recent decision (1978) Tyrer v. Smart, [1979] S.T.C. 34 (H.L.), held that the gain which accrued to a taxpayer between the date of his application for shares and his acquisition of the shares was attributable to his employment and not to "numerous factors which have no relation to the office of the employee, or to his employment in it” as said by Viscount Simonds in Abbott v. PhilbinA [8] And, obviously, I am not bound by the Income Tax Appeal Board decisions.

In conclusion, what the plaintiff got in 1974 was the expectation of making a profit. The very nature of an expectation connotes an element of uncertainty. An option is a volatile instrument. Its value will vary along with the fluctuations of the market and/or the intrinsic value of the shares which the option may purchase. As Lord Denning so well said (at page 384; All E.R. 778): “it is not the expectation to make profits, nor the right to make profits, which is taxable, but only the profits themselves". The profits only accrued to the plaintiff when he exercised his option in the 1980 taxation year.

Under the circumstances, it is not necessary for me to deal with the Minister's final argument that the plaintiff is now estopped from taking the position that the benefit should have been taxed in 1974 as he reported no benefit for that year in respect of the option to purchase the shares. The 1974 taxation year is now statute-barred. The defendant argued that the plaintiff's alternate submission amounted to what Mahoney, J. described in Taras T. Hnatiuk v. The Queen, [1976] C.T.C. 632 at 633; 76 D.T.C. 6376 at 6377, as "a text-book example of estoppel by representation”. Neither is it necessary for me to canvass the American jurisprudence submitted by the defendant.

For all those reasons the action is dismissed with costs.

Action dismissed