Dennis B Kanten v. Minister of National Revenue, [1985] 2 CTC 2251, 85 DTC 575

Taylor, TCJ: —This is an appeal heard in Calgary, Alberta, on June 6, 1985, against an income tax assessment, for the year 1981 in which the Minister of National Revenue increased the reported income of the taxpayer by an amount of $93,568 and taxed accordingly. The notice of appeal read in part:

During the years 1977 to 1981 the taxpayer’s employer, Texas Gulf Inc agreed to award the taxpayer shares in the Company. During 1981 Texas Gulf failed to satisfy this commitment but instead paid the taxpayer a cash settlement in the amount of $93,568 in lieu of the shares awarded.

Texas Gulf included this amount on the taxpayer’s 1981 T4 as income from employment.

The amount of $93,568 received from Texas Gulf Inc was, in fact, a non-taxable capital receipt paid by the Company as settlement of its breach of contract in respect of the shares the Company agreed to provide to the taxpayer but did not because of a pending takeover bid.

The position of the respondent was stated as:

— The Appellant was an employee of Texas Gulf Inc during the 1981 taxation year;

— during the years 1977 to 1981, the Appellant was awarded shares in Texas Gulf Inc under his employer’s Career Incentive Plan and Bonus Plan;

— during the 1981 taxation year, the Appellant received $93,567.68 in lieu of the shares awarded for his surrender of his rights under the Career Incentive Plan and Bonus Plan to the shares of Texas Gulf Inc.

— In reassessing the Appellant with respect to the payment under the Career Incentive Plan and Bonus Plan, the Minister of National Revenue assumed, inter alia, that the payment of $93,567.68 to the Appellant was the payment of an allowance and benefit by virtue of the Appellant's employment with Texas Gulf Inc.

And the respondent submitted that:

— . . . the receipt of the sum of $93,567.68 by the Appellant from Texas Gulf Inc in his 1981 taxation year took place during a period while the Appellant was in the employment of Texas Gulf Inc within the meaning of section 6(3)(a) of the Income Tax Act and was therefore income from employment within the meaning of section 5(1) of the Income Tax Act.

— ... the Appellant received the amount of $93,567.68 in his 1981 taxation year as a benefit by virtue of his employment within Texas Gulf Inc,

— In the alternative, . . . the Appellant has within the meaning of section 54 of the Income Tax Act disposed of a property consisting in his rights under the Career Incentive Plan and Bonus Plan and that the amount of $93,567.68 received by the Appellant in his 1981 taxation year represented the proceeds of disposition of said property with the consequence that the Appellant has realized a taxable capital gain on the disposition of said property in the amount of $46,783.84 pursuant to section 38 of the Income Tax Act.

The evidence presented established that the “$56.00 per share" received by the appellant was the same as the price per share paid to all shareholders of record as at the effective date of the “Agreement and Plan of Merger” between Texas Gulf Inc, and another corporation “Tranself Inc" which acquired the outstanding shares of Texas Gulf Inc. Therefore the mathematics of the $93,568 were not in issue, both parties agreeing that the number of shares allotted to the appellant under the Texas Gulf Inc "Career Incentive Stock Plan” (the "Plan") up to the date of the merger multiplied out to that amount.

With regard to the Plan, the appellant introduced certain documents which provided details of the basis for and allocation of shares. From Exhibit A-4, a prospectus of Texasgulf issued in 1979, which contained references thereto, I quote:

The Career Incentive Stock Plan (the “Career Plan") provides for the reservation of 500,000 shares of Common Stock of the Company held as treasury stock for awards of stock bonuses to key employees of the Company or any of its subsidiaries in order to attract, retain and motivate those whose performance will contribute to the profits and growth of the Company .. . The duration of the Career Plan is indefinite . .. Grantees are not required to provide any consideration for shares awarded under the Career Plan other than their service to the Company.

Shares are to be transferred to each grantee in increments of 20 percent per year beginning with the second anniversary of the award, provided, however, that the grantee must remain in the continuous employ of the Company until the transfer date, or the award is to that extent forfeited. If, however, the grantee dies, retires at normal retirement age, or becomes totally and permanently disabled, more than two years after the date of an award, shares awarded more than two years prior to the event will be transferred to the grantee or his beneficiary. The right to receive shares under the Career Plan is not otherwise transferable .. . There are no funds, securities or other property held under the Career Plan against which a lien could be created.

The grantee of an award is not subject to tax at the time of an award, but such grantee will recognize taxable ordinary income in the amount of the fair market value of the shares at the time of the transfer of such shares to him. Such ordinary income will qualify as personal service income subject to the maximum rate of tax provided for in Section 1348. The Company will be entitled to a deduction for federal income tax purposes in the same amount and in the same year as the grantee recognizes income.

A separate document (Exhibit A-3) which according to the evidence was issued in about the year 1970 starting the Plan, contained the following additional information:

The Plan may also be terminated at any time by the Board of Directors, without, however, adversely affecting the rights of individuals with respect to awards which have been made to them pursuant to the Plan prior to such termination.

In argument, the basic position of the appellant was restated by counsel:

. . . the payment did not arise by virtue of employment but rather constituted damages for the breach by Texasgulf of its contract to deliver shares that had previously been awarded to Mr Kanten. Alternatively we submit, and perhaps agree with the contention in the Notice of Appeal, that what occurred was the disposition of a right that Mr Kanten had for the delivery of shares, and that in substance is equivalent to the disposition of the shares themselves, therefore the transaction was of a capital nature.

The respondent however, withdrew any reliance whatever on the “capital" assertions, so therefore the question becomes simply whether the amount was income from or by virtue of Mr Kanten's employment, or damages. I put the issue that way, in order to distinguish the case from that of The Queen v Albert Manley, [1985] 1 CTC 186; 85 DTC 5150, in which the point was whether the damages for breach of warranty were taxable under sections 3, 9 and 248 of the Act as income. In the instant case it falls to the appellant to establish that the amount at issue was first damages, and if so not taxable in a manner similar to that in Manley (supra). There may well be more precision to arise out of future judgments dealing with the question of whether indeed “damages" per se may still have a base in “employment" (see page 189 (DTC 5153) of Manley (supra) in reference to The Queen v Robert B Atkins, [1976] CTC 497; 76 DTC 6258, and Jack Cewe Ltd v Gary William Jorgenson, [1980] CTC 314; 80 DTC 6233), but for this appeal I am satisfied that unless the appellant can demonstrate the payment has a base other than his employment, his cause must fail.

On this critical point therefore, counsel for the appellant made the following contributions:

. . . our contention is that the payment did not arise by virtue of employment. It arose by virtue of the shares being awarded, and that the payment, if it is to be characterized as having its source, as all income under the Income Tax Act, the scheme of the Act, Section 3, Section 5, Section 6, Section 9, contemplates that all income should have a source, we believe that the source of this payment were the rights, or were the shares that were awarded to Mr Kanten. Our contention is these rights were the equivalent of shares themselves,

. . . What was really being surrendered were the shares themselves, whose delivery was staggered.

This transaction was one where the delivery of the shares was staggered over time but the shares were vested in the employee at the time the gift was made, subject to divestiture if he should leave the employment of Texasgulf. I submit that that was a circumstance that was totally within his control and therefore should be distinguished.

The company had a right to pull out these shares at any time. These shares were awarded to Mr. Kanten, he felt he owned those shares, and subsequently he was given $56 for each share.

. . . there was a hostile take-over of Texasgulf and that subsequently there was a merger of Texasgulf with Elf Aquitaine. The result of the merger, no further shares were to be issued. As a result of the merger, Texasgulf agreed to pay cash to its employees in respect of these bonus plans.

This was not a situation where the employee consented. They had no say in what the company agreed to. It was agreed to, (by them) as a third party . . . The fact that these amounts, $56 per share, were offered to the taxpayer and he accepted them, it is submitted, is as binding as if there had been a protracted period of negotiations involving lawyers on both sides.

The fact is that the taxpayer was aggrieved, he lost his rights to receive deliverance of his shares, he was denied the right to vote at the shareholders’ meeting.

The fact that he accepted the cash payment without qualms should not lessen the fact that it was essentially an award for damages.

In response counsel for the respondent referenced considerable cases at law including: Henry Goldman v MNR, [1953] CTC 95; 53 DTC 1096, Norman W Fowler v MNR, 32 Tax ABC 353; 63 DTC 600, George W Offley v MNR, [1974] CTC 2139; 74 DTC 1101, Marshall Kulka v MNR, [1979] CTC 2989; 79 DTC 817, Thomas G Quance v The Queen, [1974] CTC 225; 74 DTC 6210. Counsel summarized the argument by:

We know that Mr Kanten was an employee of the company Texasgulf, who sought to reward its employees and to encourage them in their employment efforts by the awards of bonuses. We do know that the incentive for bonuses in this case took the form of shares and were, I suggest to you, intimately connected with his employment; so intimately connected that there can be no other view than that the source of those shares — that the source of the ultimate pay-out was the shares that were awarded, which were awarded as a result of his efforts as an employee of the company.

. . . Mr Kanten received a bonus in the form of shares for his work as an employee and ultimately, although the shares that he received a pay-out for had not been earned by him, that is my words, because he hadn’t done his time to earn them, the company decided, for whatever reason, to give him $93,000 . . .

Some reference was made at the hearing to a distinction which might be seen between the shares themselves, and the rights to these shares, but I do not see that to be critical or determinative, and perhaps only serves to confuse the issue. Two aspects of the argument of counsel for the appellant (supra), may appear contradictory:

. . . the shares were vested in the employee at the time the gift was made . . .

. it was essentially an award for damages.

But I have assumed that the co-ordination point is that Texasgulf, after the merger was unable to issue the shares “vested” in Mr Kanten and therefore the payment made was in compensation for that incapacity, according to counsel. The assertion of counsel for the appellant that the shares were vested in Mr Kanten at the time of award or allocation might be an extension of the situation difficult to support. Nevertheless, I am satisfied that at the date of the merger Mr Kanten had at least “rights” of some sort. I can think of no other reason for which Texasgulf would have proffered and paid the amount at issue. The termination of the Plan, without some relevant payment could and probably would have sparked at least legal action by Mr Kanten or others. It is not necessary for the Court in this matter to examine that point further. Mr Kanten may indeed have been desirous of retaining his position in the new company, and having harmonious relations there, but I would expect that the new company was not anxious to have a group of unhappy and dissatisfied employees on its hands either. So that for which Mr Kanten received the $93,568 was indeed in the words of the Minister (supra), . . in lieu of the shares awarded for his surrender of his rights .. .”. I can see no material difference between that statement and the one made by counsel for the appellant (supra): “In consideration of these rights, which Texasgulf had agreed to compromise in its agreement with Aquitaine, he received a cash payment.” However that does not dispose of the issue. The question remains — since there were “rights” disposed of, from whence did they arise, and what initiated the payment? They arose according to the respondent precisely according to the terms enunciated in paragraph 6(3)(b) of the Act

6. (3) An amount received by one person from another

(b) on account or in lieu of payment of, or in satisfaction of, an obligation arising out of an agreement made by the payer with the payee immediately prior to, during or immediately after a period that the payee was an officer of, or in the employment of, the payer,

And the logic of the Minister continues, the payment ensued out of that obligation — an employment base.

Conversely, from the perspective of the appellant, that obligation (arising out of the term of employment) while it remained intact for Texasgulf, could not be fulfilled by Texasgulf, because of actions taken by that company itself outside of the purview or agreement of this appellant. I would restate the position of counsel for the appellant, in this manner — while Texasgulf could not be forced (even by legal action) to provide specific performance in something it was no longer capable of doing — issue the shares, the company could be required to make the appellant whole — some form of compensation. In the proposition of counsel for the appellant, however, he takes the logic a step further and equates that compensation with damages. That must raise the question — in what way was the appellant “damaged” by virtue of the action of Texasgulf, in Texasgulf surrendering its rights to issue more shares under the merger? I can think of none. It is a fair assumption that in the merger, Texasgulf knowingly took on the task of satisfying Mr Kanten and others in a similar position (recognizing at least a moral, if not a legal obligation), and Mr Kanten was satisfied according to the terms of Exhibit A-3 (above) — “. . . fair market value at the time of the transfer of such shares to him’’. The payment at issue in this appeal was offered and accepted. I would think it was equivalent in all aspects to a fulfilment of the obligation to issue shares under the Plan. It was by any standards a reasonable and fair arrangement for Mr Kanten. The offer by Texasgulf and the acceptance by Mr Kanten of the amount of $93,568 was by virtue of his participation in the Plan, which Plan was open only to employees of the company, on account of that employment. That did not change merely because of the form the payment took.

In conclusion I would note that some analogy might be drawn between this matter and that covered in The Queen v Barbara D Sills, [1985] 1 CTC 49; 85 DTC 5096, even though the Sills appeal related to alimony payments:

Furthermore, it seems clear that the kind of allowance contemplated by subsectin 56(1)(b) would include any and all amounts paid under the agreement when- ever they are paid and received since the amount is determined in advance and, once paid, it is at the complete disposition of the recipient who is not required to account for it.

In Sills (supra), the character of the amount at issue did not change merely because it was received by the appellant at a time not specifically indicated in the agreement. The determining factor was that the moneys were payable in accordance with the definition of an allowance. In the instant case, because the compensation received by Mr Kanten took the form of money as opposed to shares of equivalent value, did not alter the fact that the basis for the obligation to pay anything, rested in the employment contract of the appellant.

The appeal is dismissed.

Appeal dismissed.