William T Harvey v. Minister of National Revenue, [1980] CTC 2826, 80 DTC 1701

The Assistant Chairman:—In 1973 William T Harvey (the appellant) was an employee of a manufacturing concern which manufactured a product under licence from Tranter, inc (hereinafter called “Tranter”), a Michigan corporation. The appellant was in the sales aspect of that licence. In May of 1973 the licence which that manufacturer had was about to expire and would not be renewed. At about that time, officials of Tranter approached the appellant to set up and run a sales operation for it in Canada, which he did. Tranter Canada Ltd (hereinafter called “Tran Can”) was incorporated and became a wholly-owned subsidiary of Tranter. Initially the appellant was the only employee of Tran Can, but it did have manufacturer’s agents selling for it. At the time of the hearing Tran Can had five employees. The appellant started out with Tran Can as general sales manager and today is its vice president and general manager. He reports directly to the vice president of Tranter. Tran Can’s sales increased about tenfold over the period 1973 to 1979. His salary also increased substantially in the same period. When he commenced his employment he received only salary, but later bonuses were paid to him. In January 1976 the vice president of Tranter, to whom he reported, advised him that they (Tranter) were happy with the results of the Tran Can operation and gave him an option to buy 1,000 common shares of Tranter at $12.50 per share on various terms and conditions. He was the only Canadian who received such an option, but he knew that the American company (Tranter) had individuals on its payroll who also received such an option. Insofar as the option was concerned, the appellant believed it was given to key employees of Tranter—people whose services were valued. The option was related to his employment. As the appellant put it, it was an inducement for employees to remain with the company. The appellant never directly exercised his option to acquire the shares.

In December 1977, Tranter entered into a merger agreement with a Delaware company called Dover Corporation. A portion of paragraph 5 and paragraph 6 of the notice of appeal describes what happened:

5. In December, 1977 the American company entered into an agreement pursuant to which, in effect, all of the shares of the American company were purchased by Dover Corporation, a corporation incorporated under the laws of the State of Delaware, but under which the American company was the surviving corporation in a merger.

6. Important among the provisions of the merger plan were the following: Dover Corporation owned all of the 1,000 issued shares of Dover-Tranter Heat Transfer, Inc (hereinafter referred to as the “subsidiary”), a corporation incorporated under the laws of the State of Michigan. As the first step in the merger, the said 1,000 shares of the subsidiary were exchanged for 1,000 treasury shares of the American company, so that Dover Corporation became the owner of 1,000 shares of the American company. The second step in the merger was that, out of funds contributed to the American company by Dover Corporation, all of the shares of the American company not owned by Dover Corporation were redeemed for $38 US in cash. In the result, the American company became a wholly owned subsidiary of Dover Corporation.

(The American company in the quote refers to Tranter.) The merger plan also called for all options to be cancelled.

The appellant did not sell any shares of Tranter to the Delaware corporation as he had not exercised, in whole or in part, his option. About midDecember 1977 the appellant received from Tranter, either by telex or a telephone call which he caused to be recorded on paper, a document which was filed with the Board and marked as Exhibit A-1, captioned “AGREEMENT”. This exhibit reads as follows:

It is agreed between Tranter, inc and WT T Harvey, herein called the Optionee, that all options for purchase of Tranter Stock by the Optionee, whether now exercisable or not, shall be surrendered to Tranter, inc, in consideration of the payment by Tranter to the Optionee, of $38 per share of such Stock, less any purchase price which would be payable thereon. If not previously performed, the time of performance shall be no later than the effective date of the proposed merger, or upon written notice by Tranter to the Optionee, whichever is sooner. This agreement will lapse if the proposed merger shall not become effective on or before March 1, 1978.

If Stock assignment and certificates have been deposited with the Company, then the transaction shall take place upon issuance of Company cheque.

The appellant stated that he deposited nothing with Tranter. By mail to his office, in the latter part of December 1977, the appellant received a letter from Tranter together with a cheque for $25,500 and a document for his signature. He signed the document. The letter and document read as follows:

Letter

TRANTER

December 20, 1977

Mr William T Harvey

3400 Rhonda Valley # 50

Mississauge, Ontario, Canada L5A 3L9

Dear Bill:

Please take notice, that we hereby accept surrender of all your options to purchase Tranter stock, in accordance with our agreement of December 9, 1977. A check for $25,500 is enclosed. Please sign and immediately return the enclosed surrender document.

	Sincerely,
	(Signed) John
JHF/sn	J H Flewelling
Enclosures	Vice President-Finance/Secretary

Document

In consideration of the sum of Twenty five thousand five hundred and 00/100 dollars ($25,500), receipt of which is hereby acknowledged, I surrender to Tranter, inc all of my options to purchase stock of Tranter, inc.

(Signed) W Harvey

(Optionee)

No of option shares	1,000
At $38 per share	$38,000
Less: option price	12,500
Total surrender price:	$25,500
I certify that this is a true copy.

Arithmetically the appellant was paid $38 per share less the cost of $12.50 per share. While the appellant did not report this gain as income, it was apparently reflected on the T-4 Supplementary form he received from his employer, Tran Can. It appears as though the gain was added to his income when the respondent assessed him as that assessment shows a substantial indebtedness. However, since a copy of the “explanation of the change” letter, which was sent to the appellant about the same time as the assessment notice, was not included among the documents filed with this Board, as I believe it should have been, one cannot be certain as to what transpired. In any event, ultimately the appellant appealed to this Board contending that the gain was not income. According to the Minister’s Confirmation, the sum was income pursuant to paragraph 7(1)(b) of the Income Tax Act after tax reform, which position was maintained by the respondent in his reply to the notice of appeal. The appellant’s position is that his gain was not income pursuant to the provisions of paragraph 7(1 )(b) of the said Income Tax Act or any other provision of the said Act.

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

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, . ..

(b) If the employee has transferred or otherwise disposed of rights under the agreement in respect of some or all of the shares to a person with whom he was dealing at arm’s length, a benefit equal to the value of the consideration for the disposition shall be deemed to have been received by the employee by virtue of his employment in the taxation year in which he made the disposition.

The appellant submitted that the appeal should be allowed on any one of the three positions he took and, if they were not successful, the appeal should be allowed at least in part on a fourth. The submissions, insofar as allowing the appeal was concerned, were:

(a) the appeal in principle was the same as, and should be governed by, the decision in the appeal of P M Reynolds et al v The Queen, [1975] CTC 85; 75 DTC 5042; [1975] CTC 659; 75 DTC 5393; [1976] CTC 792; 77 DTC 5044;

(b) there was no transfer or other disposition;

(c) what the appellant received was a windfall; and

(d) the appellant was paid four times more than he should have been.

In the Reynolds case employees were given options to acquire shares of their employer (Bethex). In some cases the options were cumulative and in others they were not. In December 1968 another corporation (Bethlehem) offered to buy all the assets of Bethex and concurrently exercised an option it had to acquire shares in Bethex, which gave it control of that company. About a month later, Bethex accepted the offer and also passed a resolution to wind up. The Court found the fact of the winding up of Bethex constituted an implicit repudiation of the option contracts. While there was no threat of legal action, agreements were entered into settling liabilities between the appellants and Bethex. While the Court in that case was considering subsection 85A(1) of the Income Tax Act before tax reform, the issue was exactly the same as in this appeal; namely, “on the 7th of February 1969 (the settlement) transferred or otherwise disposed of rights under the (option) agreement(s) ... to a person (Bethex) with whom (they)(were) deal

In these cases there was a cancellation of the rights of the appellants under their respective option agreements to acquire shares in Bethex by reason of the winding up resolution of Bethex on the 23rd of January 1969. Such constituted a discharge of the option contracts.

What each of the appellants had left after this breach of the option contracts by Bethex was a new cause of action for such breaches.

The appellants were each entitled to the common law remedy of damages for such breach. None of them pursued such remedy. Instead their new causes of action for the breaches of the option contracts were discharged between the appellants and Bethex by the agreements on the 7th of February 1969 whereby the appellants were to receive and accept the said shares in Bethlehem. These agreements were executed. Each appellant subsequently received the said shares of Bethlehem.

The receipt by each of the appellants of these shares in Bethlehem was not income within the meaning of the Income Tax Act.

Counsel for the appellant submitted that Tranter, having entered into the contract to sell all its outstanding shares to another corporation, precluded itself from living up to the option agreements it had given and so it resolved its liability to the optionees by paying cash to them and so, as in the case of Reynolds, the receipt of this cash is no more income to the appellant than the receipt of the shares was to the optionees in Reynolds. He also pointed out that the Court of Appeal affirmed the judgment of Mr Justice Gibson with short reasons, and the Supreme Court of Canada dismissed a further appeal with no reasons.

Counsel for the Crown rebutted this submission by submitting that Tranter was not precluded from issuing further shares by the merger agreement itself. Paragraph 15(a) of that agreement reads as follows:

15. The Corporation hereby makes the following representations and warranties to Dover and the Subsidiary, all of which representations and warranties are to be deemed made at the closing without any further writing and shall survive the closing and the merger:

(a) The Corporation is and will be at the closing and at the Effective Date of the Merger a corporation duly organized, existing and in good standing under the laws of Michigan, duly authorized to carry on the business presently conducted by it, and duly qualified to do business in Oklahoma, South Carolina and Texas and to the best of its knowledge not required to be qualified in any other jurisdiction by reason of the ownership of property or the manner in which it conducts business. The Corporation’s authorized capital stock consists of 1,000,000 shares of Common Stock, par value $1 per share, of which 503,288 shares are now and will be outstanding at the closing and at the Effective Date of the Merger, and no shares are or will be held in its treasury, and no other or additional shares of capital stock of the Corporation will be issued and outstanding at or before the Effective Date except such additional shares as may be issued pursuant to the proper exercise of previously outstanding Qualified Stock Options. There are and will be at the Effective Date of Merger no shares of capital stock of the Corporation held in its treasury. The Corporation will have at the Effective Date of the Merger no outstanding options or other agreements which may require it, now or in the future, to issue additional shares of its capital stock.

Counsel submitted that the agreement, while stating how many shares were then issued, still reserved the right to issue shares pursuant to a qualified stock option.

As I view it, as of the date of the merger agreement, Tranter stated: “503,288 shares are now and will be outstanding at the closing” and no reference whatsoever was made to any option agreement. I am sure that, had an option agreement been exercised prior to the date of the merger agreement, the number of shares affected by the option agreement would have been included in the number of shares “now” outstanding. How can it be stated that: “503,288 shares are now and will be outstanding at the closing”, if an option were exercised after the date of the merger agreement? I am of the view that Tranter effectively put itself in a position where it could not live up to its option agreement and so had a liability to the appellant which was settled by the payment of money. This appeal, as I view it, is the same in principle as the Reynolds appeal.

The result is, judgment will go allowing the appeal and remitting the assessment to the Minister for variation to delete the amount added to the appellant’s income because of this transaction.

Appeal allowed.