Vincent N Hurd v. Minister of National Revenue, [1978] CTC 2349, 78 DTC 1282

The Assistant Chairman:—The appellant’s appeal to this Board from an assessment for income tax for the 1973 taxation year proceeded before this Board on a statement of agreed facts. The relevant portions of the statement, excluding the “Agreement’ referred to in paragraph 3 thereof, are:

1. The appellant was a resident of Canada from September 1965 to March 31, 1971.

2. Before September, 1965 the Appellant was, and since April 1, 1971 he has been, a non-resident of Canada. From 1961 to, September, 1965 the Appellant was resident in the United Kingdom and since April 1, 1971 the Appellant has been resident in the United States of America. The Appellant is and has always been a citizen of only the United States of America.

3. Annexed hereto as Exhibit A-1 is a true copy of an agreement made as of October 4, 1967 (hereinafter referred to as the “Agreement”) between The British American Oil Company Limited (hereinafter referred to as the “Company”) and the Appellant.

After October 4, 1967 and before the exercise of the option by the Appellant, the common shares in the capital stock of the Company were subdivided on the basis that each such share was split into two such shares. Pursuant to paragraph 9 of the Agreement, the Appellant thereupon became entitled to purchase twice the number of shares (ie 5,000) at half the price otherwise applicable (ie $18.69 per share).

4. From September, 1965 to March 31, *1971, the Appellant was an employee of the Company.

5. On or about April 1, 1971 the Appellant moved to the United States and commenced to be employed by Gulf Oil Corporation, an “affiliated company”, within the meaning of the Agreement. Appellant in fact performed no duties of employment in Canada after March 31, 1971. Appellant had no permanent establishment in Canada after March 31, 1971.

6. On September 26, 1973 the. Appellant validly exercised his option in accordance with the provisions of the Agreement and purchased 5,000 common shares in the capital stock of the Company at a cost to the Appellant of $18.69 per share, being an aggregate cost of $93,437.50 for all 5,000 common shares.

7. The amount by which the value on September 26, 1973 of the 5,000 common shares exceeded the amount paid by the Appellant to the Company therefor is $77,812.50.

8. In the Appellant’s Canadian income tax return for 1973 the Appellant reported as income from his employment in Canada resulting from his exercise of the option referred to in paragraph 6 hereof the sum of $43,606.13.

9. The Appellant computed the sum of $43,606.13 by apportioning the $77,812.50 excess referred to in paragraph 7 hereof according to the number of days between the date on which the option referred to in paragraph 6 hereof was granted to the Appellant and the date option was exercised by the Appellant in which the Appellant was employed in Canada over the total number of days between those two dates. The resulting calculation, which was included in the Appellant’s 1973 Canadian income tax return, was as follows:

“Calculation of taxable portion of stock option benefit

Date option granted October 4, 1967 Date option exercised Sept 26, 1973 Date ceased to be resident in Canada and returned to US April 1, 1971

Days between grant and exercise dates:

Spent in Canada	1224	56.04
Spent in US*	960	43.96
	2184	100.00
Taxable portion of stock option benefit:
.5604 x 77,812.50 = $43,606.13
Includes 51 days spent in US on business between
Oct 4, 1967 and April 1, 1971.”

10. On the date on which the Agreement was enteted into (ie October 4, 1967), the fair market value of each common share in the capital stock of the Company was $36.75 (or 18.375 when expressed as a value per share following the aforementioned two-for-one subdivision). On the date on which the Appellant ceased to be resident in Canada (ie April 1, 1971), the fair market of each common share in the capital stock of the Company was $22.50. On the date on which the Appellant exercised his option under the Agreement (ie September 26, 1973), the fair market value of each common share in the capital stock of the Company was $35.00.

11. By Notice of Re-assessment dated July 3, 1974, the Minister of National Revenue included in the Appellant’s income for his 1973 taxation year the full amount of the $77,812.50 excess referred to in paragraph 7 hereof.

Some paragraphs of the “Agreement” will be referred to in the course of these reasons. They are:

2. Except as provided in paragraphs 5 and 6 this option shall only become exercisable by the Optionee after one year’s continuous employment immediately following the date hereof either with the Company or with a subsidiary or affiliated company or consecutively with any two or more of them.

4. This option shall be exercisable by the Optionee, except as herein otherwise provided, in whole at any time or in part from time to time within ten years after the date hereof, but not thereafter.

5. In the case of termination of employment of the Optionee by reason of early retirement or normal retirement in accordance with the retirement policy of the Company, subsidiary or affiliated company with which the Optionee is then employed, the provisions of paragraph 2 shall not apply and this option shall, notwithstanding the expiry date expressed herein, and except as herein otherwise provided, only be exercisable prior to the expiry date expressed herein or within six months after the date of the retirement of the Optionee, whichever is the shorter period.

6. In the case of the death of the Optionee the provisions of paragraph 2 Shall not apply and this option shall be exercisable by his personal repre- sentatives, but notwithstanding the expiry date expressed herein, this option shall only be exercisable prior to the expiry date expressed herein or within twelve months after the death of the Optionee, whichever is the shorter period.

7. In the case of termination of employment of the Optionee for any reason other than death, early retirement or normal retirement in accordance with the retirement policy of the Company, subsidiary or affiliated company with which the Optionee is then employed, and after this option shall have become exercisable, then notwithstanding the expiry date expressed herein, this option shall only be exercisable prior to the expiry date expressed herein or within three months after termination of employment, whichever is the shorter period.

10. This option is subject to the condition that if the Incentive Plans Committee of the Board of Directors of the Company shall determine that the Optionee has engaged in any activity in competition with or otherwise prejudicial to the interests of the Company or a subsidiary or affiliated company, the said Committee shall have full power and authority to rescind, cancel and terminate this option to the extent that it has not been exercised. The foregoing provision of this paragraph 10 shall apply whether the Optionee is or is not at such time in the employ of the Company or a subsidiary or affiliated company and the decision of the said Committee shall be final and conclusive.

In addition, I will be referring to several subsections and paragraphs of the Income Tax Act as well as two Articles of the Canada-US Tax Convention, as follows:

2. (3) Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada,

(b) carried on a business in Canada, or

(c) disposed of a taxable Canadian property,

at any time in the year or a previous year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

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 arid other benefits of any kind whatever ( . . . ) received or enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment;

7. (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;

(4) For greater certainty it is hereby declared that, where a person to whom any provision of subsection (1) would otherwise apply has ceased to be an employee before all things have happened that would make that provision applicable, subsection (1) shall continue to apply as though the person were still an employee and as though the employment were still in existence.

115. (1) For the purposes of this Act, a non-resident person’s taxable income earned in Canada for a taxation year is the amount of his income for the year that would be determined under section 3 if

(a) he had no income other than

(i) incomes from the duties of. offices and employments performed by him in Canada,

(v) in the case of a non-resident person described in subsection (2),

the aggregate determined under paragraph (2)(e) in respect of him,

(2) Where, in a taxation year, a non-resident person was

(c) an individual who had, in any previous year, ceased to be resident in Canada and who was, in the taxation year, in receipt of remuneration in respect of an office or employment that was paid to him directly or indirectly by a person resident in Canada,

ARTICLE VII

1. A resident of Canada shall be exempt from United States tax upon compensation for personal (including professional) services performed during the taxable year within the United States of America if he is present therein for a period or periods not exceeding a total of 183 days during the taxable year and either of the following conditions is met—

(a) his compensation is received for such personal services performed as an officer or employee of a resident, or corporation or other entity of Canada or of a permanent establishment in Canada of a United States enterprise, or

(b) his compensation received for such personal services does not exceed $5,000.

2. The provisions of paragraph 1 of this Article shall apply, mutatis mutandis, to a resident of the United States with respect to compensation for such personal services performed in Canada.

ARTICLE VIII

Gains derived in one of the contracting States from the sale or exchange of capital assets by a resident or a corporation or other entity of the other contracting State shall be exempt from taxation in the former State, provided such resident or corporation or other entity has no permanent establishment in the former State.

The primary position taken by the appellant’s counsel was that there was no charging provision in the Income Tax Act which charged the gain, or any portion of the appellant’s gain by his purchase of the shares, to income tax as his client, in 1973, had no income from the duties of offices and employments performed by him in Canada as required by subparagraph 115(1)(a)(i). If he were within that subparagraph and consequently taxable, it was exempt from taxation by virtue of Article VII or VII of the Canada-US Tax Convention. Counsel for the appellant also contended that the result of the proper interpretation of subsection 2(3) and section 115 of the said Act is that the appellant’s gain from the exercise of his option must be reduced to the extent it is attributable to employment performed by the appellant outside Canada, namely, in the United States. This quantum could be the increase in value of the shares by the time the appellant left Canada, without any reference to either the exercise of the option or to the date of exercise of the option, or that portion of the total gain realized when the shares were acquired referable to his period of residence in Canada after he acquired the option, computed on the basis that that gain accrued in equal daily amounts for the period of time he held the option. Likewise he contended that, if only a portion were taxable, that portion was exempt by the same Articles of the Canada- US Tax Convention.

As to the facts, it must be clearly noted that when the appellant received the option from the British American Oil Company Limited (hereinafter referred to as the “company”) in 1967, he was a resident of Canada; he worked continuously in Canada from 1967 until March 1971 for the company; he ceased being a resident of Canada in the year 1971; he performed no services or duties for the company or any other Canadian person after 1971; and he exercised the option in the calendar year 1973. When he left the company in 1971, he returned to the United States and worked for the parent of the company. The rights he acquired under the option remained ‘constant at all times with respect to the number of shares, price per share and the time of exercising the option—they never varied. It should be noted from the agreement that the appellant did not have an option to exercise until the first anniversary date of the agreement, namely, October 4, 1968 (paragraph 2) and the rights he had under the option expired no later than October 3, 1977 (paragraph 4). In the case of retirement or death, the option expired at the expiration of the shorter period of 6 months (paragraph 5), or 12 months (paragraph 6) from the event, or the expiry date. However should the appellant do something prejudicial to the company, whether he was then an employee or not, the company could rescind the option to the extent it had not been exercised (paragraph 10). Thus, one year after the option was signed, the rights the appellant had pursuant to the option were vested in him for a definitive period of time and, prior to the stated expiry date, he could only be divested of those rights by the provisions of paragraph 10. On retirement or death the period of time remaining for him or his representative to exercise that option may have decreased in time, but it would not have been less than the shorter of the time stated in paragraph 5 or 6 and the expiry date. It should also be noted that, once the appellant acquired his rights under the option, the quantum and quality of those rights did not vary while he held those rights, whether or not he continued to work for the company or an affiliated company. The market value of the stock might vary over the life of the option, but not the rights that he had acquired under the option.

On these facts and proceeding with the respondent’s submission, pursuant to paragraph 2(3)(c) and subparagraph 115(1)(a)(i), there must be found that there was employment in Canada during 1973. For the appellant to be taxable in 1973, since he was not resident, he must be within the ambit of subsection 2(3) and the respondent says that he is within that subsection as he “was employed in Canada . . . at any time in the year or a previous year . . .”’. That subsection then states, his taxable income upon which he shall be taxed shall be determined pursuant to Division D of the Act. The portion of that Division on which the respondent relies is subparagraph 115(1)(a)(i) and no other. That section says what a non-resident person’s taxable income earned in Canada pursuant to section 3 for the year is. It is his income for the year (1973) if his only income were income from the duties of offices and employments performed by him in Canada. To succeed then in this respect, it must be determined that the gain the appellant had in 1973 on exercising his stock option was from the duties of offices and employments in Canada. The respondent states that, were one to stop one’s consideration of the “problem at this section, one could not say that the appellant was employed in Canada in 1973 and so the assessment as made could not stand.

His submission continues and he makes reference to paragraph 7(1)(a), subsections 7(4) and then 6(1) of the Act. His submission, referring to subsection 6(1), paragraph 7(1)(a) and subsection 7(4), is that those portions of the Act operate to deem employment in Canada in the circumstances, and to deem performance of duties in Canada in 1973. They determine the quantum of the benefit and subsection 6(1) makes that benefit part of the income of the appellant. Subsection 6(1) would bring only some benefits into income, namely, those benefits received or enjoyed by him in the year in respect of, in the course of, or by virtue of, an office or employment. In 1973 the appellant had. no office or employment in Canada and, even if he did receive a benefit in that year, it is not every benefit which is to be included in income, only those enjoyed by virtue of an office or employment. In this case the respondent’s counsel states it could be argued, although he does not agree with such an argument, that subsection 7(1) only covers a situation where the person who acquired thé shares was an employee not only at the time the rights were acquired, but also at the time the shares were acquired. He contends it clearly covers the situation as long as the employee was an employee of the corporation when he obtained the right to acquire the shares. In any event his submission was that, if there were any doubt as to whether or not subsection 7(1) applied to the situation in this case, that doubt is dispelled by subsection 7(4). This subsection makes paragraph 7(1)(a) apply to a “former’’ employee and it also states: “shall continue to apply . . . as though the employment were still in existence’’. The respondent states that, if a former employee exercises an option to buy shares of a corporation, which option he received while he was an employee of that corporation, then, by subsection (4) of section 7, subsection (1) of section 7 shall still continue to apply as though the person were still an employee and as though the employment were still in existence. It is to be noted that the definitive article “the’’ is used before employment—referring back, it would appear, to the employment which existed when the option was granted. The submission was that the effect of subsection 7(4), in so far as employment is concerned, is that the employment with the corporation which granted the option, which employment was in existence in 1971, is still in existence in 1973. If the employment is still in existence in 1973, he is still an employee in 1973 and, if he is an employee, he is employed. Based on the definition of the word “employed” in the Income Tax Act, in 1973 he was performing the duties of an office or employment. Then by applying paragraph 6(1)(a), the benefit is income to the appellant in 1973.

The respondent’s counsel, with respect to the alternative submission of the appelant as to apportionment, just poses the question: What is the basis for any apportionment of the benefit? Assuming the facts were as they are in this case except that when he left Canada the appellant immediately ceased to work for the company or any of its affiliates and worked for some other company or was unemployed, why should some of the benefit not be taxable solely because he worked for the affiliate in the United States for some time? The increase in the value of the benefit is not referable to further “work” or “employment” which the appellant performed after he left Canada. Obviously, according to the terms of the option agreement, in March 1973 when he left Canada, his rights had been acquired (paragraph 2) and he could only be divested of them according to paragraph 10 of that agreement. He submitted that there was no basis for an apportionment to enter into consideration of this matter. After his year of employment and after he acquired his rights, he then had the right to acquire this stock at a set price. Whether or not it would be to his advantage to buy the stock after he had the right to do so would be determined by the stock market value of the shares, not by his years of employment with the company or any affiliate.

The appellant’s position is that, because of the wording of subparagraph 115(1 )(a)(i), since he had no income from the duties of offices and employments performed by him in Canada and as he was not in Canada in 1973, the benefit or gain he realized on acquiring the shares cannot be subject to tax.

As I view the combined effects of paragraph (a) of subsection 7(1) and subsection (4) of section 7 if needed, the benefit the appellant realized was a benefit he realized as an employee of the company, and if paragraph (a) of subsection 7(1) does not embrace the benefit the appellant realized, then it is clear that subsection (4) of section 7 does, and it says in these circumstances: “. . . as though the person were still an employee and as though the employment were still in existence”. If the section imputes employment, as I hold it does, then it also should be taken to impute the duties of that employment.

Consequently, I am of the view that the benefit the appellant realized when he acquired the shares in question is properly considered to be part of his 1973 income and, in addition, since the gain he realized was only referable to this option (and the stock market value) and not to duties performed after his rights in the option became vested in him, there is no basis for any apportionment of that benefit.

The appellant contended that, even if the benefit were taxable pursuant to the Income Tax Act, that gain or benefit was exempt from taxation by virtue of either Article VII or VIII of the Canada-US Tax Convention. His argument was that the appellant exchanged his capital rights when he acquired the shares from the company and, assuming there is a gain since in his argument it was a gain derived from the appellant’s sale or exchange of a capital asset, it (the gain) is to be exempt from taxation. According to counsel for the appellant, at the time the Canada-US Tax Convention was entered into, this type of transaction was a capital transaction and it continues to be so.

What transaction took place between the appellant and the company? There was no sale, and there was no exchange. In effect, the appellant advised the company: “I will take X number of shares and here is Y dollars.” The only thing he gave or surrendered to the company was his Y dollars. I do not view the transaction as being within the purview of Article VIII of the Convention and I hold that the benefit is not, pursuant to that article, exempt from taxation.

Reference by counsel for the appellant to Article VII was on the basis that it would apply if I should find that the gain the appellant realized was to be apportioned. Article VII would then operate, in his submission, to exempt that portion which I found to be taxable. Having found that the total amount of the gain is taxable, then, in the appellant’s submission, Article VII has no application.

The result is that judgment will be issued dismissing this appeal.

Appeal dismissed.