Placer Dome Inc. v. Canada (No. 2), [1991] 1 CTC 453

Denault, J.:—This is an appeal from a reassessment by Revenue Canada of the plaintiff's corporate income tax return. It involves a deduction made by the plaintiff corporation respecting its contribution to an employee stock option plan. The issue is whether the employer contribution to the plan is compensation to employees under section 5(1) or a benefit to employees under paragraph 7(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act"). If the plan falls under the provision of section 7, then the employer's contribution is not deductible.

Facts

The plaintiff is an amalgamated corporation incorporated under the Canadian Business Corporations Act, effective August 13, 1987 on the amalgamation of Placer Development, Dome Mines Ltd. and Campbell Red Lake Mines Ltd. On February 13, 1973 Placer Development Ltd. ('Placer") approved the Placer Development Ltd. Stock Purchase Plan ("the" Plan"). By resolution of the Board of Directors of Placer (the "Board") dated June 15, 1973, the Board resolved that all shares purchased by the trustee pursuant to the Plan shall be purchased on the market. The Board later resolved that effective September 1, 1975 all shares purchased pursuant to the Plan shall be purchased from the company treasury as original shares.

Under the Plan, employees, over the age of 19, who have been with the company, or one of the affiliated companies can contribute up to six per cent of their salary for the year, after one year of service. The plaintiff company and affiliated companies will contribute an amount equal to one half of the employee contribution.

In 1985, 84,106.5412 shares were purchased, of which 40,794.7412 were purchased from the accounts of other members in the Plan and 43,304 were acquired from the plaintiff's treasury. The plaintiff's contribution pursuant to the Plan was $282,076.

In the 1985 taxation year, the plaintiff deducted the $282,076 from its income as additional wages or salary for the plaintiff's employees. This was disallowed as a deduction by Revenue Canada by a notice of reassessment dated July 7, 1989 for the plaintiff's 1985 taxation year. The form T7WC attached to the notice of reassessment stated "Disallowed employer contributions to Employee Stock Purchase Plan $282,076". By notice filed on July 20, 1989, the plaintiff objected to the said reassessment. By notification dated December 13, 1989, the Minister of National Revenue confirmed the reassessment. The plaintiff appealed this reassessment.

Plaintiff's Argument

The thrust of the plaintiff's argument is that Placer's contribution under the Plan is no different from the contribution by the employee. It is compensation to the employee and taxable under subsection 5(1) of the Act which includes as income salary, wages and other remuneration. The fact that the member does not actually receive the cash in hand does not change the nature of the money. In support of this submission it relies on J.-P. Morin v. The Queen, [1975] C.T.C. 106; 75 D.T.C. 5061 at 110 (D.T.C. 5064) which held that an employee does not have to receive physically the cash in order for it to be taxable remuneration.

Essentially, the Plan is a contractual relationship between the plaintiff and its employees. The intention of the parties under this agreement is that the employer's contribution constitutes remuneration. The Plan is a cash scheme whereby the employee can choose to contribute up to six per cent of his/her salary to purchase the shares, and Placer Dome will correspondingly pay cash equal to one-half of the employee's contribution.

The trustee is appointed for the benefit of the members from whom the members can demand at any time the payment cash and/or shares which it holds for them. Moreover, the plaintiff company does not have any control over the cheques it writes to the trustee on or before the 6th of each month. The plaintiff does not know what proportion of the cheque it writes each month goes towards the purchase of shares since a portion of the moneys is paid to terminating members. Nor does the plaintiff know how much of the money goes to purchase shares from other members' accounts, that being a priority under the Plan.

In summary, it is the plaintiff's submission that the Plan does not fit under the provisions of paragraphs 7(1)(a) and 7(3)(b) since it is not a scheme to issue shares at less than fair market value with no cash payout by the employer. The employer writes a cheque each month on the employee's behalf and shares are purchased at fair market value.

Defendant's Argument

In contrast, the defendant's submission is that the plaintiff's payout to the employee cannot be considered remuneration. The employees are not performing any additional work in order to belong to the Plan and receive the plaintiff's contribution. There is no specific criterion to receive the shares. They performed no additional service to receive the benefit apart from working for the plaintiff corporation for one year and being over the age of 19. All that an employee must do is fill out a form and give it to the corporation specifying the percent of the payroll deduction. The deduction continues in an automatic fashion until an alteration is made by the employee which can either be a change in the percentage withholding or alternatively a termination of participation in the Plan. The employer will then contribute to the Plan at the employer's percentage rate, withholding income tax at source. It is submitted that the definition of salary in the Plan supports the defendant's characterization of the payment:

Salary means the base salary paid to an employee by a participating company for personal services rendered by him as an employee as such a participating company including vacation pay and payments under Placer Development Ltd. annual incentive plan but not including bonuses, commissions, overtime pay, living or other allowances, reimbursements or special payments or any contributions or benefits under this or any other plan of current or deferred compensation adopted by a participating company.

The Plan is an agreement by the corporation to issue shares to the employee through financial assistance. The end result is that the employee receives shares at a discounted rate from the fair market value and the contribution made by the plaintiff is a turnaround.

The Plan fits squarely within paragraph 7(1)(a) which is an employee benefit. It is the defendant's position that the scheme correspondingly fits within paragraph 7(3)(b) which precludes corporations from deducting its contribution to share purchase.

Therefore, the Plan is not essentially cash in nature. While the member can instruct the trustee to give him the cash out of his cash account, he can only do this twice in a ten-year period (Article VII A). This is also evidenced by the statement of objectives of the Plan which is to provide a means whereby employees can accumulate Placer shares through payroll deductions. Regarding the position of the trustee, the trust agreement requires the trustee to administer the Plan and the Plan ensures that the trustee will purchase shares. On this point, the defendant directs the court to paragraph 7(6) of the Act which provides that where a trustee is involved, the rights of the employer and the obligations flow through the trustee.

At trial, the defendant withdrew its alternative argument that the Plan would be an employee trust or an employee benefit plan under paragraphs 12(1)(n) or 12(1)(n.1) if the Court found that it did not fall within section 7 of the Act. Therefore, the issue before this Court is to decide whether the Plan falls under the provisions of section 7 of the Act.

Findings

It is not in dispute that the employees of Placer receive a taxable benefit. The Plan contemplates and ensures that the employer contribution will be taxable income for the employee. It is also agreed that the Plan fits under the definition of agreement to issue shares pursuant to subsection 7(1) of the Act which reads as follows:

Agreement to issue shares to employees.—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,

The defendant also concedes that the plaintiff receives a deduction for the amounts that it did not receive back from the trustee for the purchase of treasury shares. This amount represents the cash withdrawals by the members. Accordingly, the issue is the nature of the employer contribution to the purchase of treasury shares on behalf of the member. The dispute centres around paragraph 7(1)(a), which reads as follows:

(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;

If the employer's contributions to the Plan fall within the definition set out in paragraph 7(1)(a), the plaintiff cannot claim a deduction for its contributions to the employee purchases of company shares according to paragraph 7(3)(b). If on the other hand, the employer contribution is remuneration under subsection 5(1) of the Act, the plaintiff can claim a deduction for its contribution.

I have examined the mechanics of the Plan, as well as the intention of the employer and employees, and I find as a fact it does not fall within paragraph 7(1)(a). In order for an employee stock option plan to fall within paragraph 7(1)(a), the value of the shares at the time the employee acquires the shares must exceed the amount paid. This is not the case under the Placer Dome Stock Option Plan because the employee pays for the shares at the fair market value and not at a discounted price. It is instructive to review the method in which shares are purchased.

The Board of Directors of Placer (the "Board") appoints a trustee who is responsible for holding the moneys contributed by the participating employee as well as the employer. Once an employee becomes a member of the Plan, the amount he/she contributes is placed into an account under the stewardship of the trustee who maintains a cash account and a share account for each member (Article V A). Counsel for the defendant submits that nothing turns on the fact that the trustee is in the middle. The trustee is simply a conduit and the rights and obligations of the employer and employee flow through the trustee. However, I find as a fact the trustee is appointed to administer the Plan for the benefit of the members. It is not holding money for the company. It ensures that the intentions of the employer and employees are carried out pursuant to the Plan.

The participating company makes a cash payout each month which corresponds to one half of the employee's contribution. The participating company will pay into the employee's cash account an amount equal to one-half of the member contribution within six days after the close of the calendar month (Article IV F).

The trustee will credit the employee's account with any contribution made by him and any contribution made by the employer as well as any dividends or other income received on Placer Common Shares held for his account and any net proceeds from the sale of Placer Common Shares for his account (Article V B). The trustee will correspondingly debit the member's account for shares purchased and any cash distributed to him or his legal representative. Cash contributions by the participating company are stated to be an absolute benefit for the member. The contribution by the participating company is regarded as additional compensation and taxes are withheld at source (Article IV F).

The trustee determines the aggregate sum carried in the cash accounts of the members on the close of the tenth day, except for the accounts which it has been instructed to sell all of the Placer common shares. The trustee credits the cash account of the member who instructs him to sell the Placer shares pursuant to Article VII C. The trustee then debits his share account for the number of Placer shares or fractions being sold for his account.

On the next business day following the tenth day of each calendar month, the trustee purchases Placer Common shares for the accounts of the members according to the procedure set out in Article VI A. The trustee will purchase shares first from members who are withdrawing or terminating. Thereafter, shares are purchased from the company treasury. The price paid by the trustee for the shares is "the price per share of the last sale of Placer Common Shares on the Toronto Stock Exchange on the tenth day of the calendar month following the calendar month in which the contributions were made by the members" (Article VI A (2)).

There is a time lag between when the contributions are made and the Tith business day on which the trustee will purchase the shares. During this time, the price of Placer shares will typically fluctuate. The Plan provides for this. If the shares decrease, the trustee will place the surplus funds into the members' cash accounts. Conversely if the share prices increase, the trustee shall determine the amount of shares to be sold and that may be purchased for the accounts of the other members by (i) subtracting from the Net Contributions an amount equal to the Issued Price multiplied by any fractional interest in a share to be sold and (ii) dividing the balance by the Issued Price. The trustee then purchases the fractional interest and credits the members' share accounts (Article VII C (1)). This procedure demonstrates that the company makes a cash payout and that it has no control over the number of snares that will be purchased. It also underscores the fact that members are paying full price for the shares.

The Plan is fashioned in such a way that a member may withdraw or sell his shares. A member may direct the trustee either to transfer all or any part of the Placer Common Shares carried in his share account into his name and deliver it to him or to sell all of the Placer shares and fractions and remit the balance in his cash account. (Article VI A)

The fact that the total amount in trust to purchase shares for a given month could be used to buy shares from withdrawing or terminating members negates the defendant's argument that the Plan is merely a scheme to issue shares at a discount. In one such month, there would be no turnaround of the employee/employer contribution. Rather, this would be a cash payout to withdrawing or terminating members, with no issuance of company shares.

It is the intention of both the employer and the employees that the contribution be ordinary contribution and not merely a discount. The Plan outlines the stated purpose as follows: “to enable Employees to acquire Placer Common Shares through payroll deductions with financial assistance provided by the Participating Company" (Article II). Financial assistance does not imply that the shares will be sold at a discount rate. To the contrary, the employees are paying the full price for the shares on the date of purchase.

From the above analysis of the Plan, I find that paragraph 7(1)(a) does not apply as there was no“ benefit equal to the amount by which the value of the shares at the time [the purchaser] acquired them exceeds the amount paid" since the market value of the shares at the time the employee acquired them was equal to the amount paid.

Counsel for the defendant has submitted that the employer contribution to the purchase of shares cannot be considered remuneration since the employees have not performed any additional service for the benefit of this program. I find this argument to be without merit. An employer may offer additional remuneration or benefit packages to employees after a certain period of service with the company. This practice does not mean that an employee must receive a promotion or perform additional services. An employee may be attracted to an organization on the basis of a favourable remuneration package after a certain period of service. I find no distinction between the plaintiffs eligibility requirements for the Placer Development Ltd. Stock Purchase Plan and other benefit packages.

The employer's contributions according to the Plan, are ordinary remuneration to those who qualify and who agree to participate in the program. Therefore, the provisions of section 7 do not apply to the plaintiff's Plan.

The Minister of National Revenue wrongly assumed that in 1985, all shares were purchased from the company treasury and that the employee never had a right to the employer contribution. The procedure which I have just outlined indicates that the priority purchase of shares is from withdrawing members.

Jurisprudence

Counsel for the defendant has referred me to a number of authorities which he submits support the conclusion that the employer contribution amounts to the selling of shares to employees at a discounted rate.

The House of Lords held in Lowry v. Consolidated African Selection Trust Ltd., [1940] A.C. 648 (H.L.) that the respondent company had not transferred money to its employees, and therefore, the amount in question could not be treated as a disbursement or a deductible expense in calculating the corporate income. In that case, the respondent company allotted 6,000 shares to its employees at their face value of 5s, while the market value of the shares was 1£ 18s 9d. The company claimed a deduction in the computation of its income tax for the year in question.

The present facts are different from the Lowry situation. Here, the company makes a monthly cash payout to eligible employees who choose to participate in the Plan. The participating members pay the full market price for the stocks that they purchase each month. Moreover, it is an ongoing plan and not a single issuance of shares to employees at a discounted rate.

The defendant referred also to Kaiser Petroleum Ltd. v. Canada, [1990] 1 C.T.C. 62; 90 D.T.C. 6034; rvd [1990] 2 C.T.C. 439; 90 D.T.C. 6603 which involved a sale of shares to the plaintiff company, while the employees of the vendor had an option to purchase shares over a period of years. The plaintiff undertook to offer to pay employees a sum of money in lieu of the outstanding stock options. This was accomplished under the terms of a takeover agreement, through which the plaintiff had acquired the controlling shares of the corporate taxpayer. The plaintiff paid out over two million dollars pursuant to this agreement. The Minister had disallowed the deduction of this amount as an expense. Joyal, J. allowed the appeal on the basis that the payment was made in fulfilment of a term and condition of the employees' employment. Accordingly, it was a taxable compensation to those employees in lieu of a taxable benefit by way of stock option which they would have otherwise enjoyed. Kaiser Petroleum was reversed on appeal on the issue of capital versus income.

Counsel for the defendant submits that Kaiser Petroleum is authority for the proposition that if the money in question had simply turned around to the corporation, there would be no deductible expense. At page 70 (D.T.C. 6038), Joyal, J. characterized the payment in the following manner:

There is little doubt that without that undertaking, the plaintiff would not have incurred the expense. Upon the exercise of their several options, the employees would have been issued shares producing a benefit to the employees but at no cost to the plaintiff. What transpired, however, is that the plaintiff did bear a cost which, according to generally accepted accounting principles, was an expense properly charged against revenue.

I do not disagree that if there is a turnaround of moneys paid out by a corporation in the offer to employees to purchase of shares, there is not a deductible expense. The present case, however, is distinct from Kaiser Petroleum for several reasons. Here, there is not a single cash payout in lieu of payment of stocks, but an ongoing benefit program, through which the employees of Placer can purchase Placer Dome stocks. Additionally, the plan in Kaiser Petroleum allowed for a favourable purchase price and I have found as a fact that the employees pay the full market price for the purchase of Placer shares. Ultimately the question in Kaiser Petroleum was decided on the question of income versus capital. However, in the present case, the question is limited to the interpretation of section 7 of the Act.

While the authorities submitted were helpful in understanding how various employee stock option plans operate, the present case concerned the inter- pretation of section 7 of the Act. I have found as a fact that Placer Development's Ltd. Stock Purchase Plan does not fall within the scope of section 7. Instead, the payout made by the plaintiff company is remuneration pursuant to subsection 5(1) of the Act. Accordingly, the plaintiff is permitted to use its cash payout to the employees as a deduction.

Finally, counsel for the defendant referred to an essay written by a leading tax scholar, Vern Krishna ("Stock Option Plans” Canadian Current Tax (1986) Vol. 1 No. 36 C-177). At page C-179, Mr. Krishna described the effect of stock option plans on employers:

The employer is not allowed to deduct as an expense any of the costs that are associated with the stock option plan. The employer does not incur any outlay or expense by issuing its shares at less than their market value; it merely foregoes capital proceeds which it would have received had it issued the shares at their fair market value.

In the present case, employees purchase stocks at the fair market value and the employer makes a cash payout to assist in the purchase of the shares. Therefore, the plaintiff does incur a cash outlay.

Conclusion

This appeal is allowed with costs and the Minister is ordered to vary the reassessment in order to allow the deduction of the $282,076.

Appeal allowed.