Scott v. The Queen, 94 DTC 6193, [1994] 1 CTC 330 (FCA)

Heald J.A. (Linden and Gray, JJ.A., concurring):—This is an appeal from a judgment of the Trial Division [Scott v. Canada, [1991] 1 C.T.C. 395, 91 D.T.C. 5268] wherein the appellant’s action to set aside the Minister of National Reve- nue's (Minister’s) reassessment of his 1983 and 1984 income returns was dismissed with costs.

Facts

For a number of years, between 1970 and 1985 and at all material times, the appellant was a full-time employee of Delsco Realty Ltd., an Ontario Corporation (Delsco) [1] . Delsco had an agreement with D.Z. pursuant to which a variety of services were rendered by Delsco to D.Z. Those services were actually performed by the appellant as an employee of Delsco. D.Z. paid Delsco a flat fee, revised annually and fixed in advance, for all services provided by Delsco to D.Z. during the course of the year. The fees received by Delsco from D.Z. were in excess of the remuneration paid by Delsco to the appellant. Prior to the 1979-80 period, the services provided by Delsco to D.Z. related mainly to real estate and conveyancing matters.

However, commencing with the 1979-80 period, D.Z. entered into contracts to provide managerial and administrative services to Night Hawk Resources Ltd., a British Columbia Corporation (Night Hawk Canada) as well as to Saxton Industries Ltd., also a British Columbia Corporation (Saxton Canada). Night Hawk Canada, through its subsidiary Night Hawk U.S. and Saxton Canada through its subsidiary Saxton U.S. carried on oil and gas exploration and production activities in the U.S.A. and had investments in oil and gas properties there. The Night Hawk companies were only investors, having no responsibility for the management of the drilling or for the exploration being carried on. However, the Saxton companies were involved in the operation of some of these properties.

The appellant became a director and corporate secretary of Night Hawk Canada and Night Hawk U.S. in 1988. His work encompassed the usual work of a corporate secretary — advising directors of meetings, taking minutes, preparing directors' resolutions, etc.

In 1983, Night Hawk U.S. drilled a number of wells on its major property. This drilling became necessary since, failing such drilling activity, its lease on that property would expire in October of 1983.

In his capacity as a Delsco employee and under D.Z.'s direction, the appellant performed various managerial services for Night Hawk U.S. which included negotiations with Saxton U.S. for a drilling program as well as negotiations for financing. Night Hawk Canada was invoiced by D.Z. for these services which the appellant had performed. From 1980 until mid-1984, Night Hawk Canada had no employees or payroll of its own and no fees were paid to its directors for their services as SUCN.

On September 9, 1983, Night Hawk Canada granted stock options to its seven directors in the following amounts:

The price at which the options could be exercised was $1.20 per share. This was the trading price on the Vancouver Stock Exchange on the date the options were granted. As of that date, Night Hawk Canada was a public company. In 1983, appellant exercised his option to acquire 4,710 shares. In 1984 he exercised the option to acquire the balance of his option allotment, namely 22,000 shares. In 1983 and 1984, he disposed of a portion of the shares thereby acquired and was deemed to have disposed of the balance of his option allotment in 1985.

The appellant filed his 1983, 1984 and 1985 income tax returns on the basis that the gains from disposition of the option shares over their acquisition cost at the option exercise price of $1.20 per share constituted capital gains.

The Minister reassessed the appellant's 1983 and 1984 returns on the basis that the difference between the option exercise price and the fair market value of the shares at the time of the exercise of the options constituted a benefit from employment pursuant to 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") [2] and thus constituted employment income rather than capital gains.

The Minister did not reassess the appellant’s 1985 return in accordance with the 1983 and 1984 reassessments. As a consequence, the appellant was subject to tax on taxable capital gains amounting to $63,359 in respect of the taxation year 1985, essentially all of which reflects further dispositions or deemed dispositions of Night Hawk shares. The parties agree that if the Minister had reassessed the appellant for the taxation year 1985 on the same basis as the 1983 and 1984 reassessments, the income inclusion for 1983 and 1984 recognized by the Minister would have been included in the appellant’s adjusted cost base of his remaining Night Hawk shares, with the result that he would have realized an allowable capital loss of $6,833.65 rather than a capital gain. That loss would have been carried back and applied against the taxable capital gains realized in 1984. [3]

Analysis

In my view, the learned Trial Judge correctly stated the basic issue in this appeal at page 398 (D.T.C. 5270):

. . . whether plaintiff realized a capital gain for the years in question as he contends or whether the said amounts constituted income as a result of his having exercised stock options which he had received in respect of, in the course of or by virtue of his employment, at a time when the value of the shares exceeded the amount which he paid therefor, thereby obtaining a benefit pursuant to section 7 of the Act.

After a careful review of the evidence and the relevant statutory provisions, the Trial Judge stated at pages 404-05 (D.T.C. 5275):

. . . since I have concluded that the share options given to him were as a result of his employment by Night Hawk Canada, although his salary remuneration was paid by Delsco and his work for Night Hawk Canada was assigned to him by Delsco and directed by it or by the Del Zotto law firm who had seconded him to Delsco, the profits resulting from the acquisition of shares by the exercise of these options and subsequent sales of some of them at a profit are taxable as income in his hands.

The appellant challenges this conclusion. After observing, correctly, in my view, that the liability for tax pursuant to paragraph 7(1 )(a) does not apply if the benefit conferred was "not received in respect of, in the course of, or by virtue of the employment [4] , the appellant makes the point that section 7 would not apply to the stock options granted by Night Hawk Canada to the appellant if or to the extent that:

(a) the appellant did not have "employment" with Night Hawk Canada; or

(b) the appellant had “employment” with Night Hawk Canada, but the stock options here in issue were not granted in respect of, in the course of, or by virtue of that "employment".

(a) The appellant was not in an employment relationship with Night Hawk Canada either at common law or as defined by the Income Tax Act.

The appellant states that the essence of the employment relationship at common law is the existence of a master-servant relationship between the employer and the employee. Here only D.Z. had a contractual obligation to provide services to Night Hawk Canada. It fulfilled that obligation by engaging the services of Delsco which, in turn, employed the appellant. The appellant took his direction from Delsco and D.Z., not from Night Hawk Canada. He received no salary from Night Hawk Canada. Delsco, through the appellant, simultaneously provided services to Night Hawk U.S., Saxton Canada, Saxton U.S. and D.Z. Accordingly, it is submitted that the appellant’s relationship to Night Hawk Canada did not nave the characteristics of any common law employment relationship as established in the case of Wiebe Door Services Ltd. v. M.N.R., [1986] 2 C.T.C. 200, 87 D.T.C. 5025 (F.C.A.).

The appellant makes the further submission that, apart from the position at common law, on the facts in this case, he does not have "employment" with Night Hawk Canada pursuant to the provisions of the Act. Counsel refers to the defini- tion of "employment" as set out in subsection 248(1) of the Act [5] and submits that the use of the word "means" indicates an exhaustive definition as contrasted with the use of the word “includes” in the definitions of "employee" and "office". In his submission, a director is not in the service of the corporation. An officer's relationship with a corporation falls into the definition of employment only in circumstances where the officer is “in the service of" the corporation. In counsel's view, this is the rationale for the use in the Act of the expression “office or employment" where both positions are intended to be included. Thus, the submission is that although the appellant is a director and secretary of Night Hawk Canada, section 7 of the Act does not apply to the options acquired since subsection 7(5) refers only to “employment”, and not to “office or employment". Thus, says counsel, the appellant’s options should be treated in the same way as other acquisitions and dispositions of securities.

I am unable to accept these submissions made on behalf of the appellant. Pursuant to subsection 248(1) of the Act, an officer of a corporation is an employee of that corporation and necessarily has an employment relationship with the corporation (see Taylor v. M.N.R., [1988] 2 C.T.C. 2227, 88 D.T.C. 1571 (T.C.C.), at page 2232 (D.T.C. 1575)). There was evidence before the trial judge establishing that, at all relevant times, the appellant was a director and officer of Night Hawk Canada [6] . There was also evidence before the trial judge supporting his conclusion that the appellant was an employee of Night Hawk Canada, independently of his position as a director and an officer of the corporation. He found as a fact that although the appellant was being paid through Delsco and was, effectively under the direction of D.Z., he was "rendering practically full- time services for Night Hawk Canada and its associated companies without receiving any remuneration from it.” The appellant’s own evidence was to the effect that he was "the work horse" of the corporation (see page 399 (D.T.C. 5271), reasons of Walsh, J.). He also said the share options were given to him for the services he provided to Night Hawk Canada [7] . This is a further indication of the existence of an employment relationship between the appellant and Night Hawk Canada.

(b) Even if there was an employment relationship between the appellant and Night Hawk Canada, the stock options herein issued were not granted in respect of, in the course of, or by virtue of that "employment".

The trial judge, after reviewing the evidence, concluded that the share options given to the appellant were as a result of his employment by Night Hawk Canada (at page 404 (D.T.C. 5275)). He added at page 405 (D.T.C. 5275):

If there were any doubt as to the intent of Night Hawk Resources Ltd. in granting the options it may be found in the preamble to the agreement which reads:

Whereas the holders are directors of the company and in that capacity are devoting considerable time and effort to the affairs of the company.

The options are then granted in varying amounts, those doing little work, save as directors being given $10,000 each, with Nedo Bragagnolo and Angelo Del Zotto receiving $30,000 each and plaintiff the odd number of $26,710. During his evidence when asked to explain how this number was reached for him he readily admitted that it represented the work he did for the company.

In my view, this conclusion of the trial judge is amply supported by the evidence and should not be disturbed. Accordingly I am unable to accept this submission by the appellant.

Conclusion

For the foregoing reasons, the appeal does not succeed except in one particular area as referred to earlier herein. The appeal with respect to the 1983 reassessment is dismissed. The appeal in respect of the 1984 reassessment is allowed and the matter is returned to the Minister for reassessment only on one ground, namely, that an allowable capital loss in the sum of $6,833.65 for the taxation year 1985 should be carried back and applied against the taxable capital gains realized in 1984. In all other respects, the 1984 reassessment is confirmed. Since there has been divided success, I would not allow costs.

Pursuant to Rule 337(2)(b), the respondent may prepare a draft of an appropriate judgment to implement the Court's conclusion and move for judgment accordingly pursuant to Rule 324.

Appeal allowed in part.