Citation: 2012 TCC 86
Date: 20120404
Docket: 2010-832(IT)G
BETWEEN:
TRANSALTA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
AMENDED REASONS FOR
JUDGMENT
Margeson J.
[1]
These appeals relate to
the 2001, 2002, 2003 and 2004 taxation years. In those years, the
Appellant provided bonuses to its employees and employees of certain of its
subsidiaries under the Appellant’s Share Ownership Plan (the “PSOP”).
[2]
In computing its income
under Part I of the Income Tax Act in its returns of income for each
relevant taxation year, the Appellant deducted the amount of the bonuses that
it provided to the participants under PSOP pursuant to subsections 9(1) and
paragraph 18(1)(a) of the Income Tax Act (Canada), R.S.C. 1985,
c. 1 (5th supp.) as amended (the “Act”).
[3]
For the 2001 and 2002
taxation years, the bonuses were satisfied by shares in the capital of the
Appellant (“shares”) and for the 2003 and 2004 taxation years, partly through
the payment of cash and partly through the issuance of shares. The deductions
of the amount of these bonuses was denied by the Minister of National Revenue
(the “Minister”), arguing that the deductions were prohibited by subsection
7(3) of the Act and that the provisions of subsection 7(1) of the Act
applied.
[4]
The
parties filed an agreed upon statement of facts as follows:
Agreed Statement of Facts
The parties hereto by their respective solicitors agree on the
following facts. This agreement is made for the purpose of this appeal
only and may not be used against either party on any other occasion. Either
party may adduce further and other evidence relevant to the issues and not inconsistent
with this agreement. It is also agreed that the admission of these facts is not
a concession of the weight or degree of relevance to be attributed to these
facts. Reference will be made in this Agreed Statement of Facts to the parties’
Joint Book of Documents (the “Joint Book of Documents”) with respect to
this matter.
1.
During the Appellant’s 2001, 2002, 2003 and 2004
taxation years (the “Relevant Taxation Years”), the Appellant
provided bonuses (“Bonuses”) under the Appellant’s Performance Share
Ownership Plan (the “PSOP”) to certain of its senior management and high
potential employees, and similar employees of certain of its subsidiaries,
designated by the Appellant as participants under the PSOP (“Participants”).
2.
Throughout the Relevant Taxation Years, each of
the Appellant and its subsidiaries TransAlta Utilities Corporation, TransAlta
Energy Corporation and TransAlta Energy Marketing Corporation (the “Subsidiaries”)
was a resident of Canada for
purposes of the Income Tax Act (the “Act”).
3.
Throughout the Relevant Taxation Years, Participants included
employees of the Appellant and each of the Subsidiaries.
4.
Throughout the Relevant Taxation Years, the Appellant and the
Subsidiaries did not deal at arm’s length with one another for
purposes of the Act.
5.
Throughout the Relevant Taxation Years, the
Appellant was a “public corporation” for purposes of the Act, and the
Shares were listed for trading on (among other stock exchanges) The Toronto
Stock Exchange and the Montreal Exchange.
6.
The taxation year-end of the Appellant for all
Relevant Taxation Years was December 31.
7.
The Appellant was incorporated under the Canada
Business Corporations Act (Canada) (the “CBCA”), and continued to subsist thereunder
throughout the Relevant Taxation Years.
8.
The Appellant instituted the PSOP in 1997. The
resolution of the Appellant’s Board of Directors with respect to the PSOP is at
Tab 1 of the Joint Book of Documents.
9.
The PSOP was amended several times thereafter
prior to or during the Relevant Taxation Years. The versions applicable during
the Relevant Taxation Years are dated April 1, 1999 and July 22, 2004. The PSOP
dated April 1, 1999 is at Tab 2 of the Joint Book of Documents. The PSOP dated
July 22, 2004 is at Tab 3 of the Joint Book of Documents.
10.
Employees of the Appellant who became
participants in the PSOP after it was instituted were advised by letter. A
typical copy of such a letter is at Tab 4 of the Joint Book of Documents.
11.
New employees who were to participate in the PSOP
were so advised in their letters of offer of employment. A typical copy of a
letter of offer of employment is at Tab 5 of the Joint Book of Documents.
12.
The PSOP operates on successive three-year
cycles (each, a “Compensation Period”). A new Compensation Period
commences at the beginning of each calendar year.
13.
The following steps occur with regard to the
Bonuses:
(a)
The Human Resources Committee (the “Committee”)
notifies each Participant near the beginning of each Compensation Period of the
range of units for which such Participant is eligible for that Compensation
Period, and notifies each Participant of such potential eligibility. For
example:
(i)
a Participant in 1999 would have been notified
of a unit range with respect to the Compensation Period running from 1999
through 2001, the Bonus respecting which may be paid in 2002;
(ii)
in 2000, the same Participant would be notified
of another potential unit range with regard to the Compensation Period running
from 2000 through 2002, the Bonus respecting which may be paid in 2003; and
(iii)
this process could recur with regard to each
successive Compensation Period.
A copy of a typical notification is at Tab 6 of the Joint Book of
Documents.
(b)
No later than 120 days after the end of each
Compensation Period, the Committee determines with respect to such Compensation
Period:
(i)
the amount of any Bonus for each Participant;
and
(ii)
whether and to what extent any such Bonus will
be paid in cash or by issuing Shares.
(c)
After the Committee’s determination, the
requisite Shares are issued and/or cash payments are made.
(d)
Each Participant is notified by the Bonus
provided to him or her that involved the issuance of Shares by receipt of a
memorandum from the Appellant:
(i)
advising that the number of Shares had been
determined;
(ii)
describing the amount of the Bonus based on the
number of Shares issued in satisfaction thereof; and
(iii)
describing the amount of tax remitted to the
Receiver General for Canada in
that regard;
A copy of typical memorandum is at tab 7 of the Joint Book of
Documents.
14.
The entire relationship between the Appellant
and its shareholders is governed by the CBCA.
15.
All of the Shares that the Appellant issued in
relation to the PSOP in the Relevant Taxation Years were treasury shares.
16.
The Management Proxy Circular for the May 1,
2002 annual meeting of the Appellant’s shareholders describes the PSOP and
contains information regarding the PSOP units awarded during 2001. A copy of
that Circular is at tab 8 of the Joint Book of Documents.
17.
In each Relevant Taxation Year the Appellant
accrued in its accounting books in accordance with its understanding of
applicable accounting principles an amount as an expense with regard to future
Bonuses. Such accrued amount is estimated in the same way regardless of the
extent to which the Bonuses may be paid in cash or by issuing Shares.
18.
The amount accrued as an expense in the
Appellant’s audited year-end financial statements with respect to the Relevant
Taxation Years as part of operations, maintenance and administrative expense,
were as follows:
|
Relevant Taxation Year
|
Accounting Expense
Accrued by Appellant
|
|
2001
|
$4,800,000
|
|
2002
|
$5,300,000
|
|
2003
|
$Nil
|
|
2004
|
$3,400,000
|
19.
The amounts accrued as expenses with regard to
future Bonuses were not deducted for income tax purposes and were added back on
the Form T2(S)1 prepared by the Appellant and filed with its tax return
for each Relevant Taxation Year.
20.
The accrued future Bonus amounts with respect to
a Compensation Period were adjusted by the Appellant in accordance with its
understanding of applicable accounting principles at the end of each year,
until the end of the relevant Compensation Period, and such adjusted estimated
amounts were reflected in the Appellant’s audited financial statements.
21.
The Appellant provided Bonuses in each or by issuing
Shares to Participants in the Relevant Taxation Years as follows:
|
Relevant
Taxation
Year
|
Market Value of Shares Issued by the
Appellant at time of Issuance
|
Amount of Cash Bonuses or Withholding Tax
Paid pursuant to the PSOP
|
Total Bonus
|
|
2001
|
$1,827,694
|
$0
|
$1,827,694
|
|
2002
|
$1,848,755
|
$0
|
$1,848,755
|
|
2003
|
$1,425,263
|
$907,504
|
$2,332,767
|
|
2004
|
$1,112,576
|
$1,166,121
|
$2,278,697
|
22.
In connection with the above issuances of
Shares, the Appellant increased its stated capital account in respect of its
common shares by the following amounts, which are equal to the fair market
value of the issued Shares at the time of issuance with respect to each of the
Relevant Taxation Years:
|
Relevant Taxation Year
|
Increase to the Appellant’s Stated Capital as a result of PSOP Share
Issuance
|
|
2001
|
$1,827,694
|
|
2002
|
$1,848,755
|
|
2003
|
$1,425,263
|
|
2004
|
$1,112,576
|
23.
The Appellant understands that its addition to
such stated capital account was made in accordance with subsections 25(3) and
(4) of the CBCA on the basis that the value of uncompensated services
previously rendered by the Participants to the Appellant was at least equal to
the Shares’ aggregate fair market value at the time of issuance.
24.
The above increases to the Appellant’s stated
capital were approved by its auditors, and have been accepted by the
Appellant’s outside legal counsel in their review of the Appellant’s corporate
records with respect to various financings and other similar matters.
25.
The Appellant:
(a)
filed its tax and information returns for the
Relevant Taxation Years on the basis that the Bonuses were taxed to the
Participants as employment income;
(b)
included the Bonuses as employment income of the
Participants in T4 information slips sent to Participants; and
(c)
remitted to the Receive General for Canada in cash certain amounts as source
deductions in respect of the Bonuses.
26.
In computing its income under Part I of the Act
in its returns of income for each Relevant Taxation Year, the Appellant
deducted amounts in respect of the Bonuses awarded by the issuance of Shares or
cash, including remittances to the Receiver General made on the employees
behalf in the year. Copies of the Appellant’s tax returns for the Relevant
Taxation Years are at tabs 9 through 12 of the Joint Book of Documents.
27.
The Minister of National Revenue reassessed the
Appellant to deny certain of the Appellant’s deductions with respect to the
Bonuses, as well as certain other deductions with respect to the Relevant
Taxation Years, as follows:
|
Relevant Taxation Year
|
Disallowed Deductions
Claimed by Appellant
|
|
2001
|
$1,827,694
|
|
2002
|
$1,848,755
|
|
2003
|
$2,356,791
|
|
2004
|
$2,302,338
|
28.
The Minister issued Notices of Determination of
Loss for each of the Relevant Taxation years, which are the Notices under
appeal. Copies of the Notices are at tabs 13 through 16 of the Joint Book of
Documents.
29.
The Crown and the Appellant have resolved
certain issues related to the Appellant’s deduction of the Bonuses paid in cash
and certain related expenditures, and as a result, the only issue that remains
to be resolved is whether the Appellant has the right to deduct fair market
value of the Shares it issued under the PSOP, in the following amounts:
|
Relevant Taxation Year
|
Deduction Claimed
|
|
2001
|
$1,827,694
|
|
2002
|
$1,848,755
|
|
2003
|
$1,425,263
|
|
2004
|
$1,112,576
|
[5]
The parties also
submitted a Joint Book of Documents without restrictions.
[6]
In evidence, Benjamin Park
testified that he was responsible for the PSOP. This plan provided that within
120 days of the end of a period, notice is sent to employees about what they
will receive by way of bonus. The form of notice is set out in Exhibit R-2 at
Tab 7.
[7]
He indicated that no
one has ever surrendered these shares or cash. An estimate was made of the
amount to be paid and they were set out in the books of the Appellant as an
accrued expense. They were conservative estimates so as not to under-estimate
the expense or the liability. The matching principle required them to be
accounted for in the period they were earned. There was no difference whether
the amounts were paid in cash or shares. They were shown in the books of the
Appellant as operations, maintenance and administration expenses as shown in
paragraph 18 of the Agreed Statement of Facts. If the amounts were not paid out
then there would not be an accrual. The payout could be higher or lower. This
has happened in the past.
[8]
In the balance sheet
treatment of the expenses, there is an adjustment for any changes to the
amounts on December 31, 2004. The accrued liability is purely an accounting
function and has nothing to do with the employees.
[9]
The Compensation
Committee is made up of people who are not company executives.
[10]
If the Crown is
successful in this case, there will be a 73 to 81% effect on the employees.
[11]
In cross-examination,
the witness indicated that he was a participant in PSOP.
[12]
He had received a
document similar to that found in the Joint Book of Documents at Tab 5 but not
exactly the same. The term reward that is used is not the same as the word
bonus.
[13]
Notification is given
at the end of a compensation period.
[14]
This notice given to
shareholders is more fully described at Tabs 8 and 9 of the Joint Book of
Documents.
Argument on Behalf of the Appellant
[15]
In argument, counsel
for the Appellant said that there was no legally-binding agreement to issue the
shares. There were three-year periods. The notification could be for a range of
bonuses at the end of a period. The board decides whether the bonuses would be
paid or not and whether they were to be by shares or cash. If shares were
issued, then this could be done without notifying the recipients of the issue.
[16]
For accounting
purposes, counsel stated that the Appellant never acknowledged a liability. No
one ever attempted to return cash or the shares.
[17]
The shares were issued
for past service as indicated in paragraph 23 of the Agreed Statement of Facts.
This consideration is not sufficient to support a legally‑binding
contract. There is no issue as to the validity of the shares for past service.
[18]
Counsel also delivered
an extensive written argument which he suggested was more extensive than the
oral argument at trial and addressed the legally-binding agreement argument and
the unilateral contract issues at greater depth than during oral argument at
trial.
[19]
Counsel argued that the
appeal should be allowed in favour of the Appellant on three basis:
a)
The case law and
principles of statutory interpretation support the restriction of section 7 to
legally-binding agreements. This case presents a set of facts which show that
the parties express and implied intentions and expectations were that the PSOP
was a discretionary bonus plan that did not create legal rights or obligations.
The plain meaning of the word “agreement” caused the parties to expect tax
consequences on the basis that section 7 would not apply. If the Court here
were to extend the application of section 7 to non legally-binding situations,
significant uncertainty would be imposed on taxpayers and a high degree of
double tax would result in many cases because section 7 would apply and
paragraph 110(1)(d) would not. Such a draconian result requires clear
language in the Act. This is not to be found. A plain reading of
the word “agreement” in section 7, as well as contextual and purposive readings
of that word, support the Appellant’s position.
b)
The Unilateral Contract
Issue: a unilateral contract
is a legally‑binding obligation, which the Crown assumed in its Reply did
not exist in this case.
Further, a unilateral contract is an offer capable of acceptance
by performance. The PSOP does not involve an offer that may be accepted by
performance. There is nothing that the participants may do to contractually
bind the Appellant to issue the shares, since whether or not shares will be
issued to a participant is solely within the Appellant’s discretion under the
clear terms of the PSOP. Therefore, the PSOP does not involve the creation of a
unilateral contract.
c)
The Expenditure
Issue: The Crown relies
solely upon an obiter reference in Placer Dome Inc. v. Canada, [1992] 2
C.T.C. 99 to Lowry (Inspector of Taxes) v. Consolidated African Selection
Trust Limited, [1940] AC 648 (H.L.) which has been expressly rejected by
the Federal Court of Appeal. Further, it has been superseded by Canderel
Limited v. The Queen, 98 DTC 6100 (S.C.C.). The decision in Canderel supports
the contention that the Appellant is entitled to the deductions sought.
[20]
Counsel went on to
discuss at length the key facts which he relied upon to support his conclusion.
Suffice it to say that all of these facts will not be repeated here but are
considered by the Court in making its decision.
[21]
Some of the key facts
relied upon by the Appellant in his argument are that the PSOP is a
discretionary stock bonus plan that does not require the Appellant to issue
shares and it does not give the participants the right to demand that shares be
issued to them. This was assumed by the Crown in its Reply.
[22]
Bonuses were determined
for compensation periods of three years by the Appellant’s Human Resources
Committee of the board as determined by a formula or at the discretion of the
Human Resources Committee to pay more or less than the formula dictated. The
employees would be notified if the decision was to issue shares and that those
shares had been placed in his or her account.
[23]
The Appellant’s
financial records are consistent with the legal rights and obligations created
by the PSOP. The Appellant accrued liabilities in each of the three years of
each compensation period with regard to what amount may be taxable under the
PSOP. The readers of the financial statements would have notice of the future
expenditures with regard to what expenditures were possible under the PSOP.
This accrued liability was established for accounting purposes and not as a
result of a legal liability to the participants. Any such liability was never
acknowledged for legal or accounting purposes.
[24]
Shortly after the end
of the compensation period, the board exercised its discretion and
issued the shares or paid the bonuses in each. Then the accrued liabilities set
out in the Appellant’s books were removed as they were not required to be
maintained by accounting principles.
[25]
If the Respondent’s
arguments prevail, the combined rate of tax paid by the Appellant and its
employees will range between 73% to 81% as a result of the employees paying tax
at their rate and the Appellant paying tax at its rate.
[26]
All cases decided to
date that have applied section 7 have done so on the basis that a
legally-binding argument existed or something close to it.
[27]
The Appellant’s
position on section 7’s interpretation is supported by the history of section 7
and its use of words like “arrangement”, in related employment compensation
provisions, make it clear that section 7 is intended to apply to legally‑binding
agreements to issue shares.
[28]
Recently proposed
section 143.3 indicates from a policy point of view the kind of deductions that
are permissible from the Crown’s perspective in regard to non legally-binding
share issue arrangements between employers and employees but this section, had
it been in place during the period in issue here, would not have prevented the
deductions sought.
[29]
The Supreme Court of Canada in Canada Trustco Mortgage Co. v. Canada,
[2005] 2 S.C.R. 601 held that, to the extent possible, the Act should be
interpreted to promote consistency, predictability and fairness of taxation
consequences. A straightforward reading of the word “agreement” in section
7 would lead to this result. The employees here expected to be, and were taxed
at full employment income rates, and the Appellant expected to be entitled to
deduct the bonuses paid to the participants.
[30]
The Appellant submitted
that the Respondent has not established that the word “agreement” in section 7
is clearly intended to apply to expressly non legally‑binding
arrangements such as the PSOP, and that the appeal should be allowed.
[31]
Counsel said that the
Respondent did not refer to Lowry in its argument, while relying upon
the obiter comment in Placer Dome, which is the sole authority for the
Crown’s argument with regard to the expenditure issue. This obiter was that:
[Placer Dome] is, therefore, in no position to speak to
deductibility, it being well established that an employer must incur an expense
or a cash outlay or a loss of value of its assets in order to claim a deduction
from its taxable income.
[32]
Counsel distinguished Lowry
on the basis that here the shares were issued for fair market value and the
Appellant’s creation of stated capital in the same amount. Canderel
dictated that this Court should decide this appeal on the basis of similar
principles that applied in Canada during the relevant taxation years. The
only evidence before this Court is that the Appellant followed such principles,
made an expenditure in accordance therewith and is entitled to the deduction
sought.
[33]
In Lowry, the
Appellants did not give any consideration for the premium value of the shares
issued to them whereas in this case they did in accordance with the findings in
Teleglobe Canada Inc. v. The Queen, 2000 DTC 2493, aff’d 2002 DTC
7517 (F.C.A.). As there, the Appellant reflected the true consideration in the
stated capital account. This is prima facie evidence of the value
received for the shares and also the amount of the expenditure that results
from the issuance of those shares.
[34]
The Appellant presented
evidence to support such value by way of past performance to the equivalent
value of the shares at the time of its issuance and the fair market value of
the services provided.
[35]
The Crown presented no
evidence to the contrary and so the Appellant should succeed on this point.
[36]
In 2000, the Tax Court
of Canada rejected Lowry in Teleglobe and this decision was
confirmed by the Federal Court of Appeal. Canderel also rejected the
principle set out in Lowry and affirmed the principle that, in the
absence of an applicable rule of taxation law (statutory or otherwise), the
deductions permitted by “well-accepted business principles” are also deductible
for income tax purposes.
[37]
The Appellant here
complied with the principles referred to in Canderel, and if section 7
does not apply to restrict the Appellant’s deduction of the amount of the
bonuses paid by issuing shares, then the deductions should be permitted.
[38]
In summing up the
results of the case law, counsel argued that the result is that they stand for
the proposition that section 7 should be applied only to cases in which
legally-binding agreements to issue shares are found to exist.
[39]
If the case law is read
in a manner most favourable to the Crown the standard required should be very
close to the legally-binding standard that involves the creation of a high
degree of expectation that a specific number of shares would be issued as
illustrated in McAnulty v. The Queen, 2001 DTC 942.
[40]
The facts in this case
are at the opposite end of the spectrum. The PSOP is explicitly discretionary
and does not create legally-binding rights or enforceable obligations. In this
case, the reasonable expectation of the parties was that the employees would
pay full rates of tax and the Appellant would receive a deduction for income
tax purposes. The case law indicates that these kinds of expectations should be
respected. The appeal should be resolved in the Appellant’s favour.
[41]
When the Canderel principle
is applied in this case there is ample evidence that the Appellant followed
well-accepted business principles which presented an accurate picture of the
financial affairs. There are no other provisions of the Act, other than
paragraph 7(3)(b), or no other principles of law that would prohibit the
deductions sought. There was no evidence led by the Crown to dispute the way in
which the taxpayer has accounted for the transactions.
[42]
A fair reading of the
case law dictates that when shares are issued other than pursuant to a stock
option, as in this case, an expenditure will be permitted to the extent of the
fair market value of services rendered or property transferred in consideration
of the share issuance. Here the value of the previously uncompensated past
services had a value equal to the fair market value of the shares at the time
of issuance and that is the amount sought to be deducted by the Appellant here,
and booked as stated capital with regard to the shares.
[43]
The Appellant should be
successful with respect to the expenditure agreement as well.
[44]
The appeal should be
allowed.
Argument on behalf
of the Respondent
[45]
Counsel for the
Respondent argues that the Appellant agreed to issue shares, and the
deduction of the fair market value of the shares issued was prohibited by
paragraph 7(3)(b) of the Act.
[46]
Further, the Appellant
did not make a cash outlay or endure a loss of value of its assets in issuing
the shares. The type of deduction sought by the Appellant is the type of
deduction that Parliament had no intention of allowing.
[47]
Counsel argued that
neither the noun “agreement” nor the verb “agree” which appears throughout
section 7 of the Act, is defined in the legislation. The principles
of statutory interpretation must be used to determine their meaning for the
purposes of subsection 7(3).
[48]
A fundamental principle
of statutory interpretation is that words are to be construed in the ordinary
or popular sense.
This is in harmony with the modern approach to interpretations of tax statutes,
which is that the words are to be read in context, within the overall scheme of
the legislation under review
as indicated by the Supreme Court of Canada in Canada Trustco Mortgage Co.at paragraph 10.
[49]
The Oxford English
Dictionary assigns a broad range of meaning to these words.
[50]
The basic purpose of
section 7 has not changed over the years and that was to bring the value of
such benefits as here into employee income so that they could be taxed.
[51]
Section 7 covers
benefits realized in a specific situation and it trumps the sections of the Act
dealing more broadly with the ability to claim expenses and the disposition of
employment income.
[52]
There is a presumption
that the precise overcomes the general.
[53]
The appropriate meaning
to be given to the word “agree”, within the context of section 7 as a whole is
“to consent to or approve of” an allocation of securities to employees, whether
or not that proposal constitutes a legal contract. That meaning best fits
the section’s function within the Act that is to capture the employees
benefits that it was intended to capture.
[54]
Reference to an
agreement in legislation does not mean that the agreement must create
contractual rights or obligations. Parliament had the option to use the word
“contract” in subsection 7(1) but it did not do so because it wanted to capture
all securities issued to employees under an agreement, using broad language to
close the loopholes that had previously enabled employees to receive shares
from their employers without either party being taxed on their value.
[55]
Counsel said that the
Courts have rejected the view expressed in Fowler v. Minister of National
Revenue, 63 DTC 600 at paragraph 10, that the “agreement” for the purpose
of section 7 should be a formal written agreement concerning a stock
option plan. The terms “agreed” and “agreement” are not terms of art and a
narrow or technical interpretation of these words has been rejected in modern
jurisprudence. An “agreement” can be inferred from the status of the parties.
[56]
Counsel opined that the
ordinary meaning of the words “agreed” and “agreement” culminated in McAnulty
at paragraphs 22 and 36. Defining the term “agreed” as “consent to
or approval of” is an allocation of securities to employees is consistent with
this Court’s reasoning in McAnulty.
[57]
Counsel’s
interpretation of the facts in this case led her to conclude that the Appellant
“agreed” to issue securities under the PSOP the moment that it committed to
allocate certain shares to participating employees. It does not matter that it
was referred to as a “bonus” within the discretion of the employer.
[58]
Alternatively, counsel
took the position that the Appellant “agreed” to issue shares to the employees
through unilateral contracts as in Sail Labrador Ltd. v. Challenge One (The),
[1999] 1 S.C.R. 265 at paragraph 33.
[59]
In the case at bar, the
Appellant promised to issue a variable number of shares, based upon the
Appellant’s performance as reflected in the shareholder return. The employees
provided consideration in exchange for performance of the Appellant’s promise
when they worked to allow the Appellant to meet the necessary performance
goals. Therefore, the Appellant “agreed” to issue securities when it formed
unilateral contracts with the employees who participated in the PSOP.
[60]
Finally, counsel argued
that this appeal should be dismissed because the Appellant incurred no expense
in issuing the shares under the PSOP. The shares were issued from Treasury and
as decided in Placer Dome at paragraph 22, an employer must incur an
expense or a cash outlay or a loss of value of its assets in order to claim a
deduction from its taxable income. This, the Appellant did not do.
[61]
It created the shares
itself without expending or sacrificing any other resource to do so. Therefore,
it cannot claim a deduction of the shares “fair” market value from its taxable
income.
[62]
The Appellant deducted
amounts relating to the shares for accounting purposes, but these accounting
procedures by themselves, are not determinative of tax treatment. The
computation of income under section 9 is subject to the rules of Part 1 of the Act
regardless of whether or not those rules reflect general accounting principles.
[63]
Parliament introduced
what would become section 7 of the Act with the recognition that
employers could not deduct the value of shares issued to employees. Parliament
intended for section 7 to capture employee stock option agreements, because the
other sections dealing with cash compensation could not. The claimed deductions
should be denied.
Analysis and Decision
[64]
Although expressed
differently, both parties agree that the issues to be decided in this case, put
simply, are whether the Appellant “agreed” to issue shares, with respect
to certain bonuses paid to the employees who participated in a Performance
Share Ownership Plan (“PSOP”) by issuing treasury shares to such employees.
[65]
Secondly, does section
7 require a legally-binding agreement or does it include non-contractual
commitments or undertakings, including those present in this case?
[66]
Thirdly, in the event
that a legally-binding agreement is necessary in order for section 7 to apply,
does the payment of bonuses by issuing the shares amount to a unilateral
contract, which is a legally-binding contract?
[67]
Fourthly, if section 7
does not apply to the transactions in question, did the Appellant make a cash
outlay or endure a loss of value of the assets in issuing the shares, so that
it was entitled to the type of deduction that it claims?
[68]
At issue in this case
is the consideration of the provisions of subsection 7(3) of the Act.
This subsection provides as follows:
7(3) If
a particular qualifying person has agreed to sell or issue securities of the
particular person, or of a qualifying person with which it does not deal at
arm’s length, to an employee of the particular person or of a qualifying person
with which it does not deal at arm’s length,
(a) except as provided by
this section, the employee is deemed to have neither received nor enjoyed any
benefit under or because of the agreement; and
(b) the income for a
taxation year of any person is deemed to be not less than its income for the
year would have been if a benefit had not been conferred on the employee by the
sale or issue of the securities.
[69]
Counsel for the
Respondent says that since neither the word “agreement” nor “agree” is defined
in the legislation the principles of statutory interpretation dictate that the
words are to be construed in their ordinary and popular sense. Here that would
mean an interpretation that is as broad as the dictionary definition of them
indicates. This is in line with modern jurisprudence which rejects a technical
or narrow interpretation of the words.
[70]
Counsel claims that the
words are not terms of art.
[71]
The Court is not
satisfied that the words “agree” and “agreement” should be given such a broad
meaning as supported by the dictionary meaning in the context of their use in
tax cases. So far as this Court is concerned, the ordinary meaning that comes
to mind is something more than that contemplated by counsel for the Respondent.
[72]
The use of the words
suggest a meeting of the minds, a promise to do something in return for the
other party doing something, the bestowing of rights and liabilities to or from
the parties, the bestowing of legal rights on the employees and corresponding
obligations of the Appellant, which is a foundation of contract law.
[73]
The case law as presented
by both parties would seem to favour such a position.
[74]
The Court is satisfied
that the participants expected to be, and were, taxed at full employment income
tax rates and the Appellant expected to be entitled to the deductions. These
are the results that the parties would expect in a straightforward reading of
the word “agreement” in section 7.
[75]
If the legislature had
intended for section 7 to apply to non-legally binding arrangements it could
have used words which would suggest something less than that, such as
arrangement, which is used in other employment compensation sections of the Act,
as indicated by counsel for the Appellant.
[76]
The Court is satisfied
that the use of the words “agree” and “agreement” in section 7 must be intended
to require more than “to consent to or approve of” an allocation, as suggested
by counsel for the Respondent.
[77]
This finding is made in
spite of the position taken by the Respondent that the legislators did not use
the word contract. It is this Court’s position that the word agreement, as used
in the context of this section means basically the same thing.
[78]
This Court does not
accept the argument of counsel for the Respondent that the Appellant “agreed”
to issue securities under the PSOP the moment that it committed itself to
allocate certain shares to participating employees. That is the result of the
obiter in McAnulty but this was not germane to the decisions in that
case and is not binding on this Court.
[79]
In that case, former
Chief Justice Bowman found a legally-binding agreement to exist.
[80]
The Court accepts the
position of counsel for the Appellant that there existed no agreement to issue
shares followed by issuance. As argued, the PSOP is explicitly discretionary
and legal rights and obligations were not created.
[81]
On issues one and two,
the Appellant must be successful.
[82]
The third issue relates
to the Respondent’s alternative argument that the Appellant “agreed” to sell or
issue securities through unilateral contracts. The Respondent’s case on
this issue is less than compelling.
[83]
In Sail Labrador Ltd.,
the Supreme Court of Canada defined the term unilateral contract. It is
interesting to note that both the Appellant and Respondent found that this case
supported their appropriate conclusions.
[84]
According to this case,
a unilateral contract is one in which a party makes a promise in return for the
performance or forbearance of an act. There is no counter promise to perform
the act or forbearance. In this way, a unilateral contract is a contract in
which only one party undertakes a promise. The promise takes the form of an
offer which can only be accepted by performance of the required act or
forbearance. Such performance provides the other party’s consideration,
allowing it to enforce the original promise.
[85]
The Respondent argues
that in correspondence with the employees who participated in the PSOP, the
Appellant promised to issue a variable number of shares, based upon the
Appellant’s performance as reflected in total shareholder return. The employees
provided consideration in exchange for performance of the Appellant’s promise,
when they worked to allow the Appellant to meet the necessary performance
goals.
[86]
The Court is satisfied
that there was nothing that any of the recipients could have done other than
being informed of the intentions of the Appellant that might be considered to
be acceptance of an offer regarding the receipt of the shares.
[87]
The Court is satisfied,
as argued by counsel for the Appellant, that the participants had no right, up
to the time of the delivery of the shares to receive a bonus.
[88]
The Appellant’s
accounting records do not reflect any liability to the participants regarding
the PSOP.
[89]
The Appellant’s
accounting and corporate records indicate that the shares were issued for
uncompensated past services having a value equal to the value of the shares.
These services had not been rendered pursuant to an agreement and did not
create a liability in favour of the participants. This is consistent with there
being no contract pursuant to which the shares were issued.
[90]
The Appellant did not
make an offer to any participant that could be accepted by the participant so
as to create a bilateral contract that imposes conditions on one or both
parties. Non-action by the participants could not amount to acceptance of an
offer.
[91]
The Appellant must be
successful on this issue.
[92]
That leaves for
consideration the expenditures issue.
[93]
The Respondent’s
position is that the Appellant incurred no expense in issuing shares under the
PSOP. The shares were issued from treasury. The Appellant did not make any
cash outlay or endure any loss of value of its assets in order to issue the
shares from treasury. In support of her position, Counsel cited Placer Dome.
She argued that when Parliament created section 7 of the Act it
recognized that employers could not deduct the value of shares issued to their
employees.
Further, it was argued that the Appellant issued the shares for consideration
of less than fair market value.
[94]
Counsel for the
Appellant takes the position that the shares were issued for uncompensated past
services.
[95]
It is clear from the
evidence, and it is not contradicted, that the Appellant increased the stated
capital of its common shares in the same amount as a result of the issuance of
the shares. It was agreed that the amount of the stated capital had been
approved by the Appellant’s auditors and outside legal counsel. This was uncontested
by the Respondent in so far as the evidence was concerned, and as counsel for
the Appellant argued, the Crown’s presumptions on this point has been
destroyed.
[96]
Evidence adduced by Mr.
Benjamin Park, again, unrebutted, indicated that the procedure followed by the
Appellant in its reports or financial statements was in accordance with
applicable accounting principles.
[97]
At the end of the day,
the shares were issued as a result of discretion in respect of past
uncompensated services and not as a result of a release of any accrued
liability to the participants. The Appellant did not at any time show in its
accounting records any liability owing to the recipients of the PSOP bonus.
[98]
The Court is satisfied
that neither Placer Dome nor Lowry are a hindrance to the
Appellant being successful on this issue.
[99]
The Court is satisfied
that Alcatel Canada Inc. v. The Queen, 2005 DTC 387, rejected Lowry
and in any event is distinguishable on the basis that the participants here
gave consideration equal to the full value of the shares on the basis of past
unremunerated services rendered to the Appellant.
[100]
The Court accepts the
argument of counsel for the Appellant that the evidence here indicates that the
Appellant satisfied the requirements of the Canada Business
Corporations Act
that services be rendered by the persons to whom shares are issued and that the
services must have a value at least equal to the value of the shares that were
issued in consideration of those services.
Teleglobe Canada Inc. is applicable here as well as the case of Lockhart
v. The Queen, 2008 DTC 3044.
[101]
In the end result, the
Court is satisfied that in the absence of evidence to the contrary, of which
none exists here, the amount claimed by the Appellant as the consideration for
the issuance of the shares, which was added to the Appellant’s stated capital
amount with regard to that issuance, is accepted as both the value of that
consideration and the amount of the expenditure made by the Appellant on
issuance of the shares.
[102]
On the double taxation
issue, one would conclude that on the basis of fairness, double taxation should
be avoided although there is no provision in the Act relative thereto
and it is not germane to the issue here.
[103]
The appeal is allowed,
with costs, and the matter is remitted to the Minister of National Revenue for
reassessment and reconsideration based upon these findings.
Signed at
Toronto, Ontario, this 4th day of April 2012.
“T.E. Margeson”
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