Date: 20020618
Docket:
2001-1821-IT-I
BETWEEN:
CHARLES
BENHAM,
Appellant,
and
HER MAJESTY THE
QUEEN,
Respondent.
Reasonsfor
Judgment
Sarchuk J.
[1]
This is an appeal by Charles Benham from an assessment of tax
with respect to his 1998 taxation year. In that year, he reported
employment income in the amount of $168,668 which included
taxable stock option benefits in the amount of $25,003 and a
stock option share reduction of $6,250. In reassessing the
Appellant, the Minister of National Revenue (the Minister) added
to the Appellant's employment income stock option benefits in
the amount of $4,161 and increased his stock option and shares
reduction by the amount of $1,040. In so doing, the Minister
made the following assumptions of fact:
(a)
on or about April 2, 1996, the Appellant entered into a stock
option agreement (the "Agreement") with his employer,
Consumer's Packaging Inc. (the "Employer").
(b)
under the terms of the Agreement, the Appellant could purchase
5,000 shares of the Employer's common shares at a cost of
$7.50 per share.
(c)
on or about March 3, 1998, the Appellant exercised his option to
purchase 3,333 shares of the Employer at a cost of $24,997.50
($7.50 x 3,333);
(d)
on or about March 3, 1998, the Appellant acquired the 3,333
shares of the Employer's common stock;
(e)
on or about March 3, 1998, the fair market value of the
Employer's common shares was $16.25 per share, or
$54,161.25;
(f)
the Appellant was in receipt of a benefit (the
"Benefit") in the amount of $29,163.25 ($54,161.25 -
$24,997.50) in the 1998 taxation year.
[2]
The Appellant's position is that he exercised his option on
February 24, 1998, shares were sold on his behalf on that date
and, in due course, he received a cheque for $25,664.10 being the
proceeds of the sale at a price of $15.25 per share less option
price of $7.50 per share and commission in the amount of
$166.65.
Background
[3]
At all relevant times, the Appellant was employed by Consumers
Packaging Inc. (the employer). In March 1996, the employer
granted senior managers, in lieu of a bonus, options to acquire
shares at a price of $7.50 per share. The Appellant's option
was for 5,000 shares and the "option agreement" dated
March 15, 1996 was accepted by the Appellant on April 2, 1996.
This stock option program was somewhat unusual in that it
provided the employee with the opportunity to take advantage of
what was referred to as the "cashless exercise of employee
stock options". In this context, the agreement provided,
inter alia, that "the optionee shall, without
limiting the generality of the plan, be entitled to exercise the
option only by executing and delivering to the corporation a
letter substantially in the form of Schedule "A"
annexed hereto".
Schedule "A" provided two methods of payment to be
utilized at the time of the exercise of the option: (i) by
attaching a certified cheque payable to the employer in full
payment of the Total Exercise Amount for the shares in respect of
which the option was being exercised; or (ii) indicating that the
optionee desired to take advantage of the "cashless exercise
of employee stock option service offered by Marleau, Lemire
Securities Inc.".
The evidence also discloses that on March 26, 1996, the employer
had provided the Appellant with an information package
containing the following comments with respect to the latter
option:
2.
HOW TO "EXERCISE AN OPTION ":
...
(b)
If you plan to sell your shares immediately, and want to
take advantage of the Marleau, Lemire Securities Inc.
"Cashless Exercise of Employee Stock Option
Service":
·
indicate this on the
form
·
send no money; the shares
will be sold based on your personal arrangements between you and
the broker and a cheque for the net proceeds (actual sales price
less option price, less brokerage fees) will be sent by Marleau
Lemire.
[4]
On February 24, 1998, the Appellant exercised his option with
respect to 3,333 shares and specifically noted on the form that
he wished "to avail myself of the Marleau Lemire Securities
Inc. 'Cashless Exercise of Employee Stock Options'
service". As well in accordance with the instructions he had
received from the employer, he simultaneously advised
Loewen, Ondaatje,
McCutcheon Limited (LOM) that he wished to
sell these shares. The transaction was reported by LOM to the
employer on February 24, 1998 in part as follows:
As agents we confirm
the following sale for your account on the Toronto Stock Exchange
for settlement in your account. For Settlement on February 27,
1998. 3333 Consumers Packaging Inc. @ 15.25 Gross $50,828.25
- Commission $166.65.
The settlement
documents indicate that on March 4, 1998, LOM issued a cheque to
the order of the employer in the amount of $24,997.50 and on
March 5 issued a cheque payable to Charles Benham in the amount
of $25,664.10 representing the gross sale price less the option
price of $7.50 per share and the commission of
$166.65.
[5]
The evidence before the Court is that under normal circumstances,
it usually takes three days for a transaction to be settled,
however, the sales price is that which was in effect on the first
day and not on the third day. The time lapse is essentially an
administrative aspect and does not affect the value paid or
received for the shares. There is no doubt that in the particular
circumstances of this case, the employer's officer
responsible for dealing with the exercise of an option failed to
properly carry out his responsibilities which resulted in a
further delay of the settlement.
The Respondent also concedes that this delay came about through
no fault of the Appellant.
Analysis
[6]
Paragraph 7(1)(a) of the Income Tax Act (the
Act) provides:
7(1)
Subject to subsections (1.1) and (8), where a particular
qualifying person has agreed to sell or issue securities of the
particular qualifying person (or of a qualifying person with
which it does not deal at arm's length) to an employee of the
particular qualifying person (or of a qualifying person with
which the particular qualifying person does not deal at arm's
length),
(a)
if the employee has acquired securities under the agreement, a
benefit equal to the amount, if any, by which
(i)
the value of the securities at the time the employee acquired
them
exceeds the total
of
(ii)
the amount paid or to be paid to the particular qualifying person
by the employee for the securities, and
(iii)
the amount, if any, paid by the employee to acquire the right to
acquire the securities
is
deemed to have been received, in the taxation year in which the
employee acquired the securities, by the employee because of the
employee's employment;
[7]
The Respondent does not dispute that if in other circumstances
the Appellant had paid for the shares on the day he exercised his
option, there would be no issue as to value. However, the
Respondent contends that for the purpose of section 7 of the
Act the value of shares received under the employee stock
option purchase plan is to be determined at the time when the
Appellant acquired the shares, which in this instance was March 4
when the shares were fully paid for. Since the market value on
that date was $16.25 per share, it was used to calculate his
benefit. On this basis the Minister deemed the Appellant to have
received the additional employee benefit of $4,160.75 which was
added to his taxable income upon reassessment.
[8]
Given the particular and unusual facts before me, I am not able
to agree. More specifically, the position advanced on behalf of
the Minister appears not to consider the entire context of the
transaction. First, the Appellant opted for the cashless exercise
of his option on February 24, 1998. He was, pursuant to this
mechanism, not required to advance any funds at the time of the
exercise but only to authorize the sale of the shares he was
entitled to and to communicate that fact to the broker, in this
case LOM, which he did. The LOM records indicate that as a result
of the Appellant's exercising his option, 3,333 shares were
in fact sold from the employer's stock option account on his
behalf on February 24 with a settlement date of February 27.
The cost of the shares was deducted from the proceeds of sale
with the Appellant receiving the remainder. From these documents,
it seems clear that the Appellant and the employer intended to
and did treat the sale portion of the transaction as having taken
place on February 24. In my view, the evidence as a whole
establishes that there was a binding completed agreement between
the Appellant and the employer on that date notwithstanding the
fact that the actual payment for the shares did not occur until
March 4. The Minister relies on the fact that when the
employer's responsible officer received an exercise of an
option from the employee that information was to be passed on to
LOM as a result of which shares are sold short and due for
settlement three days after the sale is processed. According to
counsel for the Respondent, these facts establish that for the
purposes of subsection 7(1) of the Act the Appellant did
not "acquire" the shares until that was done.
Nonetheless, in my view, whatever arrangement may have existed
between the employer and LOM regarding the issuance of the
shares, I am satisfied that the Appellant was not in a position
after February 24, 1998 to demand a higher price for the shares,
nor was he entitled to sell them to a different party, nor could
he retain the shares but was at all times bound to sell them at
the price determined on that date.
[9]
To reiterate, my conclusion is that although the certificates for
the shares were not issued by the trustee until March 4,
on February 24, 1998, the Appellant and the employer had entered
into a binding agreement with the intention that the Appellant
acquire legal title to the shares as of that date. The exercise
by the Appellant of the cashless option required the company to
sell the shares on behalf of the Appellant, taking the cost of
the shares out of the proceeds of the sale and having the balance
paid to the Appellant. I am satisfied that the price received on
February 24, 1998 is the appropriate value to be used in the
calculation of the Appellant's employee benefit.
[10]
I am also constrained to observe that the Minister by assessing
as he did is taxing the Appellant on a benefit that he did not
receive, nor will he ever receive. Accepting the Respondent's
position could readily lead to an absurdity in the future. For
example, given the same facts as presently before the Court if on
March 4, 1998, the value of the subject shares was $14.25 instead
of $16.25, the Respondent's submission would mean that the
value of the shares to the Appellant on the date of acquisition,
being March 4, 1998, would be $47,495.25 and the cost would be as
before, $24,997.50 providing the Appellant with net income of
approximately $22,497.75 (minus commission and other incidental
charges). In this example, it would also be a fact that the
Appellant received $25,664 as the proceeds of the sale of the
shares (i.e. $3,166.25 more than the "net income"
amount). Applying the Respondent's position to the
hypothetical example, would the Appellant be entitled to treat
this amount as a "non-taxable receipt"? I doubt whether
the Minister would have accepted such a position.
[11]
For the foregoing reasons, the appeal is allowed and referred
back to the Minister on the basis that the Appellant's
employee benefit is to be calculated on the basis of the share
value on the date that the Appellant exercised and sold his
shares being February 24, 1998.
Signed at Ottawa, Canada, this 18th day of
June, 2002.
"A.A. Sarchuk"
J.T.C.C.
COURT FILE
NO.:
2001-1821(IT)I
STYLE OF
CAUSE:
Charles Benham and Her Majesty the Queen
PLACE OF
HEARING:
Toronto, Ontario
DATE OF
HEARING:
February 4, 2002
REASONS FOR JUDGMENT
BY: The Honourable Judge A.A.
Sarchuk
DATE OF
JUDGMENT:
June 18, 2002
APPEARANCES:
For the
Appellant:
The Appellant himself
Counsel for the
Respondent:
Sherry Darvish
COUNSEL OF RECORD:
For the
Appellant:
Name:
N/A
Firm:
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
Email this Content