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Citation: 2004TCC641
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Date: 20040927
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Docket: 2002-765(IT)G
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BETWEEN:
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DONALD ROBERT HYNDMAN,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Angers, J.
[1] The Minister of National Revenue
(Minister) initially assessed the appellant for his 1994
taxation year on May 26, 1995. In computing his income for
that year, the appellant did not include employment income in the
amount of $94,274 with respect to the exercise of stock options.
In accordance with paragraph 152(4)(a) of the
Income Tax Act (Act), the Minister reassessed the
appellant on January 19, 2001, for the 1994 taxation year to
include the stock option benefit the appellant had received. The
Minister also assessed penalties under subsection 163(2) of
the Act. In his Notice of Appeal, the appellant, admits that he
received those gains from the sale of his stocks and admits that
it represents employment income. I will therefore not deal with
these admissions. The appeal therefore rests on whether the
Minister could reassess under paragraph 152(4)(a) of
the Act and whether he could assess penalties under
subsection 163(2) of the Act for the appellant's failure
to report this income in his 1994 taxation year.
[2] The appellant is a graduate in
animal science from McGill University and worked all his life for
Pfizer Canada Inc., a wholly owned subsidiary of Pfizer U.S.A.
Over the years, he was promoted to various positions with his
employer, but in late 1989, he was demoted for reasons related to
alcoholism. The appellant's income slightly decreased in the
years before 1994, which was a result of poor performance.
[3] When the appellant was promoted to
Director of Sales Marketing, a position which required him to be
frequently away from home to meet with clients, his alcohol
consumption increased to the point that in late fall of 1988, his
wife approached his employer for assistance. Pfizer had no
experience with a problem such as that and they referred the
appellant to a medical doctor. In the years that followed, the
appellant made several attempts to overcome his alcohol addiction
and went from clinic to clinic and saw various health
professionals. He has been sober since August 5, 1995.
[4] In February 1993, the appellant
was offered a position as Senior Product Manager in the marketing
organization of Pfizer North American Animal Health Division
located in Lee's Summit, Missouri. After discussing the
matter with his family, the appellant informed his employer that
he could not accept their offer and instead proposed two
solutions: both solutions were to continue to work for Pfizer
Canada Inc. but with different termination dates and included a
request to be able to exercise his stock options until their
expiry date in August 1999.
[5] The reply came on June 21, 1993. A
hand-delivered letter from Pfizer Canada Inc informed the
appellant that his services were no longer required. The letter
also described the severance benefits he was entitled to and
included a statement showing estimated severance pay as of June
30, 1993 in the case of a lump sum payment. That amount could be
transferred to a Registered Retirement Savings Plan (RRSP). In
the case of the lump sum, which is what the appellant chose, his
termination of employment was effective June 30, 1993. As for
outstanding stock options, the exercise period was changed to one
year from date of termination or the grant expiry date, whichever
was earlier. In the appellant's case, it was June 30, 1994.
The appellant was paid his regular salary until June 21,
1994. His retirement allowance totalled $62,115 and the appellant
transferred that amount to an RRSP. His total reported income for
1994 was $110,666 which included six months salary, dividends,
interest and the retirement allowance. After the allowable
deductions, his net income was $43,085.
[6] The stock options referred to in
the letter surfaced in the mid 1980s. The appellant was informed
that the company had had a good year financially and had decided
to offer some of its employees stock options. The appellant was
given a number to write down and told he would be contacted so
that he could fill out some paper work. The paperwork is Form
8200-20A (11-83) (3-87) (4-87) (Exhibit A-8). The
appellant was given these forms, which were pre-typed or filled
in with his name, address, social insurance number, the exercise
option grant number, the number of shares and the price per
share. The section to be completed by the payroll/treasurer's
division was left blank. The appellant was asked to sign the
form, not to date it, and to keep his yellow copy. Although there
are nine such forms, the appellant actually had four of these
stock options. Over the years, some options may have been
replaced or amalgamated with others. When he was in the process
of signing these forms, the potential tax implications were not
discussed. At one point, he was given a booklet containing
procedural information to purchase Pfizer stock for non-American
and overseas employees and points of interest about the stock
option grants. The instructions on Form 8200-20, among other
things, required that the form be dated and advised all employees
to consult a tax/financial advisor when considering selling
shares from a company stock option. The appellant remembers
having received stock option status notice on December 31, 1993
and on March 31, 1994 but cannot recall if other notices were
sent. He testified that he simply filed his yellow copy and never
monitored the performance of Pfizer stocks on the stock exchange.
The only other reference to taxes on Form 8200-20A is in the
payment authorization section where the appellant instructs
Merrill Lynch to withhold taxes if applicable.
[7] In late June 1994, the appellant
received a call from the Vice-President of Human Resources at
Pfizer Canada Inc. reminding him that the deadline to exercise
his option was quickly approaching. The appellant testified that
the stock options were not on his mind at the time and were it
not for that call, he would not have exercised his options. He
had no idea what their value was, when he received the call. He
was told what to do and simply followed the instructions. On the
same day, he faxed a message to Pfizer U.S.A. instructing them to
sell all his stocks. The appellant did not discuss the tax
implications with the Vice-President during their
conversation.
[8] In October 1994, he received a
cheque from Pfizer U.S. in U.S. funds for the value of his stock.
He went to a friend at the Toronto Dominion Bank to exchange the
amount in Canadian dollars and to deposit it. He later invested
the money with Canada Trust and never considered the tax
implications nor did he discuss the matter with his wife. The
appellant testified that his recollection from the procedure
information he was given led him to believe that taxes had been
withheld and that the amount on the cheque he received was a net
amount. The information on the tax withholding read as
follows:
If you decide to exercise your option, you will be required to
pay for the shares at the time you exercise the option. The
amount of money you will have to pay to purchase the shares is
equal to the option price times the number of shares you wish to
exercise, plus any applicable withholding tax. For example, based
on the $81.00 option price, if you wish to purchase 100 shares,
you will pay $8,100. This must be paid in cash or, if permitted,
in Company stock on the day you buy the shares. You may also be
required to pay any applicable withholding tax at the date of
exercise. Exercise by the tendering of Company stock that you
already own will be permitted only if it would not require the
Company, under applicable federal law, the regulations of any
government agency or generally accepted accounting principles, to
make a charge to earnings.
[9] The Appellant's wife testified
about what life was like at home with her husband's condition
and the various efforts he made to finally treat it. She also
explained the yearly ritual she followed in order to have their
tax returns prepared. She would put into envelopes everything
that came in the mail for all the family members including her
mother. She would bring the contents to a tax accountant. Once
the returns were ready, they would drop by the accountant's
office to receive explanations and to sign the returns. She was
aware that in the fall of 1994, her husband had received a cheque
for a substantial amount and that he had converted the money in
Canadian funds and had deposited the money. Nothing further was
mentioned about the cheque and there were no discussions about
the tax consequences or how to invest. He looked after his money
and she looked after hers. When they met with the tax accountant,
the stock option cheque was not discussed.
[10] The Appellant confirmed his wife's
version with respect to how the tax returns were prepared
annually. He recalls that for 1994, his income was significantly
higher than usual because of his retirement allowance. It did not
strike him that the stock option money was missing because the
gross amount of income was higher than usual. Other than
collecting a few dividends, the appellant did not have any
experience and relied completely on Canada Trust to invest that
money.
[11] Claudio Arnoldo is a tax auditor with
the Canada Customs and Revenue Agency who was assigned the
appellant's file in April 1999. The assignment came when an
audit at Pfizer Canada revealed that 46 individuals had exercised
their stock options over a few years and that some had not
reported that income on their tax returns. He therefore issued
projects of assessments to those who failed to report income,
including the appellant. During his audit, Mr. Arnoldo
received various documents from the appellant and met with him on
two occasions. The Notice of Assessment issued indicates the fair
market value of the shares as at June 21, 1994, as $94,274
Canadian, which was added to his previously reported income and
to which a stock option and share deduction of $23,569 was made
and another amount was deducted for non capital losses of
previous years. The revised taxable income for the appellant for
the 1994 taxation year is $112,974.
[12] According to Mr. Arnoldo, the
reassessment beyond the limitation period was issued on the basis
that the appellant is an astute, intelligent individual who
decided not to do anything about the unreported revenue which
represents a substantial amount. In addition, the stock option
plan was an incentive plan for their key employees around the
world and the procedure to exercise it was well established.
Letters of explanation were sent to the appellant and he was
aware of all the implications.
[13] A review of all the facts, the
documents and the procedure set up by Pfizer indicate that the
appellant was advised to seek a tax advisor. According to
Mr. Arnoldo, the appellant not only exercised his options
but also decided to sell the shares. He therefore calculated a
penalty in accordance with subsection 163(2) of the Act. The
amount subject to the penalty on the unreported revenue is
$70,705. Mr. Arnoldo confirmed that no T-4 was issued by the
Pfizer companies, that the entire stock option was confidential
since not all documents were issued or provided and that Pfizer
may have had a communication problem. At one point, he testified
that the Pfizer file was a sensitive file but could not indicate
why nor could he explain what a sensitive file is. There is no
evidence that it may have impaired the audit conducted on the
appellant.
[14] The issues to be decided are whether
the Minister is statute-barred from reassessing the appellant for
the 1994 taxation year and whether a penalty under subsection
163(2) of the Act was properly assessed?
[15] Subsection 152(4) of the Act
allows the Minister to reassess beyond the normal reassessment
period if the taxpayer has made any misrepresentation that is
attributable to neglect, carelessness or wilful default or has
committed any fraud in filing his return. The evidence does not
show that the appellant committed any fraud. On the other hand,
based on the facts of this case, I am satisfied that the
appellant did not exercise reasonable care in filing his 1994
income tax return and that the Minister was entitled to reassess
him and include the amount he received from the exercise of his
stock options and sale. Although the appellant did not receive a
T-4 from his employer and has systematically filed his tax
returns over the years, the net income reported in documents he
received in the mail should have alerted him to the fact that not
all of his income was included. Our tax system is a system of
self assessment. The fact that the appellant was under the
impression that the taxes had been withheld by Pfizer or Merill
Lynch has no bearing on the fact that the income still had to be
reported. Taxes are withheld on a payroll and taxpayers must
still include their income on their returns. The appellant and
his wife never discussed the tax consequences when they received
the money, the appellant did not raise the issue with Canada
Trust when he invested the money and he did not do so with Pfizer
either. Such a transaction coupled with the amount of money
involved should raise the question in anyone's mind of
whether the amount is net of taxes and whether they must report
it on their tax return.
[16] During that period, the appellant was
going through difficult times and had still not overcome his
alcohol addiction. That alcohol addiction may have been severe
but not enough to prevent Pfizer from offering him a transfer to
Missouri and therefore keep him as an employee despite his
condition. He was capable of understanding the transaction that
had taken place involving his retirement allowance and that it
had been rolled over into an RRSP. He was able to convert the
U.S. funds into Canadian funds at a better cost and invest that
money with Canada Trust where he made both conservative and
riskier investments. That is the conduct of a person capable of
administering his own affairs. The appellant is a well-educated
individual. He may not have had much experience in share trading
and other related matters but such a transaction should have
alerted him about his obligation as a taxpayer to report that
income. The Minister was therefore justified in reassessing the
appellant.
[17] Was the Minister justified in assessing
a penalty under subsection 103(2) of the Act? Does the false
statement or omission made by the appellant amount to gross
negligence. In Venne v. Her Majesty the Queen, 84 DTC
6247 (F.C.T.D.); [1984] F.C.J. No. 314 (Q.L.), Mr. Justice
Strayer states the following at page 6256:
"Gross negligence" must be taken to involve greater
neglect than simply a failure to use reasonable care. It must
involve a high degree of negligence tantamount to intentional
acting, an indifference as to whether the law is complied with or
not.
[18] In Can-Am Realty Limited et al v.
The Queen, 94 DTC 6293, the Court concluded the following at
page 6303:
What is required is conduct which is exceptional and flagrant
to the degree of gross negligence
[19] Counsel for the Respondent relies on
the same facts to justify the penalty imposed. It is interesting
to note the comments of Mr. Justice Bowman in Farm Business
Consultants Inc. v. The Queen, 95 DTC 201, at pages 205 and
206 when he said:
A court must be extremely cautious in sanctioning the
imposition of penalities under subsection 163(2). Conduct that
warrants reopening a statute-barred year does not automatically
justify a penalty and the routine imposition of penalties by the
Minister is to be discouraged. Conduct of the type contemplated
in paragraph 152(4)(a)(i) may in some circumstances also
be used as the basis of a penalty under subsection 163(2), which
involves the penalizing of conduct that requires a higher degree
of reprehensibility. In such a case a court must, even
in applying a civil standard of proof, scrutinize the evidence
with great care and look for a higher degree of probability than
would be expected where allegations of a less serious nature are
sought to be established. Moreover, where a penalty is imposed
under subsection 163(2) although a civil standard of proof is
required, if a taxpayer's conduct is consistent with two
viable and reasonable hypotheses, one justifying the penalty and
one not, the benefit of the doubt must be given to the taxpayer
and the penalty must be deleted
[20] Although the amount of money involved
is quite substantial, I find that on a balance of probabilities,
the Minister has failed to establish that the conduct of the
appellant amounted to gross negligence. The appellant had
completely forgotten the benefits he could derive from exercising
those stock options. As mentioned earlier, that benefit would
have been lost had he not been notified by a Pfizer official of
the looming deadline. Such inaction could be considered to be
gross negligence by some but it is not that conduct that needs to
be assessed. It is his conduct when he filed his tax return that
must be assessed. There is no evidence here to allow me to
conclude that the appellant intentionally omitted to include that
revenue in his income. The fact that he believed that the taxes
on that amount had been withheld, and I accept his evidence on
this point, is sufficient to establish that he was not completely
indifferent as to whether the law had been complied with. He
believed that the taxes had been withheld and although he failed
to make inquiries and was careless in failing to report the
income, that does not amount to an intentional omission or
indifference tantamount to a high degree of negligence. There is
no evidence as well that his conduct amounts to wilful
blindness.
[21] The appeal is allowed only insofar as
the penalty is concerned and the matter is referred back to the
Minister for reconsideration and reassessment on this basis.
Since both parties were partially successful, there will be no
order as to costs.
Signed at Ottawa, Canada, this 27th day of September 2004.
Angers, J.
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