1 August 1991 Ministerial Letter 911478 F - Stock Option Benefit

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Subject: Stock Option Benefit

This is in reply to your memorandum dated May 28, l991 wherein you requested our views as to the tax implications of the issuance of shares pursuant to an agreement.  The relevant facts as we understand them are as follows:

Facts

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24(1)

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10.                      24(1)

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Taxpayer's Position

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Your Position                                                     1.                  24(1)

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Our Comments

1.     Agreement

         In our view    24(1) 

24(1)

2.     Applicability of subsection 7(1)

24(1)

3.     Applicability of subsection 6(3)

     Subsection 6(3) provides that an amount received by one person from another while the recipient was an officer of or in the employ of, the payer, or on account or in lieu of payment of or in satisfaction of an obligation arising out of an agreement made by the payer with the recipient immediately prior to, during or immediately after a period in which the recipient was all officer of, or in the employ of, the payer shall be treated as remuneration for the period of employment for the purposes of section 5.

     The word "amount" is defined in subsection 248(1) of the Act as meaning".... money, rights or things expressed in terms of the amount or the value in terms of money of the right or thing..." In our view

            24(1)

4.     Applicability of paragraph 6(1)(a)

24(1) 

     In support of this position, it was held in the case of waffle v.MNR. 69 DTC 5007, in which an individual employed with a car dealership obtained a cruise awarded from a car manufacturer, that although the payment of the cruise was not made by the individual's employer (i e. dealer) but rather by the car manufacturer, the value of the cruise was nevertheless taxable as a benefit from an office or employment.

     It should be noted that paragraph 6(1)(a), which requires that the value of "other benefits of any kind whatever" enjoyed by the taxpayer "in respect of, in the course of, or by virtue of" an office or employment be included in income, has been interpreted by the Supreme court of Canada, in the case of The Queen v Savage 83 DTC 5409, as a phrase with the widest possible scope intended to convey some connection between two related subject matters.

     ln addition, in a recent decision, J. Stuart Robertson v. The Queen (90 DTC 6070, FCA) the taxpayer had received an option from his non-corporate employer to purchase shares in a public company as long as he remained in the employ of the non-corporate employer.  The courts held that subsection 7(1) could not apply as he was not employed by the company by paragraph 6(1)(a) was applicable as it was quantifiable (i.e. difference between the option price and the FMV of the shares when the option was exercised) and that the very general wording in paragraph 6(1)(a), referring as it does to the inclusion in employment income of "any other benefits of any kind whatever" did apply.

24(1)

P.D. FuocoChief, Personal and General SectionBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch

NOTES

Note 1

In the Freeway Properties Inc. case (85 DTC 5183) the taxpayer corporation acquired a single piece of land for the purpose of developing it and ultimately selling the property when the "time was propitious".  For a number of reasons, the property was not developed and the taxpayer disposed of the unimproved land.  The sale proceeds included cash and a mortgage back to the taxpayer. The taxpayer acquired no other land and its only other activities consisted of entering into a joint management agreement with a property management company to undertake the construction management of the property and arranging the take-out financing Freeway had no salaried employees.  The activities were carried on by a party related to one of the shareholders for no remuneration.

The Minister assessed tax on the basis that the income from the mortgage was investment income as opposed to active business income for purposes of the small business deduction (subsection 125(1)).

The Court found in Freeway that the income from the mortgage was active business income.

In reaching this conclusion, the Court stated:

     "Where the income under consideration is part of the normal business activity of a company and it is inextricably linked with an active business it is considered active business income.  (Supreme Theatres Limited v.R., CTC 190, 81 DTC 5136).  For taxation purposes, the characterization of income received from property, including mortgages, depends upon the purpose for which the initial investment was made (R.v. Biltmore Investments - 76 DTC 6156)... I also held in the Riviera Hotel case (Riviera Hotel Company Ltd v.R., 82 DTC 6054) that, where the sale of property constitutes an active business, then the income and interest derived therefrom constitute active business.

     The defendant had conceded that the sale of the land by Freeway constitutes an adventure in the nature of trade and, although the Crown does not concede that the mortgage interest constituted income from an active business, the Crown does admit that Freeway's management income does... I find no difficulty in concluding that the sale of the property which was effected in direct pursuance of the objects for which it was incorporated, constituted an active business enterprise.  The mortgage, as stated by the witnesses Barr and Wilboughby, was negotiated and entered into for the purposes of facilitating the sale of the property.  Without that mortgage, the sale would probably have not taken place.  It was therefore inextricably linked with the sale.  There was a close interdependence between the sale and the mortgage.  Therefore, according with the principals which I have mentioned, the mortgage and the interest payable thereunder are to be considered as part of the parcel of the active business of the taxpayer."

Note 2

The presumption in Marconi is one that is rebuttable and in fact was rebutted in Ben Barbary Company Limited v.M.N.R. (89 DTC 242). In that case, the corporate taxpayer held land and the assets of certain business being operated thereon.  In 1982, the taxpayer sold a portion of the land together with certain of the business assets and took back a mortgage and a promissory note.  The Minister assessed the taxpayer on the basis that the interest received by it on the mortgage and promissory note was "Canadian investment income" (Subsection 129(4)).  The Court held that the facts in the case indicated that the presumption was rebutted.  The taxpayer's objects specifically included only the carrying on of its business.  The mortgage and the promissory note in question were virtually its only investments and these were not employed or risked in that business.  In that case the Court stated:

     "If the wording of an object in a corporate charter is to be a significant fact in determining the character of corporate income, one could visualize a careful lawyer drafting specific objects and tracking the language of section 125 or section 129 of the Income Tax Act depending upon the taxation goals which the incorporators wanted to achieve.

     When the charter of a modern corporation requires or permits a statement of corporate objects, a variety of object clauses may be extracted from precedent books by the incorporating lawyer and grafted like boiler plate onto the corporate charter with relatively little input from the actual client/incorporator.  All nine object clauses in the Appellant's Articles of Incorporation, when read in their entirety, represent a good example of the precedent based "cover-the-waterfront" style of drafting a corporation charter prevalent since the 1950's.  In Regal Heights Ltd. v. M.N.R., 60 Dtc 1270, when the Appellant relied on one of its objects to support its argument that a gain realized on the sale of certain land was a capital gain, Judson J. (for the majority in the Supreme Court of Canada) stated at page 1272:

     "Nothing turns upon such a statement in such a document.  The question to be determined is not what business or trade the company might have carried on but rather what business, if any, it did in fact engage in.

     In order to determine the character of income from a particular source within a private corporation, it should be possible to rely only on actual transactions and corporation conduct without reference to any objects whether declared in the charter or provided in the legislation".

In Ben Barbary the Court also refers to Ensite Limited v.R. (86 DTC 6521) and quotes the following therefrom:

     "The rebuttable presumption that corporate income is income from a business (see: Canadian Marconi Co. v.R., released concurrently herewith) is of no application here as it would tend to collapse the distinction between active business income and other sources of income which Parliament clearly intended to preserve in its amendment of s.129(4) of the Act."

The Court goes on to state in Ben Barbary that..."any rebuttable presumption arising from an object clause set out in a corporate will not apply if the taxpayer is a private corporation and the issue is whether income from a particular source is "active business income" or "investment income.  If my understanding of the Ensite case is correct, the object clauses in the Appellant's corporate charter are irrelevant in deciding the appeal herein."

Note 4

It is interesting to note that the taxpayer also argued in the Ben Barbary case that the mortgage interest was income from an "active business" because it was income from property that was "incident to" or "pertained to" an active business carried on by the taxpayer within the meaning of 129(4.1)(b) of the Act.  However, the Court stated that while the evidence indicated that the mortgage and promissory note was important to and used in the business retained by the taxpayer (a restaurant business)..."The truth of that statement does not assist the Appellant, however, because the mortgage and promissory note, regarded as property, were not incident to and did not pertain to the Appellant's restaurant business.  The mortgage and promissory note were no more connected with the restaurant than any other income producing investment which the Appellant might have purchased with redundant capital if it thereafter used the income from such investment to support the operation of the restaurant.

The fact that a corporation, carrying on an active business and holding certain property (i.e. investments) unrelated to the business, uses the income from property in connection with the operation of the active business does not mean that the property is "incident to or pertains to" the active business."

Note 5

In the case of Alexander Cole Limited v. MNR (90 DTC 1894) Rogar Inc., a wholly-owned subsidiary of the corporate taxpayer, had been in the business of developing and holding commercial properties as capital assets from which to derive income.  Three such commercial properties in the United States encountered financial difficulties and were sold on terms requiring the vendors to take back long-term wrapped-around mortgages.  The three sales were reported as capital sales.  The Minister assessed the taxpayer in respect of its 1980 taxation year on the basis that, for purposes of the foreign accrual property income rules, Rogar Inc,'s income from such wrapped-around mortgages was not active business income.

In Alexander Cole the taxpayer relied heavily on the rebuttable presumption established in Marconi and the precedent established in Freeway.  However, the Court stated as follows:

     "Counsel for the Respondent distinguishes the Freeway case in that Freeway was the sale of inventory whereas the sales herein were of capital assets.  The Court accepts this distinction even though the three wrap-around mortgages were inextricably linked with the sales and there was a close interdependence between the sales and the mortgages.

     The Court is satisfied that whether a business is active or inactive is one of fact dependent on the circumstances of each case and that the resolution depends on the Courts view of the true nature of the business based on the facts of the particular case before it.  The quantum of activity may very well vary from case to case but still it is necessary for the Court to weigh all the evidence to characterize the quality of the particular business. My authority for this is the Federal Court of Appeal decision of King George Hotels v. The Queen, 81 DTC 5082."

The Court further stated:

     "Counsel for the Appellant has asked the Court to find as a fact that Rogar changed its business approach and entered into an active investment business when it sold these properties.  This the Court declines to do.  Alexander Cole gave no evidence which would support such a finding.

     The Court herein is driven to the conclusion that during the years 1977-1978-1979, Rogar made a business decision to get out of the active business of owning and managing commercial shipping and office enterprises.  It must be kept in mind that the driving force behind the Appellant and therefore behind Rogar was the principal Alexander Cole who in 1977 was 71 years of age.  There is no evidence before me to allow the Court to determine that Rogar was entering into an active investment business.  The evidence of Alexander Cole destroyed whatever presumption that existed to his benefit.  On review of the meagre evidence presented to the Court, it concludes that the holding of the three wrap-around mortgages was not active business, therefore the income therefrom was not income from an active business.

     The fact that the mortgages were the result of selling capital assets of active businesses is of no assistance to the Appellant. The active businesses ceased upon the sale of the capital assets.  It cannot be said that the mortgages were incidental to the active businesses.  The cases that the Court was referred to on incidental use are of very little benefit."