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".[1] 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.".[2] The evidence also discloses that on March 26, 1996, the employer had provided the Appellant with an information package[3] 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.[4]
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.[5] 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.[6] 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,[7] 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
[1] Exhibit R-1, tab 5, page 3, paragraph 5(b) and Schedule "A".
[2] Subsequently, Marleau, Lemire Securities Inc. was replaced by Loewen, Ondaatje, McCutcheon Limited.
[3] Exhibit A-1.
[4] See Exhibit R-1, tab 11.
[5] Exhibits A-2 and R-1, tab 15.
[6] Exhibit R-1, tabs 7 and 11.
[7] Exhibit R-1, tab 14.