Montminy v. The Queen

Montminy v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2016-05-03
Neutral citation
2016 TCC 110
File numbers
2012-2142(IT)G, 2012-2144(IT)G, 2012-2145(IT)G, 2012-2146(IT)G, 2012-2147(IT)G, 2012-2148(IT)G, 2012-2150(IT)G
Judges and Taxing Officers
Johanne D’Auray
Subjects
Income Tax Act
Decision Content
[ENGLISH TRANSLATION]
Docket: 2012-2142(IT)G
BETWEEN:
MARIO MONTMINY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Alberto Galego (2012‑2144(IT)G), Serge Latulippe (2012‑2145(IT)G), Rémi Dutil (2012‑2146(IT)G), Éric Haché (2012‑2147(IT)G), Philippe Beauchamp (2012‑2148(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2144(IT)G
BETWEEN:
ALBERTO GALEGO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Serge Latulippe (2012‑2145(IT)G), Rémi Dutil (2012‑2146(IT)G), Éric Haché (2012‑2147(IT)G), Philippe Beauchamp (2012‑2148(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2145(IT)G
BETWEEN:
SERGE LATULIPPE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Alberto Galego (2012‑2144(IT)G), Rémi Dutil (2012‑2146(IT)G), Éric Haché (2012‑2147(IT)G), Philippe Beauchamp (2012‑2148(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2146(IT)G
BETWEEN:
RÉMI DUTIL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Alberto Galego (2012‑2144(IT)G), Serge Latulippe (2012‑2145(IT)G), Éric Haché (2012‑2147(IT)G), Philippe Beauchamp (2012‑2148(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2147(IT)G
BETWEEN:
ÉRIC HACHÉ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Alberto Galego (2012‑2144(IT)G), Serge Latulippe (2012‑2145(IT)G), Rémi Dutil (2012‑2146(IT)G), Philippe Beauchamp (2012‑2148(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2148(IT)G
BETWEEN:
PHILIPPE BEAUCHAMP,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Alberto Galego (2012‑2144(IT)G), Serge Latulippe (2012‑2145(IT)G), Rémi Dutil (2012‑2146(IT)G), Éric Haché (2012‑2147(IT)G) and Jacques Benoit (2012‑2150(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Docket: 2012-2150(IT)G
BETWEEN:
JACQUES BENOIT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Mario Montminy (2012‑2142(IT)G), Alberto Galego (2012‑2144(IT)G), Serge Latulippe (2012‑2145(IT)G), Rémi Dutil (2012‑2146(IT)G), Éric Haché (2012‑2147(IT)G) and Philippe Beauchamp (2012‑2148(IT)G) on September 24, 25 and 26, 2014, and May 26 and 27, 2015, at Québec, Quebec
Before: The Honourable Madam Justice Johanne D’Auray
Appearances:
Counsel for the Appellant:
Anne-Marie Bonin Lavoie
Counsel for the Respondent:
Anne Poirier
JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2007 taxation year is dismissed without costs.
Signed at Ottawa, Canada, this 3rd day of May 2016.
“Johanne D’Auray”
D’Auray J.
Translation certified true
On this 11th day of January 2017
François Brunet, Revisor
[ENGLISH TRANSLATION]
Citation: 2016 TCC 110
Date: 20160503
Docket: 2012-2142(IT)G
BETWEEN:
MARIO MONTMINY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2144(IT)G
BETWEEN:
ALBERTO GALEGO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2145(IT)G
BETWEEN:
SERGE LATULIPPE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2146(IT)G
BETWEEN:
RÉMI DUTIL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2147(IT)G
BETWEEN:
ÉRIC HACHÉ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2148(IT)G
BETWEEN:
PHILIPPE BEAUCHAMP,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2012-2150(IT)G
BETWEEN:
JACQUES BENOIT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
D’Auray J.
I. Background [1] These appeals relate to the 2007 taxation year and were heard on common evidence.
[2] The appellants were all management employees of 9178‑4488 Québec inc., formerly known as Cybectec inc. (“Cybectec”).
[3] Cybectec is a company offering customers consulting and custom design services in relation to industrial IT systems.
[4] In 2001, Cybectec established a stock option plan (the “stock option plan”) in favour of the appellants.
[5] Pursuant to paragraph 110(1)(d) of the Income Tax Act (the “Act”), a taxpayer may deduct half of the value of the taxable benefit under a stock option plan subsequent to the disposition of the taxpayer’s shares. Certain conditions must be met in this regard.
[6] The appellants submit that they have fulfilled all the conditions imposed by paragraph 110(1)(d) of the Act and section 6204 of the Income Tax Regulations (the “Regulations”). Each of the appellants consequently deducted, under paragraph 110(1)(d) of the Act, half of the value of the taxable benefit he received subsequent to the disposition of his shares.
[7] The respondent argues that the appellants did not fulfil the conditions of paragraph 110(1)(d) of the Act and section 6204 of the Regulations and that, as a result, the appellants may not deduct half of the taxable benefit received under the stock option plan.
[8] In this case, the issue to be determined is whether the appellants fulfilled the conditions set out in paragraph 110(1)(d) of the Act, that is, whether the shares of Cybectec were prescribed shares under section 6204 of the Regulations. The appellants must further establish, as prescribed in paragraph 110(1)(d) of the Act, that the price paid for the security, $0.20 per share, was no less than the fair market value of the securities on the date the stock options were granted.
II. The facts [9] At the hearing, the parties filed a partial agreed statement of facts, which is reproduced below in full:
A. [translation] Partial agreed statement of facts 1 The appellants were employees of 9178‑4488 Québec inc. (formerly Cybectec inc.) (the Company).
2 [Paragraph struck by the parties.]
3 Until December 1, 2003, the Company was controlled by Yves Racine and Jean-Louis Pâquet by way of the companies 2755‑5945 Québec inc. and 2755‑5952 Québec inc.
4 Effective December 1, 2003, all shares of the capital stock of the Company were held by 9135‑8184 Québec inc.
5 On May 1, 2001, the Company established a stock option plan (the “Plan”) for its officers and management employees.
6 Under section 7.2 of the Plan, the options granted could be exercised only upon the occurrence of one of the following events: (1) a public offering by the Company followed immediately by listing of Class A shares of the capital stock of the Company on a recognized stock exchange or (2) the sale of all shares of the capital stock of the Company issued in all classes and in circulation.
7 On December 16, 2001, the number of shares set aside for the purposes of the Plan was increased from 1,740,000 to 2,500,000 Class A shares of the Company.
8 On December 17, 2001, and January 18, 2002, the Company distributed stock options among eleven (11) employees as follows:
Date
Employee
Options
December 17, 2001
Rémi Dutil
130,500
December 17, 2001
Serge Latulippe
348,000
December 17, 2001
Jacques Benoît
261,000
December 17, 2001
Mario Montminy
261,000
December 17, 2001
Alberto Galego
261,000
December 17, 2001
Éric Haché
261,000
December 17, 2001
Philippe Beauchamp
43,500
December 17, 2001
Denis Corriveau
43,500
December 17, 2001
Paul Dionne
174,000
December 17, 2001
Claude St-Pierre
174,000
January 18, 2002
Manon Lessard
17,400
Total:
1,974,900
9 On January 10, 2007, the Plan was modified so that the sale of substantially all of the Company’s assets to a third party, Cooper Industries (Electrical) Inc., be considered an event allowing the exercise of stock options granted under the Plan.
10 The Company set the fair market value of the share at the date of granting the stock options at $0.20 per share.
11 On January 28, 2007, some of the employees holding stock options exercised their right under the Plan.
12 On January 28, 2007, the Company distributed shares among nine (9) employees at $0.20 per share as follows:
Employee
Shares
Price/Share
Total
Manon Lessard
17,400
$0.20
$3,480
Denis Corriveau
43,500
$8,700
Philippe Beauchamp
43,500
$8,700
Rémi Dutil
130,500
$26,100
Mario Montminy
261,000
$52,200
Alberto Galego
261,000
$52,200
Jacques Benoît
261,000
$52,200
Éric Haché
261,000
$52,200
Serge Latulippe
348,000
$69,600
1,626,900
$325,380
13 On January 28, 2007, these employees sold the Class A shares of the capital stock of the Company, which they held to 9135‑8184 Québec inc. at a price of $1.2583 per share for a total of:
Employee
Shares
Price/Share
Total
Manon Lessard
17,400
$1.2583
$21,894
Denis Corriveau
43,500
$54,736
Philippe Beauchamp
43,500
$54,736
Rémi Dutil
130,500
$164,208
Mario Montminy
261,000
$328,416
Alberto Galego
261,000
$328,416
Jacques Benoît
261,000
$328,416
Éric Haché
261,000
$328,416
Serge Latulippe
348,000
$437,888
1,626,900
$2,047,128
14 The Company sold all of its assets on January 26, 2007.
15 For the 2007 taxation year, the appellants received and reported a taxable benefit from employment computed based on proceeds of disposition of $1.2583 and an adjusted cost base of $0.20.
16 For the 2007 taxation year, the appellants claimed deductions corresponding to 50% of the taxable benefits in accordance with the provisions of paragraph 110(1)(d) of the Act, the taxable benefit and deduction claimed by each appellant being as follows:
Employee
Shares
Taxable benefit
110(1)(d) deduction
Philippe Beauchamp
43,500
$46,036
$23,018
Rémi Dutil
130,500
$138,108
$69,054
Mario Montminy
261,000
$276,216
$138,108
Alberto Galego
261,000
$276,216
$138,108
Jacques Benoît
261,000
$276,216
$138,108
Éric Haché
261,000
$276,216
$138,108
Serge Latulippe
348,000
$368,288
$184,144
17 During the audit phase, the Agency set the fair market value of the share at the date of granting the stock options at $0.415 per share.
18 On or about November 16, 2010, the Minister of National Revenue (the Minister) issued a reassessment for the 2007 year against the appellants, disallowing the deduction claimed under paragraph 110(1)(d) of the Act.
19 On or about December 10, 2010, the appellants filed notice of objection with the Minister concerning the reassessments issued for the 2007 taxation year.
20 During the objection phase, the Agency set the fair market value of the share at the date of granting the stock options at $0.3246 per share.
21 On February 27, 2012, the Minister upheld the reassessments.
B. Corporate status and capital stock of Cybectec [10] Cybectec was created in 1980 by four individuals, including Jean‑Louis Pâquet and Yves Racine. The two other founding shareholders of Cybectec left the Company shortly after its creation.[1]
[11] Up to the time of the Company’s sale in 2007, Mr. Pâquet and Mr. Racine held equal shares of Cybectec. Mr. Pâquet was the president of Cybectec. He was an engineer and contributed actively to the technical aspects of projects. Mr. Racine was the vice-president of Cybectec and was responsible for business development and company operations.
[12] On May 2, 1998, Cybectec entered into a crystallization transaction so that Mr. Pâquet and Mr. Racine could use their capital gains exemptions. In 1998, prior to the crystallization transaction, Cybectec had issued 200 Class A common shares and 12 Class D shares.[2] As part of the transaction, Mr. Pâquet and Mr. Racine each disposed of 13 Class A shares in consideration of 13 Class C shares redeemable for $32,000 at the option of the holder.[3]
[13] Following at transaction, 174 Class A shares remained issued and in circulation. These 174 Class A shares were then split, resulting in 17,400,000 Class A shares. Taking into account the number of shares resulting from the split, each Class A share was valued at $0.32 at the time of the crystallization transaction.[4] It is important to note that at the time of the crystallization transaction, no official valuation of the fair market value of the shares had been carried out. The value of the shares had been determined internally by Cybectec’s longtime accountant, Mr. Legros.[5]
[14] Prior to December 1, 2003, Cybectec was controlled by Mr. Pâquet and Mr. Racine through portfolio companies. Mr. Pâquet’s portfolio company, 2755‑5952 Québec inc., held 50% of the shares of Cybectec, and Mr. Racine’s company, 2755‑5945 Québec inc., held the other 50%.[6]
[15] Following this transaction and the creation of 9135‑8184 Québec inc., the latter became holder of the shares of Cybectec effective December 1, 2003.[7] The corporate structure of Cybectec was as follows:
C. The evolution of the Activities and the customer base of Cybectec [16] The breakdown of Cybectec’s activities between the provision of custom software development services and semi-standardized product design has evolved over the years. Until 1999, Cybectec allocated 100% of its efforts to custom software development.[8] This ratio then began to decrease, falling to 80% by mid-2001.[9]
[17] Cybectec billed its customers on a flat-fee basis for its custom software development services and on an hourly basis for software maintenance tasks.[10] For larger projects extending over multiple years, Cybectec billed as it reached designated milestones as arranged in advance with each customer.
[18] Mr. Pâquet testified that between 1993 and 2000, Cybectec’s contracts typically ranged in value between $10,000 and $100,000. The Company also won a smaller number of large-scale (more than $1,000,000) contracts, including contracts with its main customer, Hydro‑Québec.[11] The majority of contracts were won through a bidding process.
[19] Around 1994, Hydro‑Québec commissioned Cybectec to modernize the IT systems at several hundred control centres throughout its electricity network. Cybectec proposed an innovative system called a multiprotocol system (MPS) to modernize Hydro‑Québec’s IT infrastructure.[12] It is important to note that Hydro‑Québec held the intellectual property rights to this MPS, while Cybectec was responsible for designing the system.
[20] Sometime during 1998, the supplier of the data processing hardware used to operate the MPS stopped manufacturing said hardware.[13] That was a devastating turn of events for Cybectec, as that data processing hardware was a critical component for running the software Cybectec had developed. As a result of that setback, Cybectec had to develop new software for Hydro‑Québec at its own cost.[14] In this context, Cybectec assumed ownership, for the first time, of the intellectual property rights to data processing hardware[15] operating with a system referred to henceforth as MPS2.
[21] In late 1999, Hydro One in Ontario expressed its interest to Cybectec in acquiring software similar to the MPS developed for Hydro‑Québec. Subsequent to an international tender process, Hydro One awarded the contract to Cybectec. In 2000, Cybectec started working on this project for Hydro One.
[22] The primary difference between the contract signed with Hydro‑Québec and that signed with Hydro One is that Hydro One was not willing to cover the entire cost of software development. Cybectec consequently agreed to deliver the software. This was in keeping with Cybectec’s business plan in terms of growing sales and services relating to generic products in order to reduce its dependence on negotiating specific development contracts with its customers.
[23] Around the same time, that is, in late 1999 or early 2000, Hydro‑Québec awarded Cybectec a large-scale contract to supply load control devices.[16] The role of a load control device in an electrical transmission system is to take stress off the system during peak demand periods to help prevent power outages. This type of system requires use of a specific hardware component along with software to link the component to the transmission system.
[24] In the light of the complexity of the integration software for the load control device, Hydro‑Québec wanted Cybectec to also supply the hardware. Cybectec initially bought the hardware from GenTech, a load control device manufacturer, and resold it at a profit to Hydro‑Québec for a fixed price including the development costs of the integration software.[17]
[25] The load control device supply contracts were signed for a renewable two-year period and involved the provision of 25 to 30 devices per year.[18]
[26] During his testimony, Mr. Pâquet stated that in 2001, Cybectec was not expecting to get any new large-scale contracts for custom software development.[19]
D. Stock option plan for Class A shares [27] On May 1, 2001, Cybectec’s board of directors, made up of Mr. Pâquet and Mr. Racine, adopted a resolution authorizing the establishment of a stock option plan for the Company’s officers and management employees (“employees”). Fierce competition for workers specializing in industrial IT and issues with staff turnover led Cybectec to put this stock option plan in place to improve retention of key employees. Under this plan, Cybectec would issue Class A shares to its employees at the fair market value of the shares as determined by the board of directors at the time of granting the options.
[28] On December 17, 2001, Cybectec granted stock options to the appellants under the stock option plan.[20]
[29] All of the appellants, with the exception of Philippe Beauchamp, held technical positions and had been working for the Company for at least 10 years at the time of the granting of the stock options.[21] Mr. Beauchamp worked in the sales department and had been with the Company for only a few years. This explains the fact that he was granted a lesser number of stock options.
[30] The agreement adopted on May 1, 2001, governing the stock option plan stipulated that the stock options could not be exercised until the occurrence of either of the events described in sections 7.2 and 7.3, which provided as follows:
7.2 [translation] Any options granted under the Plan may not be exercised until the occurrence of one of the following events:
7.2.1 A public offering by the Company followed immediately by listing of Class A shares of the capital stock of the Company on a recognized stock exchange;
7.2.2 The sale of all shares of the capital stock of the Company issued in all classes and in circulation.
7.3 Any options granted under the Plan may also be exercised on the tenth anniversary of the date of their granting if neither of the events set out in articles 7.2.1 or 7.2.2 has occurred before the tenth anniversary. . . .
[31] Based on Mr. Pâquet’s testimony, in the light of the absence of any plans for an initial public offering or to sell all shares of the capital stock, exercising the options after 10 years appeared the most likely route.[22]
[32] In 2007, Cybectec received an unsolicited offer from Cooper Industrial Electrical Inc. (“Cooper”) to purchase all shares it had issued. For taxation reasons, however, Cooper sought to buy substantially all of Cybectec’s assets. In the light of this situation, Cybectec’s board of directors had to clarify the conditions governing the exercise of options. That clarification was necessary because article 7.2.2 of the Plan covered the sale of shares of Cybectec but not the sale of substantially all of its assets.
[33] Mr. Pâquet and Mr. Racine found it unfair not to allow management employees—the appellants—to exercise their stock options on technical grounds.[23]
[34] On January 10, 2007, Cybectec’s board of directors passed a written resolution authorizing employees with options under the stock option plan to exercise their options. Pursuant to this resolution, the sale of substantially all of Cybectec’s assets to Cooper constituted an event enabling the exercise of options under article 7.2.2 of the Plan.
[35] Also on January 10, 2007, Mr. Pâquet and Mr. Racine, the officers of Cybectec, forwarded a letter to each of the appellants stating, in particular:
[translation] CYBECTEC INC.
730 Commerciale Street
Suite 200
St-Jean-Chrysostome, Quebec G6Z 2C5
January 10, 2007
Employee
c/o CYBECTEC INC.
730 Commerciale Street
Suite 200
St-Jea[sic]-Chrysostome, Quebec G6Z 2C5
Subject: Stock option plan for officers and management employees (the “Plan”)
Dear Sir,
In accordance with the provisions of a resolution passed by the company’s board of directors on January 10, 2007, the Company has deemed that subsequent to settlement of the transaction involving the sale of substantially all of the company’s assets to Cooper Industries (Electrical) Inc. scheduled to take place on or about January 30, 2007, you will have the right to exercise the stock options granted to you under the Plan on December 17, 2001.
Subject to successful completion of the transaction, you will consequently be able to exercise these options at the price and under the terms and conditions prescribed in the Plan.
Upon issue of the shares underlying the options you have exercised, you undertake to sell these shares immediately pursuant to your commitments regard under the terms of the “Beneficiary Declarations and Commitments” document you signed on December 17, 2001, at the time of the granting of your options.
The sale will be transacted with 9135‑8184 Québec inc., which on that date will acquire all [number of shares] issued to you at the price of $1.2583 per share for a total of [amount].
. . .
Lastly, you hereby authorize 9135‑8184 Québec inc. to withhold, from the sale price of the shares issued to you upon exercising your stock options, an amount corresponding to the strike price of your options and to forward it on your behalf to the company as payment of the share issue price.
CYBECTEC INC.
By: Jean-Louis Pâquet
By: Yves Racine
[36] All of the appellants approved and signed this letter, thereby agreeing to sell their shares to 9135‑8184 Québec inc., a company related to Cybectec inc.
[37] On January 28, 2007, Cybectec’s board of directors passed a written resolution confirming that the employees had exercised their stock options on January 28, 2007, and that the shares had been issued to the appellants at a price of $0.20 per share in accordance with the terms and conditions of the Plan.
[38] On January 28, 2007, the board of directors of 9135‑8184 Québec inc. passed a written resolution authorizing the company to purchase the Class A shares held by designated Cybectec employees—the appellants—at a price of $1.2583 per share for a grand total of $1,626,900.
III. Issues [39] In computing their income for the 2007 taxation year, were the appellants entitled to deduct, under paragraph 110(1)(d) of the Act, half of the benefit received under the stock option plan?
[40] To address this question, we must examine the following two questions:
- Were the shares of Cybectec prescribed shares under section 6204 of the Regulations?
- Was the price paid by the appellants, or $0.20 per share, no less than the fair market value of the shares on the date the stock options were granted (December 17, 2001)?
IV. Applicable law and legal analysis [41] The provisions applicable to the present case are subsections 7(1) and 7(1.1) and paragraphs 110(1)(d) and 110(1)(d.1) of the Act, and section 6204 of the Regulations.
[42] Subject to subsections 7(1.1) and 7(8) of the Act, subsection 7(1) is applicable to taxpayers where a corporation agrees to sell shares of its capital stock to its employees. Employees acquiring shares of their employer under a stock option plan in this manner are generally required to report, as employment income for the taxation year in which they received the shares, an amount corresponding to the benefit received.
[43] However, subsection 7(1.1) of the Act defers taxation for employees of a Canadian-controlled private corporation (CCPC), making the reference the taxation year in which they dispose of their shares. Therefore, taxpayers may defer taxation of the amount of the benefit received under the stock option plan to the time of disposition of the shares.
[44] The counterpart of section 7 is the deduction of half of the taxable benefit, which simulates the effect of a capital gain. Deductions relating to stock option plans are set out in paragraphs 110(1)(d) and 110(1)(d.1) of the Act. These deductions significantly reduce the tax burden on employees, but employees are not automatically eligible.
[45] In the light of the facts of this case, paragraph 110(1)(d.1) of the Act is of no assistance to the appellants, since one of the conditions for application of this paragraph is that the appellants must have held their shares for at least two years subsequent to their acquisition. In this appeal, the shares of Cybectec were acquired by the appellants on January 28, 2010, and sold that same day. Insofar as the requirement concerning the holding period was not fulfilled, paragraph 110(1)(d.1) of the Act is of no use to the appellants.
[46] To be able to deduct half of the benefit, the appellants must consequently invoke paragraph 110(1)(d) of the Act.
[47] The conditions provided for under paragraph 110(1)(d) of the Act are as follows:
1. The securities must be prescribed shares under section 6204 of the Regulations at the time of their sale or issue;[24]
2. The amount paid by the taxpayer to acquire the shares must be no less than the fair market value of the shares at the time of their granting;
3. Immediately following conclusion of the agreement, the taxpayer must be dealing at arm’s length with the employer or other corporation issuing the shares.
[48] In this case, the third condition under paragraph 110(1)(d) of the Act is satisfied. The appellants are dealing at arm’s length with Cybectec.
[49] With respect to the first condition, the appellants must show that the shares of Cybectec are prescribed shares under subsection 6204(1) of the Regulations.
[50] Regarding the second condition, the appellants must establish that the price paid to acquire the shares of Cybectec, or $0.20 per share, is no less than the fair market value at the time of granting the options (on December 17, 2001).
1) Are the shares of Cybectec prescribed shares under subsection 6204(1) of the Regulations?[25] A. Position of the parties [51] The respondent argues that the shares in question are not prescribed shares because the appellants have not met the conditions set out in paragraph 6204(1)(b) of the Regulations, which provides that “the corporation or a specified person in relation to the corporation cannot reasonably be expected to, within two years after the time the share is sold or issued, as the case may be, redeem, acquire or cancel the share in whole or in part.” I will refer to the requirement in paragraph 6204(1)(b) as the “two-year reasonable expectation.”
[52] The appellants acknowledge that the two-year reasonable expectation is not met because when Cybectec issued the shares, the corporation related to Cybectec, 9135‑8184 Québec inc., had already agreed to purchase the appellants’ shares. When the shares were issued, the related corporation consequently expected that the shares would be purchased.
[53] However, the appellants argue that in the light of the exception set out in paragraph 6204(2)(c) of the Regulations, the shares of Cybectec are prescribed shares. The appellants submit that they did not have to hold their shares for two years.
[54] The appellants submit in this regard that subsection 6204(2) of the Regulations allows exceptions and that these exceptions are applicable to all of subsection 6204(1), including paragraph 6204(1)(b), not only to certain paragraphs of subsection 6204(1) as argued by the respondent. The appellants argue that their interpretation of subsection 6204(2) is confirmed in the opening provisions, which read as follows in English and French:
6204(2) Pour l’application du paragraphe (1) :
6204(2) For the purposes of subsection (1),
[55] According to the appellants, paragraph 6204(2)(c) of the Regulations disregards the two-year reasonable expectation prescribed in paragraph 6204(1)(b) of the Regulations. According to the appellants, if Parliament[26] had wanted to limit application of subsection 6204(2) to certain paragraphs of subsection 6204(1), then the introductory paragraph in subsection 6204(2) would have specified, “for the purposes of paragraph 6204(1)(a).”
[56] Therefore, the appellants argue that if taxpayers meet the conditions set out in paragraph 6204(2)(c) of the Regulations, they do not have to meet the condition set out in paragraph 6204(1)(b) with respect to the two-year reasonable expectation.
[57] In this regard, the appellants submit that they meet all conditions listed in subparagraphs 6204(2)(c)(i), (ii) and (iii) and clause 6204(2)(c)(ii)(B) of the Regulations. Consequently, the appellants assert that the shares of Cybectec are prescribed shares under section 6204 of the Regulations and that the first condition in paragraph 110(1)(d) of the Act is therefore met.
[58] The appellants argue further that the stock option plan was implemented to assist in retaining the officers and management employees of Cybectec; hence, there is no compensation in disguise. Thus, according to the appellants, the stock option plan does not infringe upon taxation policy governing stock option plans. In this regard, the appellants cite Janette Pantry[27] concerning the purpose of section 6204 of the Regulations:
[translation] Section 6204 of the Regulations sets out the applicable requirements concerning prescribed shares. Essentially, the shares must be “plain vanilla common” shares. The purpose of section 6204 is to ensure that the employees granted stock options and qualifying for a tax rate corresponding to that applicable to capital gains acquire their stock options in circumstances where the value of the shares in question is not guaranteed to increase. For example, employees should not be eligible for the deduction for stock options where the salary or other compensation they would normally receive is replaced by options to acquire shares designed to increase in value . . .
[59] As for, the respondent, it is argued that the interpretation of subsections 6204(1) and 6204(2) of the Regulations offered by the appellants is incorrect.
[60] The respondent submits that subsection 6204(2) of the Regulations applies only to certain paragraphs of subsection 6204(1). According to the respondent, reading subsections 6204(1) and 6204(2) of the Regulations as a whole confirms that interpretation.
[61] For example, the respondent notes that paragraph 6204(2)(a) of the Regulations applies only to subparagraph 6204(1)(a)(i). Paragraph 6204(2)(b), meanwhile, applies only to subparagraph 6204(1)(a)(ii). The respondent notes further that none of the paragraphs in subsection 6204(2) apply to subparagraphs 6204(1)(a)(iii) or (v).
[62] With respect to paragraph 6204(2)(c) of the Regulations, the respondent argues that this paragraph applies only to subparagraphs 6204(1)(a)(iv) and 6204(1)(a)(vi). Paragraph 6204(2)(c) can be used to disregard the rights and duties provided for in subparagraphs 6204(1)(a)(iv) and 6204(1)(a)(vi). For example, if a corporation has the right to redeem shares under, paragraph 6204(2)(c) this redemption right can be disregarded if all of the conditions prescribed in that paragraph are met.
[63] The respondent also notes that the relevant provisions, i.e., paragraphs 6204(1)(a) and 6204(1)(c) and subparagraphs 6204(1)(a)(iv) and 6204(1)(a)(vi) of the Regulations, all use the same wording. They all refer to rights or duties arising from the terms or conditions of the share or any agreement in respect of the share or its issue.
[64] According to the respondent, paragraph 6204(1)(b) of the Regulations makes no reference to rights or duties arising from the terms or conditions of the share or any agreement in respect of the share or its issue. The respondent submits that paragraph 6204(1)(b) raises a factual question: could it be reasonably expected that the shares would be acquired or redeemed within two years following their issue? As a result, paragraph 6204(2)(c) cannot be used to disregard the two-year reasonable expectation.
[65] The respondent argues that if the facts had established that Cybectec or 9135‑8184 Québec inc. could not, at the date of issue of the shares, reasonably expect that the related corporation would purchase the appellants’ shares within two years following the issue of the shares, then the criterion in paragraph 6204(1)(b) would be met.
[66] However, the respondent submits that in the circumstances at hand, neither Cybectec nor 9135‑8184 Québec inc. could reasonably expect the shares not to be redeemed within two years following their issue by Cybectec. In this regard, the appellants had signed an agreement prior to the issue of the shares under which 9135‑8184 Québec inc. committed to buying the appellants’ shares on the same date as the issue of the shares, January 28, 2007.
[67] The respondent submits that in the present case, the appellants do not meet the criterion in paragraph 6204(1)(b) of the Regulations. The respondent argues that insofar as the shares of Cybectec were not prescribed shares within the meaning of subsection 6204(1) of the Regulations, the appellants are not eligible for the deduction provided for in paragraph 110(1)(d) of the Act.
B. Analysis [68] The parties stated at the hearing that there was no case law concerning the interaction of paragraphs 6204(1)(b) and 6204(2)(c) of the Regulations as to whether paragraph 6204(2)(c) can be used to eliminate from consideration the two-year reasonable expectation in paragraph 6204(1)(b). To determine this question, I will turn to the doctrine of the Supreme Court of Canada as to the interpretation of tax laws.[28] In Canada Trustco Mortgage Co. v. Canada, [2005] 2 SCR 601, 2005 SCC 54 (CanLII), at paragraph 10, the Supreme Court of Canada sets out how the tax laws are to be interpreted:
. . . The interpretation of a statutory provision must be made according to a textual, contextual and purposive analysis to find a meaning that is harmonious with the Act as a whole. When the words of a provision are precise and unequivocal, the ordinary meaning of the words play a dominant role in the interpretive process. On the other hand, where the words can support more than one reasonable meaning, the ordinary meaning of the words plays a lesser role. The relative effects of ordinary meaning, context and purpose on the interpretive process may vary, but in all cases the court must seek to read the provisions of an Act as a harmonious whole.
[69] At paragraph 13, the Supreme Court states that “the Income Tax Act remains an instrument dominated by explicit provisions dictating specific consequences, inviting a largely textual interpretation.” On the other hand, “where the words of a statute give rise to more than one reasonable interpretation, the ordinary meaning of words will play a lesser role, and greater recourse to the context and purpose of the Act may be necessary.”[29]
[70] I will first analyze subsections 6204(1) and 6204(2) of the Regulations and thereby use a textual approach and then use an approach placing greater emphasis on the context and purpose of the Act.
[71] On reading subsections 6204(1) and 6204(2) of the Regulations, it is noted that subsection 6204(2) is a rule of application. As such, subsection 6204(2) may be used to disregard certain rights, conditions and obligations set out in certain paragraphs of subsection 6204(1).
[72] Subsection 6204(1) of the Regulations defines what constitutes a prescribed share. It provides as follows:
6204 (1) For the purposes of subparagraph 110(1)(d)(i) of the Act, a share is a prescribed share of the capital stock of a corporation at the time of its sale or issue, as the case may be, if, at that time,
(a) under the terms or conditions of the share or any agreement in respect of the share or its issue,
(i) the amount of the dividends (in this section referred to as the “dividend entitlement”) that the corporation may declare or pay on the share is not limited to a maximum amount or fixed at a minimum amount at that time or at any time thereafter by way of a formula or otherwise,
(ii) the amount (in this section referred to as the “liquidation entitlement”) that the holder of the share is entitled to receive on the share on the dissolution, liquidation or winding-up of the co