Phaneuf Estate v. The Queen, 78 DTC 6001, [1978] CTC21 (FCTD)

The Associate Chief Justice:—The principal issue in this appeal is whether the late George Farnsworth Phaneuf, who died on October 23, 1977, after the commencement of this appeal, was liable for income tax in respect of the value of a benefit received on the purchase by him on or about June 5, 1973 of 152 shares of Charles Ogilvy Limited at their par value. If so, further issues as to the year in which the value is taxable and as to its amount arise. The appeal is probably a test case as a similar benefit was received at or about the same time by some 240 other persons in like situations from the same source and on like conditions.

The material on which the case is to be decided consists of a Statement of agreed facts, a series of eight documents admitted by consent as exhibits and some oral testimony given by Mr R H Hyndman, the president of Charles Ogilvy Limited. The agreed statement is as follows, the references therein to the plaintiff being references to Mr Phaneuf:

1. The Plaintiff was at all material times an employee of Charles Ogilvy Limited (hereinafter called “the Company’’).

2. Charles Ogilvy, the founder and then principal shareholder of ‘the Company, died March 26, 1950.

3. By his Will dated May 14, 1947, Mr Ogilvy directed his Executors to sell 1,800 of his common shares of the Company to employees of the Company within one year after the death of the survivor of him and his wife at their par value of $20.00 per share.

4. The widow of the late Mr Ogilvy died November 10, 1972.

5. The com mon'"shares of the Company had been split ten for one between the date Mr Ogilvy made his Will and the date of Mrs Ogilvy’s death. After making allowances for direct bequests contained in Mr Ogilvy’s Will, only 1713 (17,130) of the stipulated 1800 (18,000) common shares of the Company were available for sale to the employees.

6. On April 27, 1973, the Supreme Court of Ontario ordered that the 17,130 common shares of the Company were available for sale to the employees in accordance with the terms of Mr Ogilvy’s Will at a price of $2.00 per share.

7. On May 2, 1973, the Board of Directors of the Company met and revised the list of employees entitled to purchase shares because of the death and resignation of entitled employees since the list was first settled at a meeting of the Board of Directors on March 6, 1973.

8. It had been the practice since 1964 that all employees who purchased Shares of the Company did so subject to the provisions of a Shareholders Agreement.

9. On March 1, 1973, Mr R H Hyndman, on behalf of Mr W J Tate and himself, acting as Trustees, tendered the sum of $34,260.00 to the. Executor of Mr Ogilvy’s estate, being the purchase price of 17,130 common shares at a price of Two ($2.00) Dollars per share. The said sum of $34,260.00 was borrowed by the Trustees from their bank.

10. The 17,130 common shares of the Company were transferred by the Executors of the Estate of the late Charles Ogilvy to Messrs Hyndman and Tate as Trustees.

11. On May 15, 1973, the entitled employees were invited, in writing, by Mr Hyndman to purchase the number of shares allotted to them.

12. On June 5, 1973, the Plaintiff purchased 152 shares at a price of $2.00 per share by cheque payable to Messrs Hyndman and Tate.

13. The fair market value of the common shares of the Company on the date of purchase was $17.25 per share.

14. The fair market value of the common shares of the Company on the date of Mr Ogilvy’s death was $30.00 per share; however, after his death the common shares were split five for one.

15. By Notice of Reassessment dated May 20, 1975, the Minister of National Revenue reassessed the Plaintiff for his 1973 taxation year by adding to his declared income an amount of $2,318.00 and indicated in the accompanying form T/7W-C that the Plaintiff's income had been adjusted to include the taxable benefit received in the purchase of 152 common shares of the Company for $2.00 per share when their actual worth was $17.25 per share.

16. On or about August 7, 1975, the Plaintiff duly served and filed a Notice of Objection to the said Assessment.

17. In a notification by the Minister of National Revenue dated June 11, 1976, the aforementioned assessment was confirmed indicating that the sum of $2,318.00 was a benefit received by the Plaintiff by virtue of his office or employment resulting from the acquisition of shares of the Company at less than their fair market value and that the amount was properly included in computing the Plaintiff’s income in accordance with the provisions of section 6(1 )(a) of the Income Tax Act.

All of which facts are admitted and agreed to by the parties and their counsel.

The late Mr Ogilvy left no children. He and his first wife had owned all the shares of Charles Ogilvy Limited and, in 1940, he had given some 48% of the shares to employees. His wife died in 1946. In 1950, when his will was made, he was contemplating a second marriage and this is so expressed in it. It provided first for a number of specific bequests to individuals and for the payment to his widow of the income on the residue of his estate for her life. It went on to provide that thereafter his residence was to be conveyed to Charles Ogilvy Limited to be operated as a rest and convalescent home for employees of the company. He expressed a desire that the business of the company be carried on for 15 years after the death of his widow or after his death, if he survived her, and he gave to certain nieces and nephews the dividends on 1,800 shares of the company to be set aside during such 15-year period, or until the shares were purchased by employees under the provision referred to in paragraph 3 of the statement of agreed facts, and to pay the proceeds of their sale to the such nieces and nephews. The provision for the employees read as follows:

I AUTHORIZE AND DIRECT my said. Executors and Trustees to enter into an agreement with the employees of Charles Ogilvy Limited (the term “employees” to include any Directors of Charles Oqilvy Limited who may not be on the regular payroll of the Company), who may, with the sanction and approval of the Directors of the said Company for the time being, desire to enter into such agreement, for the sale to such employees of the said eighteen hundred (1800) shares hereinbefore directed to be set aside for the benefit of my nephews and nieces hereinbefore named and the widows of my said deceased nephews, Gavan Russell and James G. Ogilvy, at the price or sum of Twenty ($20.00) dollars per share, being the par value thereof; provided that no employee of the Company may become a purchaser of the said stock or any part thereof except with the sanction and approval of the Board of Directors of the said Company for the time being, and provided further, that no employee may become a purchaser of any greater number of said shares than the number which may be designated by the said Board of Directors. The said agreement, in addition to such provisions as the said employees may desire to make as among themselves, shall contain the following terms and provisions . . .

Then followed provision for a scheme for contributions by employees to a fund over the 15-year period to be accumulated to pay for the shares. As matters turned out, the shares were purchased for cash and these provisions did not come into effect. The will then continued:

THE Privilege hereby conferred upon the said employees of Charles Ogilvy Limited of purchasing the said eighteen hundred (1800) shares, being a portion of my holdings in the capital stock of the said Company, shall be exercised by them, and the said agreement shall be entered into within one year following the death of my said wife or within one year following my death in the event of my wife predeceasing me, and if the said privilege is not exercised and the said agreement is not entered into within the said period of time, then my said Executors and Trustees may revoke the said privilege, and subject to the other terms^ and provisions of this my Will, may dispose of the said stock in such manner as they may deem advisable in the best interests of my estate as if the said privilege had not been conferred upon the said employees of Charles Ogilvy Limited.

IT is my desire that William Russell Burnett, of the City of Ottawa, Solicitor, hereinafter named as one of my Executors and Trustees, shall after my death and during the said period of fifteen years after the death of my said wife, be a Director of Charles Ogilvy Limited and take an active interest in the said business, and that he shall at all times be consulted as to the affairs thereof in order that the policies of fair dealing towards the public and towards my employees laid down by me with respect to the said business shall be carried into effect.

The residue of the estate was then given to charitable institutions.

I turn now to the practice referred to in paragraph 8 of the Statement of agreed facts.

Since 1964 there has been in existence an agreement between the employee shareholders of the company and R H Hyndman and William J Tate as trustees which provides for valuing the shares of the company and establishing a price for them at the beginning of each year and restricts the shareholders who are parties to the agreement, in disposing of their shares, to selling them to the trustees and at the prevailing price established for the year. The trustees buy the shares at that price and dispose of them at the same price to employees of the company. The agreement provides for a point system for allocation to employees of the right to purchase such shares from the trustees which is based on the length of service of such employees and their salaries and bonuses, with a further weighting formula based on seniority in the company. The purpose of this agreement is to keep the control of the company in the hands of its employees and any employee purchasing shares allocated to him pursuant to its provisions is required to subscribe and become a party to it.

As the trustees under this agreement, Mr Hyndman and Mr Tate were in no sense trustees of the rights of employees under Mr Ogilvy’s will, but when the board of directors of the company carried out the function committed to it by the will, it approved the purchase of the 1,713 shares from the executor by Messrs Hyndman and Tate as trustees and allocated them to employees on the basis of the system of the agreement so far as it was based on points for length of service and salary and bonus. The board also made the allocation of the right to purchase subject to the employee subscribing and becoming party to the agreement with respect to the shares so purchased. As set out in the statement of agreed facts, Mr Phaneuf was allotted the right to purchase 152 shares and he did so and thereby realized the benefit in question in this appeal.

The relevant provisions of the Income Tax Act are subsections 5(1) and 6(1). They provide:

5. (1) Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by him in the year.

6. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from an office or employment such of the following amounts as are applicable:

(a) the value of board, lodging and other benefits of any kind whatever (except the benefit he derives from his employer’s contributions to or under a registered pension fund or plan, group. sickness or accident insurance plan, private health services plan, supplementary unemployment benefit plan, deferred profit sharing plan or group term life insurance policy) received or enjoyed by him in the year in respect of, in the course of, or by virtue of an office or employment;

The arguments submitted by both parties ranged over many aspects and details of the matter and many cases were referred to and discussed, but basically, as I understood them, the position of the plaintiff was that the benefit received by Mr Phaneuf in being given the privilege or right or opportunity to purchase the shares at so low a price was a gift or bequest to him personally under the will of Mr Ogilvy, while that of the defendant was that the right accrued to Mr Phaneuf in his capacity as an employee and is therefore a benefit of the kind rendered taxable by paragraph 6(1 )(a) as income from employment.

In Ransom v MNR, [1968] 1 Ex CR 293; [1967] CTC 346; 67 DIC 5235, which arose under corresponding provisions of the Income Tax Act applicable prior to 1972, Noel, J (as he then was), after referring to the difference between Schedule E, Rule 1 of the English statute, on which there is a considerable body of jurisprudence, and the provisions of the Income Tax Act, RSC 1952, c 148, observed at page 307 [358, 5242]:

I now come to Section 5(1)(a) and (b) of the Act which, as already mentioned, is couched in language which appears to be wider than the English taxation rule on which the taxpayers in Hochstrasser v Mayes and Jennings v Kinder (supra) were held not to be taxable. The Canadian taxation section indeed uses such embracing words that at first glance it appears extremely difficult to see how anything can slip through this wide and closely interlaced legislative net.

In order, however, to properly evaluate its intent it is, I believe, necessary to bear in mind firstly, that Section 5 of the Act is concerned solely with the taxation of income identified by its relationship to a certain entity, namely, an office or employment and in order to be taxable as income from an office or employment, money received by an employee must not merely constitute income as distinct from capital, but it must arise from his office or employment. Similar comments were made in Hochstrasser v Mayes with reference to the English legislation by Viscount Simonds at p 705 and by Lord Radcliffe, at p 707. Secondly, the question whether a payment arises from an office or employment depends on its causative relationship to an office or employment, in other words, whether the services in. the employment are the effective cause of the payment. I should add here that the question of what was the effective cause of the payment is to be found in the legal source of the payment, and here this source was the agreement which resulted from the open offer of the employer to compensate its employee for his loss and the acceptance by him of such offer. The cause of the payment is not the services rendered, although such services are the occasion of the payment, but the fact that because of the manner in which the services must be rendered or will be rendered, he will incur or have to incur a loss which other employees paying taxes do not have to suffer.

I agree with this and, in my view, it applies as well to the present provisions introduced by the 1970-71-72 Act (SC 1970-71-72, c 63). I would add that the nature of the subject matters of paragraphs (b) to (f) inclusive of subsection 6(1) appears to me to further support the view that, to fall within the very broad wording of what is now paragraph 6(1 )(a), the amount must be of an income as distinct from a capital nature, and must arise from the office or employment in the sense that the services rendered in the employment must be the effective cause of the payment.

It is often difficult to determine in a particular case whether a payment or benefit arose from employment in the material sense. For this purpose, the relationship of the employment and the services rendered in it to the payment or benefit are always important since they are always part of the context in which the problem arises. But, while in some cases it is easy to see that they are the effective cause of the payment so that it may be affirmed that it arose from the office or employment, in others they are but sine qua non's. Tips received by waiters, hotel porters or taxi drivers are ready examples of payments other than salary or wages that arise from employment, that are related to services rendered in the course of the employment and that are of a recurring nature in the course of that employment. However, while non-recurring gifts that are related in some way to employment or services, whether received from the employer or from some other person, can also arise from the employment, they raise a much closer question.

In Seymour v Reed, [1927] AC 554 at 559, Viscount Cave, LC expressed the question arising in cases of this kind under the English Statute as follows:

The question, therefore, is whether the sum of 939/ 16s fell within the description, contained in r 1 of Sch E, of “salaries, fees, wages, perquisites or profits whatsoever therefrom’’ (ie, from an office or employment of profit) “for the year of assessment,’’ so as to be liable to income tax under that Schedule. These words and the corresponding expressions contained in the earlier statutes (which were not materially different) have been the subject of judicial interpretation in cases which have been cited to your Lordships; and it must now (I think) be taken as settled that they include all payments made to the holder of an office or employment as such, that is to say, by way of remuneration for his services, even though such payments may be voluntary, but that they do not include a. mere gift or. present (such as a testimonial) which is made to him on personal grounds and not by way of payment for his services. The question to be answered is, as Rowlatt J put it: “Is it in the end a personal gift or is it remuneration?” If the latter, it is subject to the tax; if the former, it is not.

The same distinction was adopted by the Supreme Court in Goldman v MNR, [1953] 1 SCR 211; [1953] CTC 95; 53 DTC 1096, a case that turned on the wording of the Income War Tax Act, RSC 1927, c 97. See per Kellock, J at page 215 [100, 1099], and per Rand, J at page 219 [103, 1100].

While the language of the statutes differ, the test expressed by Viscount Cave, LC (supra) appears to me to express, as well as it can be expressed, the essence of what falls within the taxing provision of the Income Tax Act. Is the payment made “by way of remuneration for his services” or is it “made to him on personal grounds and not by way of payment for his services”? It may be made to an employee but is it made to him as employee or simply as a person. Another way of stating it is to say is it received in his capacity as employee, but that appears to me to be the same test. To be received in the capacity of employee it must, as I see it, partake of the character of remuneration for services. That is the effect that, as it seems to me, the words “in respect of, in the course of, or by virtue: of an office or employment” in paragraph 6(1)(a) have.

Turning first to its origin, the source of the benefit here in question was a testamentary gift made by Mr Ogilvy» in effect, to such employees and on such terms and in such quantity as the board of directors of the company might sanction and approve. In exercising its function to sanction and approve, the board, as it seems to me, was not carrying out its authority as the board of directors of the company but was acting solely as a body designated for the purpose by the will and pursuant to its authority, and the gift to Mr Phaneuf though sanctioned and approved by the board remained the gift of the testator. Moreover, there is nothing in the way in which the provision of the will is expressed, or in the will as a whole, which, in my view, would serve to characterize the benefit as being a reward or payment for services rendered. On the contrary, the impression which I derive both from the gifts made by Mr Ogilvy in 1940 to employees of his company and from the whole tenor of the will is that this provision was simply one of his bounty to his employees as persons and not in any sense as remuneration for their services as employees. In this connection Jenkins, LJ, in his dissenting judgment in Bridges v Hewitt, [1957] 2 All ER 281, observed at page 291:

If, in response to the taxpayers’ representations, Mr Frank Hornby had in his lifetime transferred to each of them eight thousand shares in the company, it may be that such shares could in all the circumstances of the case, and on the principles laid down by the authorities to which I have referred, properly have been held to have been given by Mr Frank Hornby and received by the taxpayers as a present made in token of their long and successful business association with him, and not as remuneration. If Mr Frank Hornby had given the taxpayers substantial holdings of shares in the company by his will, as in effect he had promised to do, it seems Clear that such shares would have come to the taxpayers purely by an act of testamentary bounty on the part of Mr Frank Hornby wholly removed from the sphere of remuneration.

The lack of any wording in the will to couple the gift with services performed or to be performed for the company in the present case may be compared with the wording of the deed in Patrick v Burrows (1954), 35 TC 138 at 142, where the purpose to be achieved in making the appointment was expressed in the instrument creating the gift to be

.. . . the intention being that the said shares shall be available for distribution amongst any of the said employees of the Company to whom the Directors may from time to time deem it expedient to give an interest or an increased interest as shareholders in the Company in consideration of past or future services and with a view to promote the prosperity of the Company.

So there was here, as I see it, nothing about the will to characterize the benefit as remuneration for services.

Next, while it may conceivably have been open to the board of directors, had they seen fit to do so, in exercising the power given to them by the will, to give their sanction and approval in the case of some or all of the employees on terms that would have had the effect of characterizing the benefit as remuneration for services rendered or to be rendered to the company, I do not think what the board did had any such effect. It appears to me that what the board sanctioned and approved as a basis for distribution of the right was not the employer-employee relationship at all, even though the appointees had to fall within the class of employees, but an agreement among shareholders, to which the company was not a party. The agreement was not one in respect of their services to the company as employees but in respect of their shareholdings in the company and had been made for the purpose of ensuring continuing employee control of the company. This rather than a basis of rewarding service to the company was what the board adopted as the basis for distribution. The board’s action was as if it had said: “‘We approve the allocation of the right to persons who are parties to the agreement or who under like provisions may become parties provided that they become parties in respect of the shares to be purchased.” Further, while the scheme itself for distribution was based to some extent on service, since, in the agreement, years of service and salary and bonus earned were taken into account, I think that in the circumstances that is no more than the formula by reference to which distribution was made and that, in itself, it is ineffective to give the character of remuneration to the right allocated to the employees chosen pursuant to it. See The Glenboig Union Fireclay Co, Ltd v Commissioners of Inland Revenue (1922), 12 TC 427, and The Queen v Atkins, [1976] CTC 497; 76 DTC 6258. Moreover, while the board may have hoped or even thought that the employees to whom the right to buy shares was allotted would be encouraged thereby to stay in the company’s employ, that is a long way from making it a requirement.

Finally. from the point of view of employees, the right to purchase shares at par was not something they were entitled to under their contract of employment nor was there any service they were required by their contract to render for it either to the employer or anyone else. Nor was the employer the source of it. The only fact that, from their point of view, appears to support the defendant’s position is that only employees of Charles Ogilvy Limited were eligible as recipients, but that, in my opinion, is a mere sine qua non. It is a feature of the situation which tends to confuse but does not help to solve the problem. For, the provision having been restricted by the will to such employees, no one could benefit from it, either as a gift or as remuneration. if he were not an employee. Compare Bridges v Hewitt (Supra), per Morris, LJ at page 297:

But the question which arises is whether he received them as remuneration or aS a personal gift. In one sense Mr Bearsley received the shares by reason of his office. Had he not held the office he would not have had them. But that merely shows that he would not have had the shares (either as remuneration or as a gift) if he had not given many years of service to the company down to Dec 30, 1949.

I should add at this point that I do not see in the judgment in Laid/er v Perry, [1966] AC 16, anything that would avail to change the view I reach on the facts of this case since in that case the vouchers of £10 each received by the employees at Christmas were given to them by the employer and the essential question for decision was whether in the particular case the finding of the Commissioners that the vouchers were made available in return for services rather than as gifts was supportable in law.

On the other hand, the view I take appears to derive support from the view expressed by Morris, LJ in Bridges v Hewitt (Supra), when he said at page 299:

Where some payment, and particularly some non-recurring payment, is received from someone other than an employer, it will probably only have the attributes of remuneration in those classes of cases where it is reasonable to expect that remuneration would come from some other source than from the pocket of an employer.

On the whole I am of the view that the benefit here in question was conferred on Mr Phaneuf as a person rather than as employee, as a personal gift rather than as remuneration, and that it was not a benefit in respect of which the recipient was liable for income tax.

In view of this conclusion, it is unnecessary to further state or consider the other issues to which reference was made at the outset of these reasons.

At one point in the argument, counsel for the defendant also sought to justify the assessment under subsection 7(6) of the Act but, in my view, that provision has no application in the present situation and the point was not pressed.

The appeal accordingly succeeds and it will be allowed with costs. The reassessment will be referred back to the Minister for reassessment on the basis that Mr Phaneuf was not liable for income tax in respect of the benefit in question.