A-15-74
Nathan Bernstein (Appellant)
v.
Minister of National Revenue (Respondent)
Court of Appeal, Ryan and Le Dain JJ. and Hyde
D.J.—Montreal, March 9; Ottawa, May 16, 1977.
Income tax — Calculation of income — Companies —
Stock option benefits to employees Election re averaging
Whether scheme for appropriating undistributed profits —
Income Tax Act, R.S.C. 1952, c. 148, s. 85A.
The Minister, in re-assessing the income of the appellant,
president of a corporation, denied him the right to apply the
provisions of section 85A of the Income Tax Act, concerning
stock benefits to the appellant as an employee of the company.
The sum of $99,800 was thereby added to the appellant's
income for the taxation year 1964. The Trial Division dismissed
the appellant's appeal from this assessment.
Held, the appeal is dismissed. Although the judgment of the
Trial Division might imply that an employee who was a con
trolling shareholder could not qualify for the election provided
in section 85A(2), this is not the case. All the factors surround
ing the granting of the benefit by the corporation must be taken
into consideration. When it is evident that the options were
granted because the employees were shareholders, they cannot
qualify.
INCOME tax appeal.
COUNSEL:
Bruce Verchère and S. Sweibel for appellant.
Alban Garon, Q.C., and Jean Paul Fortin,
Q.C., for respondent.
SOLICITORS:
Verchère & Gauthier, Montreal, for appel
lant.
Deputy Attorney General of Canada for
respondent.
The following are the reasons for judgment
rendered in English by
HYDE D.J.: Appellant (Bernstein) has appealed
from a judgment of the Trial Division [[1973]
F.C. 1305] which dismissed his appeal from his
assessment for the year 1964 under the Income
Tax Act, R.S.C. 1952, c. 148.
The dispute arises from the election by Bern-
stein as to the manner in which a stock option
benefit, amounting to $99,800, received by him in
1964 should be taxed as provided in section 85A of
the Act. The arithmetic by which the contested tax
is arrived at is not in question but only the right of
Bernstein to make the election provided for in
subsection (2) of section 85A.
Bernstein was both an employee and a share
holder of Highland Knitting Mills Inc. (High-
land) in fact he was the President of the Com
pany and beneficial owner of fifty per cent of its
capital stock, the other fifty per cent being benefi
cially owned by one Kamichik its Vice-President
and Secretary-Treasurer.' Bernstein and Kamichik
incorporated Highland in 1956 to take over their
unincorporated partnership business of manufac
turing and distributing knitted clothing—a suc
cessful operation as indicated from its increase in
sales from $350,000 in 1956 to $1,100,000 in
1964.
By a complicated series of transactions High
land acquired 20,000 5% non-cumulative non-vot
ing redeemable preferred shares of a wholly owned
subsidiary corporation, Berkam Investments Lim
ited (Berkam), at the par value of $10 each in
October 1964. 2 On November 23, 1964 Highland
gave Bernstein and Kamichik each the option to
purchase 10,000 of Berkam preferred shares for
the sum of $200 which option they each exercised
on December 11, 1964.
' The record only shows Kamichik as Secretary-Treasurer
but Stanley S. Rosan C.A., the auditor of Highland Knitting
Mills Inc. and principal witness called by Bernstein at trial,
during cross-examination on being asked what office he held in
1960 replied "I would imagine he was Vice-President, I think
he was also Vice-President and Treasurer" (transcript p. 172).
2 As the various steps in this series are material to this case I
give the Trial Judge's account [[1973] F.C. 1305 at pp.
1307-08]:
Some time in September 1964 they acquired the charter of a
company known as Salbron Investments Limited which had
been incorporated under a Quebec charter on December 2,
1963 but which had never commenced operations. Its author
ized capital consisted at the time of 9,900 5% non-cumulative
non-voting redeemable preferred shares of the par value of
$10 each. They obtained supplementary letters patent dated
September 11, 1964 increasing the capital by creating an
additional 11,000 5% non-cumulative non-voting redeemable
preferred shares of the par value of $10 each and changing
On December 14, 1964 Berkam redeemed these
preferred shares so that Bernstein received $100,-
000 for an outlay of $200 or the substantial benefit
of $99,800—the basis of the disputed assessment.
The issue on appeal is whether the stock option
benefit received by the appellant is one contem
plated by section 85A, and the appellant is, there
fore, entitled to elect the special calculation of tax
provided for by subsection 85A(2) ' .
the name of the company to Berkam Investments Limited,
hereinafter referred to as "Berkam". At a meeting of High
land on October 28, 1964 it undertook to subscribe for 94
common shares and 20,000 of the said preferred shares of
Berkam at their par value of $10 a share and to pay for all
these shares so subscribed for, as well as for the six common
shares which had been allotted and issued to the three
original applicants for incorporation. The company borrowed
the money from its bank to pay for these shares, a cheque for
$201,000 being issued by Highland in favour of Berkam,
which cheque was dated October 26, 1964 but not date-
stamped by the bank until December 4, 1964.
On November 23, 1964 Highland gave an option to each
of Messrs. Bernstein and Kamichik to purchase from it
10,000 of the said preferred shares for the price of $200 and
by letters dated December 11, 1964 they each took up this
option and the same day a meeting of Berkam approved the
transfer from Highland to them of the said shares. On
December 14, 1964 Berkam approved a by-law providing for
the redemption and cancellation of 20,000 of its said pre
ferred shares. This was duly approved at a special general
meeting of shareholders the same date and supplementary
letters patent were obtained on December 16, 1964 confirm
ing the reduction of the capital of Berkam by the cancella
tion of the said shares so that the capital would thenceforth
consist of 900 preferred shares and 100 common shares of
the par value of $10 each. At all meetings of both companies
from the time Highland acquired the shares in Berkam it was
Messrs. Kamichik and Bernstein who attended and formed
the quorum of directors or shareholders as the case may be.
'85A....
(2) Where a benefit is deemed by paragraph (a), (b), (c) or
(d) of subsection (I) to have been received by an employee by
virtue of his employment in a taxation year, the employee shall,
if he so elects, pay as tax for the year under this Part, in lieu of
the amount that would otherwise be payable, an amount equal
to the aggregate of
(a) the tax that would be payable by the employee for the
year under this Part if no benefit were so deemed to have
been received by him in the year, and
(b) the amount, if any, by which
(i) the proportion of the benefit so deemed to have been
received that the aggregate of the taxes that would have
been payable by the employee under this Part for the 3
years immediately preceding the taxation year (before
making any deduction under section 33, 38 or 41), if no
(Continued on next page)
His original assessment of June 28, 1965 was
made on the basis of this election but by notice of
re-assessment dated June 25, 1969 he was re
assessed and denied the right to make such elec
tion so that the sum of $99,800 was added to his
ordinary taxable income for 1964. He filed an
objection but the re-assessment was confirmed and
his appeal to the Federal Court was dismissed in
the Trial Division—hence the present appeal.
The re-assessment was based on subsection (7)
of section 85A which reads:
85A....
(7) This section does not apply if the benefit conferred by
the agreement was not received in respect of, in the course of or
by virtue of the employment.
Appellant's principal attack on the judgment
appealed from is directed against the reasoning [at
page 1325] that:
... appellant and Mr. Kamichik were the sole shareholders as
well as being bona fide employees and that in their capacity as
sole shareholders of Highland they caused it to so act as to
confer a benefit on them which, although stated to be conferred
by virtue of their employment, was in actual fact received by
them in consequence of their being able as sole shareholders of
the company to so control its actions as to cause this benefit to
be paid. It was not, therefore, received by virtue of their
employment within the meaning of section 85A(7) but rather
by virtue of their being shareholders of the company with the
result that section 85A cannot be used in the case of appellant
as an exception preventing the application of section 137(2)
and section 8(1)(c) of the Act. The appeal is therefore dis
missed with costs. [Underlining mine.]
Read out of context this might imply that an
employee who was a controlling shareholder could
not qualify for the election provided in subsection
85A(2) which I do not consider to be so. All the
factors surrounding the granting of the benefit by
the corporation must be taken into consideration.
One of these factors is certainly that Bernstein
and Kamichik were the sole shareholders, each for
one half. But that is not enough by itself given the
(Continued front previous page)
benefit were deemed by paragraph (a), (b), (c) or (d) of
subsection (1) to have been received by him in those years,
is of the aggregate of the employee's incomes for those
years minus the benefit deemed by paragraph (a), (b), (c)
or (d) of subsection (1) to have been received by him in
those years,
exceeds
(ii) 20% of the amount of the benefit so deemed to have
been received.
fact that they were also the most important
employees.
For reasons not explained while Bernstein and
Kamichik each received salaries of $17,000 in
1963, in 1964 Bernstein's was $34,000 while
Kamichik's was only $18,000, and still the stock
option benefit was conferred on them equally.
Moreover, this transaction required the appro
priation of a substantial part of Highland's earned
surplus on which tax had been paid. Compared
with a salary or bonus adjustment, which would
have been a deductible expense to the company, it
was from that point of view not in the company's
interest but designed, taxwise, particularly tc
favour the recipients. While it is true that Bern-
stein and Kamichik had rendered most valuable
services there were other employees who, if there
had been no share control, might reasonably have
been expected to participate in such an important
employee benefit arrangement. For example Mr.
Rosan (transcript p. 223) testified that there were
three long-term employees who had been with
Messrs. Bernstein and Kamichik since 1950 or
earlier, before the business was incorporated, who
in 1964 were receiving comparatively modest sal
aries of $7,000 a year.
Furthermore, Highland was obliged to borrow
from its bankers to provide the $200,000 it paid
Berkam for its preferred shares which loan was
repaid on January 8, 1965 with loans from Bern-
stein and Kamichik of an equal amount against
which they each received from Highland promisso
ry notes of $100,000. Although these notes bore
interest at 6% per annum, Mr. Rosan testified that
this interest was waived by Messrs. Bernstein and
Kamichik.
As subsection (7) of section 85A indicates, the
exception provided for stock option benefits is that
they be received as employees not as shareholders.
That an employee may incidentally be a share
holder does not disqualify him but when it is
evident, as 1 believe it has been shown to be the
case in this instance, that the options were granted
because these employees were shareholders—in
fact the only ones they cannot qualify.
Obviously, the self-serving statement in the
option agreement (Ex. Mc vol. I, p. 70) that the
benefit is conferred on Bernstein "in respect of and
by virtue of his employment" does not establish
that as a fact. When one reads Rosan's testimony
(particularly pp. 183 to 232) it is clear that the
two partners did not want to take the surplus
earnings out of the company through dividends in
the normal way because of the tax impact and that
this scheme was devised by Mr. Rosan, with legal
advice, to accomplish indirectly what they did not
wish to do directly.
I believe that the factors I have noted are suffi
cient to show that appellant Bernstein does not
escape the proviso of subsection (7) of section 85A.
I would dismiss this appeal with costs.
* * *
RYAN J.: I concur.
* * *
LE DAIN J.: I concur.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.