Focus On

Income Tax Act has paramountcy over regulations in share distribution case: Federal Court of Appeal

Tuesday, November 23, 2021 @ 9:23 AM | By Ian Burns


Lexis Advance® Quicklaw®
The Federal Court of Appeal has sided with Ottawa in a conflict over how to tax a share transfer from an Ontario-based company to its employees, ruling it should have been treated as income and not under the rules which govern prescribed trusts.

The case in McNeeley v. Canada 2021 FCA 218 involved the distribution of shares in Kitchener, Ont.-based D2L Corporation from a trust to several of the firm’s employees. Those employees treated the share distribution as a capital gain on the belief that the rules applicable to prescribed trusts under income tax regulations should apply, but the Canada Revenue Agency (CRA) reassessed them on the grounds that the trust constituted an employee benefit plan and therefore should have been treated as income. In Canada there is generally no special tax treatment for employment income, but capital gains amount to one-half of the tax rate on normal income.

And a unanimous Federal Court of Appeal sided with a lower court ruling which said that the trust was an employee benefit plan, so it could not also be a prescribed trust under income tax regulations (McNeeley v. Canada 2020 TCC 90). Justice Wyman W. Webb, who authored the court’s opinion, held the paramountcy of the Income Tax Act over the regulations must govern.

“Parliament could have provided that a prescribed trust is not an employee benefit plan. [The] definition of an employee benefit plan exclude[s] a number of arrangements and trusts from the definition of an employee benefit plan,” he wrote. “If Parliament had also intended to exclude prescribed trusts from the definition of an employee benefit plan, a reference to a prescribed trust could have been added.”

The court also rejected D2L executive John Baker’s arguments that distribution of the shares to him should not be considered to be distributions from an employee benefit plan on the basis that he did not receive these shares as an employee of D2L.

“No portion of this arrangement is excluded from the definition of an employee benefit plan. Therefore, there is only a single arrangement,” Justice Webb wrote. “All amounts received by a taxpayer out of or under an employee benefit plan are included in computing the income of that taxpayer from an office or employment.”

Pamela Cross, Borden Ladner Gervais LLP

Pamela Cross, a tax lawyer with Borden Ladner Gervais LLP in Ottawa, said it is “very difficult” to enter into arrangements which lead to capital gains treatment in the context of employment relationships because the Income Tax Act casts a fairly broad net on what employment income is.

“This case reaffirms the breadth of the employment rules and the fact that most income connected to your job is going to be taxed as employment income,” she said. “And if you are going to use trusts you are going to have to be very careful because if you try to do that you might get caught in the arrangement being considered an employee benefit plan, which means that the employees are no better off than they would have been had they just received employment income directly.”

Cross noted that capital gains normally involve an investment where a person has something at risk, which one of the reasons they are given preferential tax treatment.

“There is this element that you have invested in an asset and if that asset appreciates you should be somewhat compensated for that risk,” she said. “In this case I don’t think the employees had any of their own money invested — this appears to have been designed to provide them with compensation in the form of shares with the hope they would get capital gains treatment on it.”

CRA media officer Charles Drouin said in an e-mail that the confidentiality provisions of the Income Tax Act prevent the agency from commenting on the specific details of court cases, but it welcomed the decision because it “promotes fairness and is consistent with the need for all taxpayers to pay their fair share towards the benefits that all Canadians enjoy.”

“The courts provide Canadians with a further independent review of disputed issues, and publicly available information can be obtained from the Tax Court of Canada or the Federal Court of Appeal for any matters before the court,” he said.

Counsel for the appellants declined to comment on the case.

If you have any information, story ideas or news tips for The Lawyer’s Daily please contact Ian Burns at Ian.Burns@lexisnexis.ca or call 905-415-5906.