Share Compensation Taxable as Business Income When Receivable

Under accrual accounting, which is required for business and property income, amounts become relevant to the computation of income and cost when they become receivable. The time at which amounts are receivable is a critical timing issue in computing the business or property income of accrual-basis taxpayers, especially amounts to be paid in foreign currency or with property other than money. The standard test is that “for an amount to become receivable in any taxation years, two conditions must coexist: (1) a right to receive compensation; (2) a binding agreement between the parties or a judgment fixing the amount” (Maple Leaf Mills Ltd. v. MNR, [1977] 1 SCR 558). Further, this right must be “clearly legal, though not necessarily immediate” (MNR v. John Colford Contracting Co. Ltd., 60 DTC 1131 (Ex. Ct.)).

These principles were applied to somewhat unusual facts in Lockwood Financial Ltd. (2020 TCC 128). In 2010, Lockwood assisted in brokering a farm-in agreement between its client, LEO, and another corporation, AOI. Pursuant to the agreement, a portion of the fee payable to Lockwood (once LEO reached certain expenditure targets) was to be paid in LEO common shares with an agreed-on value of $250,000, issued to Lockwood. A subsequent corporate acquisition and legal action resulted in this obligation being settled in 2012 by AOI issuing its shares (instead of LEO shares) to Lockwood. Those shares were disposed of in the same taxation year.

The main issue before the TCC was when the shares became receivable: in 2010 or 2012. Following the two-part Maple Leaf Mills test, the TCC held that the shares would be “receivable” when Lockwood had a clear legal, albeit not immediate, right to receive them, and the number of shares to be received was fixed pursuant to an agreement or a judgment. The shares were not receivable in 2010 because there was no evidence that LEO had met its expenditure targets at that time, and thus the conditions precedent were not satisfied. The TCC also found that the agreement did not fix the amount purportedly receivable by Lockwood, since the agreement specified only a maximum, but not a minimum, number of shares to be issued.

The TCC further held that the issuance of shares to Lockwood was business income. The shares were payment for services rendered, with the amount of income realized equalling the value of the shares on the date the shares were receivable. The TCC found that the AOI shares received by Lockwood in 2012 were intended to replace the LEO shares under the agreement. As a result, the value of the AOI shares on the issue date was included in Lockwood’s business income in 2012. Lockwood had cost in its AOI shares equal to the business income inclusion pursuant to subsection 52(1), and therefore the capital gain was reduced from the amount that Lockwood had reported.

Both of these findings were adverse to the taxpayer. Lockwood’s position had been that the LEO shares were receivable in 2010 and, as a result, $250,000 would have been included in business income at that time pursuant to paragraph 12(1)(b). This $250,000 amount would also have been the cost of the AOI shares. Further, the amount by which the value of the AOI shares eventually received exceeded $250,000 would have been a capital gain realized at the time the AOI shares were sold. The timing difference was relevant to the computation of the taxpayer’s income. If the court had found that the shares were receivable in 2010, it would have resulted in reduced business income in 2010 and a larger capital gain in 2012.

Vanessa M. Zuchetto
Felesky Flynn LLP, Calgary
vzuchetto@felesky.com


Canadian Tax Focus
Volume 11, Number 1, February 2021
©2021, Canadian Tax Foundation