Payments Made to Employees for Surrendering Stock Options on Account of Capital

On November 10, 2011 the Federal Court of Appeal (FCA) released its decision in Imperial Tobacco Canada Limited v. The Queen, 2011 FCA 308.  The issue for the Court to determine was whether $118 million paid by the taxpayer to its employees and employees of its subsidiaries for surrendering stock options was on account of income or capital. 

At the Tax Court of Canada (TCC) the taxpayer argued that the amount of the payments was deductible from income on the basis that the payments were employee compensation.  The Minister argued that the payments were made on account of capital because they arose in the context of a capital reorganization of the taxpayer and extinguished all of the outstanding obligations of the company to issue shares.   

The TCC found that the facts before it were indistinguishable from those present in Kaiser Petroleum Ltd. v. The Queen, 90 DTC 6603 and as such the payments were made on account of capital.  In Kaiser, the FCA concluded that payments made to “eliminate extraneous shares or share possibilities” were made in respect of capital.      

The FCA in Imperial Tobacco agreed with the TCC that the facts present were sufficiently similar to Kaiser to merit a similar outcome.  As such, the TCC made no error that would justify the intervention of the Court.  The taxpayer’s appeal was dismissed.