Federal Court of Appeal decision


On May 24 2012 the Supreme Court of Canada dismissed the taxpayer's application for leave to appeal in Imperial Tobacco Canada Limited v The Queen. The Federal Court of Appeal decision should now be viewed as the final word on the matter.(1) The Federal Court of Appeal had upheld the Tax Court of Canada decision, which had concluded that the amounts paid by the taxpayer, Imasco, to the holders of employee stock options in consideration for the surrender or termination of those options were on capital account and were not tax deductible (for further details please see "Stock option surrender payments made on going-private transaction non-deductible").


As part of a going-private transaction, Imasco had accelerated the vesting of options under its employee stock option programme, so that all options became exercisable before completion of the transaction. In addition, Imasco amended the stock option programme to give the option holders discretion to surrender their options, instead of exercising them. If an option holder surrendered his or her options, he or she would receive a cash amount equal to the so-called 'in the money' value of the options; the options in question would then be cancelled. These amendments to the programme were conditional on completion of the underlying going-private transaction. Before the closing of the transaction, all of the outstanding stock options issued under the stock option programme were either exercised or surrendered and cancelled. The stock option surrender payments were substantial, totalling approximately C$118.6 million.

Imasco had argued that the stock option surrender payments were tax deductible as a current expense related to employee compensation. The Canada Revenue Agency took the position that they were expenditures of a capital nature, made in the context of Imasco's capital reorganisation; accordingly, the payments were not tax deductible.

Federal Court of Appeal decision

In support of its position, the Canada Revenue Agency focused on an earlier decision of the Federal Court of Appeal in Kaiser Petroleum Ltd v The Queen,(2) which found that the company's payment to extinguish employee stock options was a non-deductible capital payment. The critical finding in Kaiser was that the payments were made in conjunction with the company's capital restructuring.

On the other hand, Imasco focused its argument on the more recent Tax Court decision in Shoppers Drug Mart.(3) This decision arose from a related aspect of Imasco's going-private transaction. At the time, Imasco was the parent company for Shoppers Drug Mart, which had reimbursed Imasco for payments that it had made to Shoppers Drug Mart employees in exchange for the surrender of their options under the stock option programme. The reimbursement payment was held to be tax deductible to Shoppers Drug Mart on the basis that it did not pertain to a capital restructuring of the company and that such reimbursements provided no enduring benefit to it.

The Federal Court of Appeal found that the amounts paid by Imasco in conjunction with the termination of the stock option programme were governed by the Kaiser decision and therefore represented non-deductible capital expenses. In its reasons, the court was not swayed by Imasco's argument that the increasingly prevalent practice of compensating employees through the use of stock options should necessarily result in the payments at issue being classified as a current expenditure. Rather, the court based the non-deductible nature of the payments on three factors:

  • The payments coincided with a reorganisation of Imasco's share capital. The court focused on the fact that Imasco had implemented a going-private transaction and, as part of this transaction, had subsequently amalgamated with the acquisition company formed to complete the transaction.
  • The payments at issue were intended to facilitate the capital reorganisation.
  • The payments terminated Imasco's future obligations under the stock option programme, which the Federal Court of Appeal described as a "once and for all" payment that resulted in an enduring benefit to Imasco. The characterisation of the payment as "once and for all" and as creating an "enduring benefit" to the company indicated the traditional judicial hallmarks of a non-deductible capital payment.(4)

The Federal Court of Appeal noted that two factors supported Imasco's tax-deductible treatment of the stock surrender payments. First, the stock option programme was a longstanding form of compensation to Imasco's employees and had for many years contemplated periodic surrenders of stock options. Second, the shares represented by the surrendered options represented only a small proportion of Imasco's issued shares. Presumably, the implication was that the shares being issued under the stock option programme were not a significant component of Imasco's share equity and would not have been the critical focus of the proposed changes to Imasco's capital structure. However, the court found that these two factors could not outweigh a finding that the payments at issue were outlays on account of capital.

Overall, the stock surrender payments made by Imasco were deemed to be capital payments and were not tax deductible pursuant to Paragraph 18(1)(b) of the Income Tax Act (Canada).


Unfortunately, having denied Imasco leave to appeal, the Supreme Court of Canada will not be providing its perspective on the tax deductibility of the stock option surrender payments.

The Federal Court of Appeal decision provides clear guidance that a payment made to cancel a grant of an employment stock option, if that payment is made in the course of the taxpayer's capital reorganisation, will not be a deductible expense to the taxpayer. Furthermore, the court rejected the contention that the increased use of stock option plans in current business practice should automatically cause such stock option surrender payments to be classified as ordinary employment compensation eligible for a tax deduction.

However, the court did not conclusively enumerate the circumstances that must be established in order for the stock option surrender payment to be a current business expense that would be tax deductible according to the reasoning of the Shoppers Drug Mart decision. The Federal Court of Appeal acknowledged that:

"[it] is arguable that a payment made by a corporation on the surrender of an employee stock option is employee compensation, and therefore deductible by the corporation, if it is one of a number of like transactions undertaken as part of the day to day interaction of the corporation with its employees."

Taxpayers would need to thoroughly analyse their facts and circumstances to ensure that there was no hint of a capital restructuring, as was found to exist in Kaiser and in the present case.

Even if the stock surrender payment were tax deductible to the corporation, a competing consideration is whether the corporation would now want to file an election under the recently enacted Section 110(1.1) of the Income Tax Act and thereby forgo the deduction. Pursuant to Paragraph 18(1)(m) of the Income Tax Act, the employer cannot claim a tax deduction if it files an election under Section 110(1.1) in respect of stock option surrender payments made to its employees.(5) The motivation for filing the election under Section 110(1.1) is that the amounts paid to the employees should still be eligible for the 50% stock option deduction under Paragraph 110(1)(d) of the Income Tax Act, provided that the general conditions of Section 110(1)(d) are satisfied. Many employees would expect that their choice to receive the stock surrender payments in lieu of shares under the stock option agreement would not limit their eligibility for the Paragraph 110(1)(d) deduction. Accordingly, the ability of a company to deduct stock surrender payments from its taxable income may become irrelevant when compared to its employees' competing desire to minimise their personal taxation on the cash receipts.

For further information on this topic please contact Daniel Lang at Borden Ladner Gervais LLP by telephone (+1 416 367 6000), fax (+1 416 367 6749) or email ([email protected])


(1) Imperial Tobacco Canada Limited v The Queen, 2011 FCA 308.

(2) 90 DTC 6603, [1990] 2 CTC 439.

(3) Imperial Tobacco Canada Limited (Successor to Amalgamation to Shoppers Drug Limited) v The Queen, 2007 TCC 636.

(4) The principle is derived from British Insulated and Helsby Cables Ltd v Atherton (1925), [1926] AC205 (UK HL).

(5) Subsection 110(1.1) had not been enacted at the time that the Imasco and Shoppers Drug Mart transactions took place.