http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/72963/index.do 
Mathieu v. The Queen (June 27, 2014 – 2014 TCC 207, Paris J.).
Précis: Michel Mathieu, his wife Doris Landry and son, Ken Mathieu controlled Forages Garant & Frères inc. Between 2004 and 2006 Michel received stock option benefits from Forages Garant totalling roughly $4.5 million. The first issue was whether he was related to Doris Landry during those years. They were married in 1972, separated in 1990, received a formal judgement of “separation as to bed and board” in 1993 and divorced in 2008. The Court held that the 1993 separation judgment did not sever the marital relationship for income tax purposes. As a result he did not deal at arm’s length with Forages Garant during the period in which the benefits were received. The second issue was whether even though he was not taxable under section 7 of the
Income Tax Act ( because he dealt at less than arm’s length with Forages Garant), did section 6 nevertheless apply to tax the options as employee benefits. The Court held that neither section 7 nor section 6 applied to the options; they were taxable under section 7 or not at all. The Court agreed this was a “loophole” but held it was not its role to remedy that loophole.
Decision: The taxpayer received stock option benefits totalling roughly $4.5 million in his 2004, 2005 and 2006 taxation years from Forages Garant & Frères inc. (Forages Garant). He claimed a deduction under paragraph 110(1)(d) of the
Income Tax Act which the Minister denied on the basis that he was dealing at less than arm’s length with Forages Garant:
[3] The remaining issues concern the 2004, 2005 and 2006 taxation years in which the appellant’s deductions under paragraph 110(1)(d) of the
Income Tax Act (the ITA) were disallowed. That provision allows a deduction of 50% of an employment benefit that is included in the taxpayer’s income under section 7 of the ITA, which provides for the taxation of stock options granted by an employer to an employee.
[4] A deduction under paragraph 110(1)(d) is only possible if the employer and employee are dealing with each other at arm’s length. In this case, the Minister found that the appellant and his employer Forages Garant & Frères inc. (Forages Garant) were not dealing with each other at arm’s length and disallowed the appellant’s deductions under paragraph 110(1)(d).
The corporation purchased options from the taxpayer in each of the taxation years under appeal:
[8] During the years at issue, the appellant was employed by Forages Garant. As an employee, he was eligible for Forages Garant’s stock option plan.
[9] In 2004, 2005 and 2006, Forages Garant issued notices to exercise stock options, and each year the appellant chose to have Forages Garant redeem his options.
[10] Forages Garant paid the following amounts to the appellant for buying his options:
2004 $1,117,594
2005 $2,037,379
2006 $1,401,630
There were two issues before the Court:
[5] The first issue is whether the appellant and Forages Garant were not dealing with each other at arm’s length, justifying the Minister’s disallowance of the deductions.
[6] If the Court decides that the appellant and Forages Garant were not dealing at arm’s length, the respondent and appellant agree that the benefits received by the appellant and resulting from the stock options are not taxable under section 7 of the ITA. Therefore, a second issue arises: should the value of the benefit received by the appellant each year be added to his income under paragraph 6(1)(a) of the ITA?
Forages Garant was controlled by a group consisting of the taxpayer, his wife Doris Landry and his son Ken. The arm’s length issue boiled down to the simple question whether he was related to Doris Landry for the purposes of the Act. If so, then he was a member of a related group that controlled the corporation and he would be deemed to deal at less than arm’s length with the corporation. The taxpayer took the position that he was not related to Doris Landry because they had been judicially separated for years prior to the purchase of the options:
[15] The appellant and Doris Landry stopped living together on October 1, 1990, and obtained a judgment of separation as to bed and board on September 29, 1993. The judgment ratified a [Translation] “draft agreement and agreement on corollary relief” between the appellant and Doris Landry dated May 17, 1993.
[16] The appellant and Doris Landry signed an agreement on corollary relief (the agreement) on January 10, 2008, whereby they stipulated that they had never gone back to living together and that wanted to make the [Translation] “effects of the dissolution of the matrimonial regime retroactive to the date when they ceased living together, namely, October 1, 1990”. The Superior Court of Québec ratified the agreement in the judgment of divorce dated March 27, 2008. The divorce took effect on April 27, 2008, and the certificate of divorce of the appellant and Doris Landry was issued on May 15, 2008.
After a thorough analysis of the underlying law the Court concluded that the judgment of separation did not negate the simple fact that they continued to be married until their divorce in 2008 and were deemed by the Act to be related until that date.
[44] Even though, in practice, a separation from bed and board reflects a permanent breakdown of the marriage, it does not, strictly speaking, break the marital bond and is not equivalent to a divorce: article 507 C.C.Q. reads as follows:
507. Separation from bed and board releases the spouses from the obligation to live together; it does not break the bond of marriage.
As stated by the Supreme Court of Canada in
Éric v. Lola,
87. . . . Since separation from bed and board — although it loosens the marital bond by releasing the spouses from the obligation to live together — does not terminate the marriage, it does not terminate the other effects of marriage . . . .
[45] In addition, it cannot be concluded, on the basis of the context of the ITA, that Parliament intended to exclude spouses separated from bed and board from the phrase “connected by marriage” found at paragraph 251(2)(a). When Parliament wanted to take into account in the ITA situations where spouses are still married but live separate and apart, it did so by using language such as “living separate and apart because of the breakdown of their marriage” in the definition of support amount in subsection 56.1(4), or “separated and living apart as a result of the breakdown of their marriage” at subsection 160(4). It also seems to me that, under subsection 251(6), due to the mere fact of being married, persons are connected by marriage.
[46] Finally, although neither the appellant nor the respondent has referred to the object of paragraph 251(1)(b) of the ITA, it seems to me that Parliament wanted to define certain categories of persons who, because of their relationships, are likely not to act in their best commercial interests. Parliament intended to create a rule that is simple to apply. It is not incompatible with this goal to include all married persons.
The parties were in agreement that if the taxpayer dealt at less than arm’s length with Forages Garant then section 7 did not apply to make the option purchases taxable. The question remained whether they were taxable as a benefit from employment under section 6:
[57] The appellant submits that the application of paragraph 6(1)(a) is precluded by paragraph 7(3)(a). Paragraph 7(3)(a) reads as follows:
(3) Special provision — If a particular qualifying person has agreed to sell or issue securities of the particular person, or of a qualifying person with which it does not deal at arm’s length, to an employee of the particular person or of a qualifying person with which it does not deal at arm’s length,
(a) except as provided by this section, the employee is deemed to have neither received nor enjoyed any benefit under or because of the agreement; and
Section 7 was amended in 2010 to make options to employees dealing at less than arm’s length with their employer taxable as benefits from employment:
(b.1) if the employee has transferred or otherwise disposed of rights under the agreement in respect of some or all of the securities to the particular qualifying person (or a qualifying person with which the particular qualifying person does not deal at arm’s length) with whom the employee was not dealing at arm’s length, a benefit equal to the amount, if any, by which
(i) the value of the consideration for the disposition
exceeds
(ii) the amount, if any, paid by the employee to acquire those rights
is deemed to have been received, in the taxation year in which the employee made the disposition, by the employee because of the employee’s employment;
The Crown, relying upon the Technical Notes to the amendment, argued that this amendment just “clarified” the pre-existing law. The Court rejected the Crown’s argument:
[84] In my view, the introduction of the new paragraph 7(1)(b.1) made a change to the ITA, not a mere “clarification”. First, the respondent is not disputing that the benefits received by the appellant are not taxable under section 7 (the version in effect during the years at issue), but she maintains that paragraph 6(1)(a) applies to include the benefits in the appellant’s income. However, there is an important difference between the application of paragraph 6(1)(a) and of the new paragraph 7(1)(b.1). Paragraph 6(1)(a) would add the benefit to the appellant’s income at the time when the stock option is granted, not when the right is disposed of, as paragraph 7(1)(b.1) now provides. Thus, the addition of paragraph 7(1)(b.1), at the very least, amends the time when the benefit is included in the employee’s income.
[85] Even more important is the effect of subsection 7(3) of the ITA, which is that section 7 is a complete code for the taxation of benefits received under stock options granted by an employer to its employee. Since the respondent does not dispute that, for the years at issue, section 7 did not apply to the benefits received by the appellant, it is clear that the addition of paragraph 7(1)(b.1) results in a change in section 7, not a clarification.
The fact that the former provision operated as a “loophole” was not something the Court could remedy for the Crown’s benefit:
[79] The respondent has not shown that there was an ambiguity at paragraph 7(3)(a) or at subsection 7(1) with regard to the benefits that Parliament chose to tax, and, in my view, the language used in these provisions is clear and unequivocal. The fact that the benefits received by the appellant will not be taxed is due to a loophole in the legislation, but it is not the role of the Court to interpret tax provisions in a way that protects the tax authorities.
The Court therefore concluded that the option proceeds were exempt from tax:
[89] In this case, the wording of paragraph 7(3)(a) is clear, and there is no need to resort to the presumption that its interpretation is likely to lead to absurd results.
[90] Hence, I conclude that the amounts received by the appellant from Forages Garant in relation to the stock option should not be included in the appellant’s income for 2004, 2005 and 2006.
As a result the appeal was allowed with costs to the taxpayer.