• by Lesley Singer
Originally published in the OFLM 2024-06 edition
Overview
This article reviews the recent decision of Walker v. Walker (2024 ONSC 198) and offers a discussion on imputing incomes in the context of stock options made available through employment remuneration.
This discussion includes a summary of the general principles that courts follow when imputing the income of a spouse who has not reasonably utilized property under s. 19(e) of the Federal Child Support Guidelines.
Introduction
(a)Overarching principles when imputing income for underutilized assets
As both child and spousal support are predicated on income, courts are sensitive to efforts to mask or understate income.
Section 19(1) of the Federal Child Support Guidelines, (“the Guidelines”) identifies circumstances where it may be appropriate to impute a spouse’s income. This article is concerned with those situations that fall under s.19(1)(e) of the Guidelines.
When a court imputes a party’s income, in general, the “amount to be imputed must … be grounded in the evidence" and "reasonable in the circumstances" (Michaud v. Kasali, 2016 ONSC 443, at paras. 48-49).
Particular to s. 19(1)(e) of the Guidelines, a determination of whether property has been ‘reasonably utilized’ is an objective test (Fielding v. Fielding, 2018 ONSC 5659 at para. 73). This objective test has "regard to the entire context, including the extent to which a spouse is in fact generating income from their assets" and the party seeking the imputation bears the onus of illustrating its reasonableness. On this point, s.19(1)(e) cannot be used merely to monitor “the manner in which a party manages his or her financial affairs, which is beyond the purpose of the provision, or the manner in which it has been judicially interpreted" (at para. 83).
While investment income is part of a payor’s total income, the underlying investments are not. Pursuant to s.19(1)(e), income that can be derived from capital may be imputed as income. However, a payor is generally not required to sell capital unless it is not being reasonably utilized to generate income (Bak v. Dobell, 2007 ONCA 304 at para. 52).
(b) A typical s.19(1)(e) scenario - failing to generate rental income
There is an abundance of cases where courts rely upon s.19(1)(e) of the Guidelines to impute a spouse’s income when a spouse could use his or her property to generate rental income.
For example, in Lefebre v. Lefebre (2020 ONSC 311), a spousal support recipient claimed she would be unable to generate income from renting out her cottage, from which she previously generated both modest and significant rental income. The recipient argued that she was not able to rent the cottage because she lacked a property manager and the cottage’s accompanying barn required some renovations. Taking issue with the recipient’s credibility, Justice Fryer rejected this alleged obstacle, stating that:
I do not accept that [the recipient] is unable to generate an income from the cottage property … It appears that [the recipient] only stopped marketing the cottage on various rental websites when she realized the [recipient] was going to introduce the evidence at trial (at paras. 353 & 355).
Thus, pursuant to s.19(1)(e), the cottage property was not reasonably utilized. The recipient’s income was imputed to the "rational and reasonable amount" of $15,000 in net income for the years that the cottage ought to have been rented out (at para. 361).
S.19(1) and its application to stock options
S.19(1)(e) of the Guidelines is also applicable to circumstances where a spouse has access to stock options through his or her employment remuneration package. When stock options are available, an employee can exercise (i.e., purchase) company shares, generally at a below-market price, which vest after a prescribed period. Once vested, the employee’s shares can be sold.
With this in mind, the court must weigh various factors to determine if it should impute income to the spouse for failure to exercise or sell his or her stock options. This query is central to Justice Audet’s recent decision, Walker v. Walker (2024 ONSC 198).
Differential treatment of income from stock options under the Guidelines and the Income Tax Act
Under the Income Tax Act, exercised stock options are not considered a form of income. It is only when the underlying shares are sold that those proceeds may go towards the payor’s income. (Walker, at para. 46)
On the other hand, pursuant to Schedule III and s. 13(1) of the Guidelines, once exercised, the value of the shares form part of the payor’s income for that respective year. The capital gains, realized upon the selling of the shares, go towards the payor’s income for the year they are sold.Accordingly, the cash value of those shares is deducted from the gains realized to avoid double-dipping(at para. 47).
Under s.19(1)(e), timing matters in the exercise and selling of stock options
While the timing for when to include income generated through stock options is clear under the Guidelines, there is ambiguity in whether “the payor should be left with complete discretion as to the timing for the exercise of available stock options or the sale of the underlying shares”.
There is a risk in granting a payor total discretion to determine when to sell stock options. That risk is that they can “choose whether and when to exercise stock options and delay the sale of the underlying shares (once vested) to defer compensation for many years and ‘shield income’ beyond the time when support terminates” (Walker, at para. 50).
The above situation arose in Patterson v. Patterson (2006 CanLII 53701 (ONSC), one of the seminal cases on underutilized stock options, which provided clarity to the Guidelines. In Patterson, the husband, through his employment, was entitled to annual, restricted shares that were held in trust for three years. Upon vesting, he could either leave the shares to generate trust income or take them out. The latter option would enable him to sell and realize a sizeable capital gain on the shares. Having decided to leave the shares in trust, the payor deferred sizeable income from his tax returns. Patterson is therefore a “selling” case.
A key component of the Patterson decision, according to Justice Audet, is that the payor’s intentional deferral of significant income was guaranteed to be available to him upon vesting.The court in Patterson rejected the payor’s argument that he was making an investment decision, noting that the only advantage in keeping the shares in trust was to shield his income. Since the payor’s shares were “reasonably available once vested and [were] within the [payor’s] control”, the court held that it “is fair to deem that he will exercise the shares as soon as they are vested” (Patterson, at para. 104).
Importantly, in Patterson, the court concluded that both the timing of a payor’s exercise of stock options and the sale of those underlying shares is relevant and can be considered under s.19(1(e) of the Guidelines. Stock options available to a payor can therefore be added to his or her income for support purposes the year they vest, even if neither exercised nor sold.
A guide to imputing income to a payor for unexercised stock options or unrealized shares
In Walker, Justice Audet held that the income of a payor with unexercised stock options or a payor who has failed to sell vested shares should not be automatically imputed. Rather, a careful, multi-factored analysis is required, in recognition of the fact that there may be valid reasons for the payor’s decision.Justice Audet, at paragraph 61, provides a detailed, non-exhaustive list of factors to consider for both stock option scenarios, including:
a. What are the terms pursuant to which stock options can be exercised?
b. Is the employee required to finance the purchase?
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d. Is there a requirement for the employee to pay a portion of the purchase price up front (in which case the employee must have immediate access to cash)?
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f. Would a reasonable person in the same circumstances exercise the stock options?
g. What was the employee/payor’s practice in relation to the exercise of stock options during the marriage? Has his/her practice changed post-separation? Is there a valid justification for such change? What would have likely happened if the family had remained intact?
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h. What are the terms upon which vested shares can be realized?
i. What are the restrictions, if any, associated with their sale?
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l. What are the reasons/justifications for the deferral? For instance, if company is not performing well and the shares would be sold at a low profit, a deferral might be reasonably justified;
The chief consideration in the sale of underlying vested shares is if valid reasons for the deferral of available compensation exists, or rather if the employee is intentionally attempting to minimize ongoing or prospective support obligations.
The nature of the support obligation may also be a key factor
Justice Audet affirms that without context-specific, valid reasons for doing so, a payor should not be permitted to delay readily available compensation at the expense of his or her children’s current needs and well-being.
In the context of compensatory-based spousal support, a payor who has exercised stock options may have a greater responsibility elect to immediately receive compensation once it becomes available. Poor market conditions, however, may justify a deferral.
Application of to the facts in Walker
In Walker, the payor had access to a Share Purchase Plan (“the Plan”) through his employment that would grant him “significant financial benefits, in the form of the cash value received at the time he exercises his stock options, in the form of dividends payable on Paid Shares, and in the form of capital gains he realizes when he sells the underlying shares in the manner permitted by the Plan” (at para. 49).
The payor, however, only partially exercised stock option from the Plan. In comparison to Patterson however, there was no indication the payor’s decision was “for the purpose of minimizing his support obligations”. On the contrary, Justice Audet found that the payor’s reasons for not fully exercising the Plan “made sense” and “provided a reasonable explanation for the financial decisions he made during those years” (Walker, at para 66). For example, the payor invested in real estate to build himself a new home and was unsure about his future financial situation given the ongoing litigation with the recipient.
Given this, Justice Audet did not impute additional income to the payor under s.19(1)(e) to account for either his unexercised stock options or for the capital gains the payor would have realized upon selling his vested shares. The court gave weight to the fact that the company, who employed the payor, required employees to come up with 1/3 of the stock option purchase price. Furthermore, significant restrictions were imposed on an employee’s ability to sell the shares.
Instead, the court imputed the payor’s income only to reflect the cash value of the stock options that he did exercise in the year that they were purchased. With respect to future sales of any underlying shares, those capital gains would be added to his income for support purposes the year that they would be sold.
Conclusion
Under S.19(1)(e) of the Guidelines, courts are empowered to impute income for underutilized stock options for support purposes. Under the Guidelines, stock options become part of a payor’s income as soon as they are exercised, which unfortunately incentivizes some to shield their income. This is why courts can consider the timing of the exercise and selling of stock options and can add income to the year they vest, even if never exercised.
The factors set out in Justice Audet’s Walker decision provide courts with a thorough and helpful roadmap towards determining the reasonableness of imputing income related to stock options. Therefore, the support payor will need to offer up credible explanations for not realizing available income. Conversely, payors will need to show circumstances where it is objectively prudent or financially difficult not to pull the trigger and exercise their available stock options.