Delimiting the Concept of Income:
The Taxation of In-Kind Benefits
Kim Brooks*
that employees must be
The issue of which in-kind benefits should be
taxed and how these benefits should be valued have
legislators,
concerned
tax
and
academics since
the introduction of the personal
income tax system. Building her theoretical analysis on
the income concept advanced by Henry Simons and
relying on traditional tax policy notions of equity,
neutrality, and administrative practicality, the author
asserts
taxed on
employer-provided in-kind benefits. To this effect, the
article offers guidelines for distinguishing between
taxable in-kind benefits and non-taxable conditions of
employment. The author argues that the correct method
of valuation of in-kind benefits is their fair market
value, rather than the cost to the employer or the
subjective value of the benefit to the employee. The
article
inconsistencies,
inequities, and inefficiencies that have resulted from the
manner in which Canadian
tax administrators and
courts have delineated taxability of in-kind employee
benefits. Discussing
as
educational
courses,
clothing,
subsidized parking, and discounts on goods and
services, the author makes suggestions that may be
utilized to develop a matrix of detailed and consistent
rules on the
taxability of these and others in-kind
benefits.
such
employee
in-kind benefits
proceeds
by
revealing
administrators,
fully
trips,
Depuis l’av~nement du syst~me d’imp6t sur les
revenus de particuliers, les 16gislateurs, administrateurs
et academiciens se soucient des questions pos6es par
l’imposabilit6 et l’6valuation des prestations non-
finaci~res. Dans cet article, l’auteur affirme que les
employ6s doivent
re compltement impos6s sur les
prestations non-financi~res offertes par l’employeur.
Elle fonde son analyse th6orique sur le concept de
revenu d6velopp6 par Henry Simons et a recours aux
notions traditionnelles de politique fiscales telles que
l’6quit6, la neutralit6 et la praticabilitd administrative.
Cet article offre un cadre grface auquel peut se faire une
distinction entre bendfices imposables et conditions
d’emploi non imposables. L’auteur soutient que la
m6thode d’dvaluation appropri6e est la valeur sur le
marchd plut6s que le coot pour l’employeur ou la valeur
subjective de la prestation pour l’employ6. L’article
r6v~le 6galement des incoh6rences, des in6galit6s et des
pertes rsultant de la mani~re dont les autorit6s fiscales
et les cours canadiennes ont d61imitd l’imposabilit6 des
prestations non-financi~res offertes aux employ6s.
L’auteur examine des b6n6fices tels que les cours, les
voyages, les vetements, le stationnement subvention6
et les rabais sur les biens et services, et offre des
suggestions qui pourraient servir A d6velopper une
matrice
sur
l’imposabilit6 des prestations non-financi~res.
r6glementaire d6taill6e et cohrente
. B.A. (University of Toronto), LL.B. (University of British Columbia), LL.M. (Osgoode Hall Law
School), Assistant Professor of Law, Queens University. Thanks to Lisa Philipps, David G. Duff, and
two anonymous reviewers for their thoughtful comments. Thanks also to Carson M. Coughlin and
Amy Kaufman for their helpful research assistance.
McGill Law Journal 2004
Revue de droit de McGill 2004
To be cited as: (2004) 49 McGiU L.J. 255
Mode de r6f~rence: (2004) 49 R.D. McGill 255
256
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
Introduction: Kleinwaichter’s Conundrum-ls Attending the
Opera with Your Employer a Condition of Employment or a
Taxable In-Kind Benefit?
I. The Importance of Taxing In-Kind Benefits
A. Horizontal Equity
B. Vertical Equity
C. Neutrality
D. Administrative Practicality
E. Social Policy Considerations
II. Determining the Boundaries of Taxable In-Kind Benefits
A. Equity
B. Neutrality
C. Administrative Practicality
D. Occasionally Referred to but Inappropriate Guidelines
III. Determining the Value of Taxable In-Kind Benefits
IV. Evaluation of Present Law and Practice
A. Educational Courses Leading to a University Degree
B. Combined Employment-Related and Pleasure Trips
C. Clothing
D. Subsidized Parking
E. Trips Taken with Frequent Flyer Points
F Discounts on Goods and Services
Conclusion: Confounding Kleinwaichter-Delimiting the
Concept of Income
257
260
261
264
266
267
268
268
269
272
272
273
275
279
279
285
290
293
297
302
305
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
257
in every direction
That it should be possible to delimit the concept [of
income] precisely
to be
expected. The task rather is that of making the best of
available materials; … one devises tools of analysis which
are useful, if crude; and a tax base may be defined in such
manner as to minimize obvious inequities and ambiguities.
Such at least is the present task.
is hardly
Henry C. Simons’
Introduction: Kleinwachter’s Conundrum-Is Attending the Opera
with Your Employer a Condition of Employment or a Taxable In-
Kind Benefit?
In his classic contribution to the intellectual development of the idea of a
comprehensive income tax base, Personal Income Taxation: The Definition of Income
as a Problem of Fiscal Policy,2 Henry Simons disparaged utilitarian attempts to define
income by reference to notions of sacrifice, faculty, or ability to pay. Instead, to
reduce opportunities for the government to meddle in the allocation of resources, but
at the same time to make the income tax a more effective policy instrument for
redistributing income earned in market transactions, Simons proposed that income be
defined simply as “the algebraic sum of (1) the market value of rights exercised in
consumption and (2) the change in the value of the store of property rights between
the beginning and end of the period in question.”‘ Simon’s book was his attempt to
show that based upon this formulation, a practical, conceptually coherent, and
equitable income tax base could be enacted. His formulation is now widely accepted
as the point of reference for the design of a comprehensive income tax base.’
Simons correctly anticipated that despite the practical value of his definition, the
scope and limits of both of its components would be contentious In recent years, tax
‘Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (Chicago:
University of Chicago Press, 1938) at 43.
‘Ibid.
3Ibid. at 50.
4 Most notably, Canada’s Royal Commission on Taxation used Henry Simons’ work as the baseline
for the development of a comprehensive income tax base in 1967. See Canada, Report of the Royal
Commission on Taxation, vol. 1 (Ottawa: Queen’s Printer, 1966) at 9-10 (Chair: Kenneth LeM.
Carter) [Carter Report].
‘ At the outset of his treatise, Simons admits that it will not be possible to “define, establish, or
adhere” to an ideal tax base (supra note 1 at 30). He adds, however, that “[a]lthough personal income
is not amenable to precise definition, it has, by comparison to the concept of social income, a much
258
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
policy analysts have grappled, in particular, with the second part of Simons’
definition-that income includes “the change in the value of a taxpayer’s store of
property rights.” The impracticality of determining this value annually has led all
countries to tax income only when a change in the value of assets has been realized.
This concession to Simons’ definition is so significant that it has been referred to as
the Achilles’ heel of the income tax,6 and has led many public finance scholars to
advocate the fairness, efficiency, and administrative advantage of a consumption over
an income tax. This paper, however, focuses not on this second part of Simons’
definition, but rather on the first part-the “market value of rights exercised in
consumption.”
Simons conceded that the problem of defining the value of a taxpayer’s personal
consumption posed theoretical difficulties when dealing with such forms of income as
the utility of leisure time, the imputed income from self-performed services, and the
ownership of consumer durables.7 In particular, Simons notes that determining the
market value of rights exercised in consumption by employees who receive in-kind
benefits presents intractable difficulties. In illustrating this point, Simons referred to a
German author, Friedrich Kleinwichter, who, Simons reports, “endeavors to discredit
the whole concept of income by pointing out that some arbitrary delimitations are
unavoidable” and “confounds himself and his reader with interesting conundrums
having to do mainly with income in kind.”8 The problem of imposing tax equitably on
an ordinary military officer as compared to a Flflgeladjutant (a regimental aide-de-
camp) to the sovereign is the most memorable of Kleinwichter’s conundrums
recounted by Simons. Although both receive the same cash salary, the Fifigeladjutant
“receives quarters in the palace, food at the royal table, servants, and horses for sport.
He accompanies the prince to theatre and opera, and, in general, lives royally at no
expense to himself and is able to save generously from his salary.”9 Simons
complicates the problem by asking us to suppose that the Fliigeladjutant detests opera
and hunting.’ He laments that the problem this example poses to equitable taxation
smaller degree of ambiguity. Its measurement implies estimating merely the relative results of
individual economic activity during a period of time” (ibid. at 49).
6 William D. Andrews, “The Achilles’ Heel of the Comprehensive Income Tax” in Charles E.
Walker & Mark A. Bloomfield, eds., New Directions in Federal Tax Policy for the 1980s (Cambridge,
Mass.: Ballinger Publishing, 1983) 278.
‘However, for a whole host of administrative and political reasons, these kinds of income would
likely not be subject to tax under even the most comprehensive tax base. See Boris I. Bittker, “A
‘Comprehensive Tax Base’ as a Goal of Income Tax Reform” (1967) 80 Harv. L. Rev. 925 [Bittker,
“Comprehensive Tax Base”].
6 Simons, supra note 1 at 43, n. 3.
Ibid. at 53. For a translation of Kleinwdichter’s discussion of the position of this officer to the
sovereign, see Friedrich Kleinwdichter, Das Einkonmen und Seine Verteilung (Leipzig: C.L.
Hirschfeld, 1896) trans. by Hannelore McDowell (copy available in the Wake Forest University Law
School Library) at 6.
‘0 Kleinwachter also offers this complication. See Kleinwachter, ibid. at 8.
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
259
“is clearly hopeless”. He states that “[t]o neglect all compensation in kind is obviously
inappropriate. On the other hand, to include the perquisites as a major addition to the
salary implies that all income should be measured with regard for the relative
pleasureableness of different activities-which would be
the negation of
measurement.”” Given this perceived dilemma, Simons finesses the problem of
distinguishing taxable from nontaxable in-kind benefits by suggesting that minimal
amounts of in-kind compensation are provided to individuals, and that the in-kind
compensation that is provided might be assumed to vary in a “continuous manner
along the income scale”.'” Simons reiterates this excuse for the nontaxation of many
in-kind benefits no less than three times in his book.” In his extended discussion of
the taxation of income in kind, Simons adds to his list of reasons for the nontaxation
of in-kind income the fact that it might be taken to offset the noninclusion of income
from leisure activities.”
relationships-whatever
Over sixty-five years after the publication of Simon’s book, the taxation of in-
kind benefits remains one of the most enduring problems in fashioning an equitable,
efficient, and administrable income tax. The proposition that taxpayers should have to
include in their income the value of in-kind benefits received as a result of their
employment
take-seems
uncontentious. However, problems arise in deducing the basic principles that might be
used to define “rights exercised in consumption” and in giving the appropriate weight
to the interests of equity, neutrality, and administrative practicality in formulating
detailed rules. The purpose of this paper is not to resolve Kleinwichter’s conundrum
but to continue Simons’ project of delimiting the concept of income by attempting to
formulate reasonable guidelines for taxing in-kind benefits that will “minimize
obvious inequities and ambiguities.”‘”
receipt might
form
the
In developing and applying guidelines for taxing in-kind employee benefits, this
paper proceeds as follows. Part I argues that in-kind benefits should be taxed because
taxing them is in line with the evaluative criteria of traditional tax policy: equity,
neutrality, and administrative practicality. Based upon the principles underlying the
equitable, neutral, and simple taxation of income, Part II proposes guidelines that
should be used for distinguishing between taxable in-kind employee benefits and
employer-provided goods and services that should not be taxable. Part Ill explores the
correct approach to determining the value of in-kind benefits. In particular, this part
takes issue with the commonly held view that the theoretically correct method of
valuing in-kind benefits is to determine the subjective value of the benefit to the
employee. It is argued that employees should have to include in their income the fair
” Simons, supra note 1 at 53.
12 Ibid.
” Ibid. at 53, 113, and 124.
“Ibid. at 113.
” Ibid. at 43.
260
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
inconsistencies,
in Part 111 and reveals
market value of all in-kind benefits that provide them with a personal benefit. Part IV
reviews the tax treatment of selected in-kind benefits. This review draws on the
guidelines developed
inequities, and
inefficiencies in the manner in which the courts and Canadian tax administrators have
defined taxable in-kind employee benefits. Where the treatment by the courts or the
Canada Customs and Revenue Agency’6 is inconsistent with the guidelines, more
appropriate approaches to taxing particular in-kind benefits are suggested. The paper
concludes by revisiting Kleinwichter’s conundrum. The principles
that should
underlie the taxation of in-kind benefits and the guidelines proposed in Part E[I are
referred
the
Fliigeladjutant.
the concept of income, even as
to in delimiting
it applies
to
I. The Importance of Taxing In-Kind Benefits
Although unlikely to be accompanying their employers to the opera or on hunting
trips, most contemporary employees receive myriad in-kind benefits. Many of these
benefits (such as contributions to private pension plans, premiums for group accident
insurance plans, private health
insurance and group term life insurance, and
counselling services) are specifically exempted from tax.” The government has
deliberately encouraged employers to provide these benefits to increase the economic
security of employees and to relieve the government of future social assistance
payments. These in-kind benefits are appropriately analyzed by applying budgetary
criteria to determine, for example, whether they achieve their intended purposes.
However, in addition to the benefits provided by these deliberate tax expenditures,
employers frequently provide employees with a wide range of goods and services
from which employees derive a personal benefit, including, for example, educational
courses leading to a university degree, combined employment-related and pleasure
trips, clothing, subsidized parking,
trips taken with frequent flyer points, and
discounts on goods and services. This paper is concerned with the proper tax
treatment of these in-kind benefits.
6 In the article text, “Revenue Agency” is used to refer to the Canada Customs and Revenue
Agency and to Revenue Canada (Canada Customs and Revenue Agency before the 1 November 1999
name change). On 12 December 2003, the Canada Customs and Revenue Agency changed its name
again to the Canada Revenue Agency. See online: Canada Revenue Agency
” For example, paragraph 6(1)(a) of the Canadian Income Tax Act (R.S.C. 1985, (5th Supp.), c. 1)
exempts the following benefits from tax: employer contributions to a registered pension plan, group
sickness/accident insurance plans, private health care services plans, supplementary unemployment
insurance plans and deferred profits sharing plans, benefits under an employee benefit plan or an
employee trust as a retirement compensation arrangement, and benefits derived from counselling
services for health or re-employment or retirement.
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
The theoretical case for requiring employees to include the value of in-kind
benefits in income for tax purposes is straightforward. To take the simplest case, if
these benefits are items that an employee would otherwise purchase with after-tax
income, from the employee’s point of view, their receipt is equivalent to receiving
cash. Thus, they clearly represent an increase in the employee’s “market value of
rights exercised in consumption.”‘ To illustrate, an employee who is provided with a
$2,000 recreational club membership by her employer and who would otherwise
purchase such a membership for personal use has the same gross income as an
employee who does not receive such a benefit but who receives an additional $2,000
cash bonus. Equity demands that these two employees pay the same tax on this
additional remuneration. Moreover, taxing in-kind benefits is important not only to
ensure an equitable distribution of the tax burden, but also to ensure an efficient
allocation of society’s scarce resources. Failing to tax in-kind benefits reduces the
after-tax cost of providing them and causes employers to alter compensation packages
offered to employees. This tax-induced behaviour will result in social waste as
resources are shifted from their market-determined best use. Thus, if employer-
provided recreational gym memberships, for example, are not taxed, an employee in
the forty per cent tax bracket who would otherwise purchase such a membership out
of her after-tax income would prefer a club membership to a $2,000 cash bonus even
if the value of the membership to her were some amount below $2,000, so long as it
was above $1,200.
Despite the apparently strong theoretical case for taxing in-kind employee
benefits, some analysts have argued that the equity case for taxing them is overstated
and that the distortions caused by their nontaxation are not serious. The nontaxation
of some in-kind benefits is supported also on the ground that their taxation is
administratively impractical and that nontaxation will further social policy goals. To
underline the importance of getting the taxation of in-kind benefits correct, the
traditional tax policy considerations of equity, neutrality, and simplicity are reviewed
as they apply to in-kind benefits. In the course of this review, each of the arguments
that have been made in support of an indifferent attitude to the taxation of in-kind
benefits will be analyzed and shown to be wanting.
A. Horizontal Equity
The concept of horizontal equity requires that individuals who are similarly
situated be treated the same. The difficulty arises in determining when two individuals
are similarly situated for tax purposes. The implication of the Simons’ definition of
income from an equity perspective is that taxpayers should pay tax on the value of
their personal consumption. Consequently, all in-kind benefits that provide an
employee with a personal benefit should be subject to tax. Another way of stating this
” Simons, supra note 1 at 50.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
same point is to say that to the extent that an in-kind benefit is in substitution for a
personal expense, the employee should be taxed on its value. A personal expense is an
expense that provides the employee with a personal benefit, or an expense that
originates from a personal decision.
Although the notion that the tax system will not be horizontally equitable if in-
kind benefits are not taxed is intuitively appealing, and although much is made of the
need for horizontal equity in debates over the taxation of in-kind benefits, some tax
policy analysts, most notably Charles Clotfelter, have claimed that the concern over
horizontal inequity in the nontaxation of in-kind benefits is not as compelling as is
often contended for two reasons.’9 First, Clotfelter argues that it is not practical to
apply the concept of horizontal equity to the taxation of in-kind benefits since
employees likely have very different tastes for different in-kind benefits. For example,
in discussing Kleinwichter’s conundrum, he notes that whether the officer in the field
was taxed inequitably compared to the officer on the sovereign’s personal staff, the
Fliigeladjutant, depends crucially on whether or not the Fliigeladjutant had a taste for
theatre, opera, horses, and the food served at the royal table. In asserting that the
correct taxation of the Fliigeladjutant requires knowing his preferences, Clotfelter
assumes that the theoretically correct value of an in-kind benefit is its subjective value
to the employee. But, as will be shown, this assumption is wrong. Employees should
be taxed on the objective fair market value of the benefits they consume, as discussed
in detail below.
inequities since,
tax
like with many apparent
Second, Clotfelter argues that not taxing in-kind benefits might not create
horizontal
inequities, market
mechanisms will compensate to neutralize the horizontal inequities resulting from the
nontaxation of in-kind benefits.’ In employment relationships, where significant value
is provided to an employee in nontaxed benefits, cash wages will be lowered to reflect
the provision of these tax-free benefits, leaving employees who receive nontaxed
benefits no better off than employees who receive fully-taxed cash wages. Clotfelter
argues that “to the extent that labor markets work efficiently and adjust rapidly, the
attempt to apply this criterion [horizontal equity] by taxing fringe benefits will result
in different before-tax wage differentials between jobs but no material improvement
in horizontal equity.”2′
‘” See Charles T. Clotfelter, “Equity, Efficiency, and the Tax Treatment of In-Kind Compensation”
(1979) 32 Nat’l Tax J. 51 at 52.
20 This argument is similar to that made by Boris Bittker in relation to providing tax concessions for
income from capital assets: Boris I. Bittker, “Equity, Efficiency, and Income Tax Theory: Do
Misallocations Drive Out Inequities?” (1979) 16 San Diego L. Rev. 735.
2 Clotfelter, supra note 19 at 53. The potential “capitalization” of the tax advantages of nontaxable
in-kind benefits has also been noted by other scholars. See e.g. Thomas D. Griffith, “Efficient
Taxation of Mixed Personal and Business Expenses” (1994) 41 UCLA L. Rev. 1769 at 1782.
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
263
The argument that bargaining between the employer and employee might remove
a good deal of the inequity of not taxing in-kind benefits can be simply illustrated
using the example set out earlier. Compare an employee who receives a nontaxed gym
membership worth $2,000 and an employee who receives an additional $2,000 of
taxable cash compensation. If the value of the gym membership is not taxed, there
might appear to be a tax inequity between the two employees. However, assume that
before the provision of this increased compensation, both employees earned $60,000
and paid tax at a marginal rate of forty per cent. The employer might simply have
approached the first employee and agreed to provide the $2,000 membership if the
employee accepted a $3,333 reduction in her cash salary.” If the employee agreed-
because the gym membership provided by the employer was convenient and would
not affect her after-tax position-then even though one employee was receiving a
nontaxed in-kind benefit there would be no inequity between employees. The
reduction in cash compensation paid to the employee receiving the nontaxed in-kind
benefit would completely offset her tax advantage. The employer, in this example,
captured all of the tax savings that arose from not taxing the in-kind benefit in the
form of reduced wages. To put the same point a different way, if labour markets are
operating efficiently, and if all nontaxable in-kind benefits were suddenly taxed, those
employers providing significant nontaxed benefits as part of the employees’
compensation packages might simply raise cash salaries so that the newly taxed
employees were no worse off after tax than before the imposition of the tax.
There are, however, many reasons why labour markets may not operate as
efficiently as assumed by this argument. 3 First, there is often a good deal of
uncertainty about the value of the in-kind benefits an employee may receive in a year
and, thus, the value of the benefits cannot be weighed accurately in the bargaining
process. Second, the employees’ salaries might not be reduced by the full value of the
in-kind benefits they receive in a year simply because the costs of precisely
calculating the value of those benefits are too great. Third, even if employees were
aware of the precise value to themselves of the benefits they might receive in a year,
since employers usually bargain with groups of employees and members in the group
will have different marginal tax rates, the variation in salary would reflect the average
value of that benefit to the employees, but would not perfectly reflect the actual value
to each individual employee. In other words, if the employees are bargaining as a
group and have different marginal tax rates, it is unlikely that the employer will be
able to reduce each employee’s salary by the amount required to fully capitalize the
22 $3,333 is the amount the employee would have to receive before tax to be left with $2,000 after-
tax income when the tax rate is 40 per cent.
23 Several commentators have criticized the general argument that the implicit tax created by an
increase in the purchase price of a tax-free good or service (or a reduction of wages because of the
receipt of a nontaxable in-kind benefit) may equal the explicit tax savings, thereby eliminating any
inequities created by nontaxation. In the context of in-kind benefits, see e.g. William D. Popkin, “The
Taxation of Employee Fringe Benefits” (1981) 22 B.C.L. Rev. 439 at 446-52.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
value of the nontaxed benefit. Fourth, although employees likely bargain as a group,
they may in reality receive different numbers of in-kind benefits. For example, one
employee may have an opportunity to go on several business-related trips that can be
extended into personal vacations, while another employee may not have access to
those trips. The tax savings realized by individual employees in receipt of nontaxable
in-kind benefits could not be captured in across-the-board wage settlements. Fifth,
employees may be able to win some of the tax benefit realized on the receipt of
nontaxable in-kind benefits either because of their bargaining power or because they
may conceal their preferences about the value of the benefit. Sixth, even if employees
who receive nontaxable in-kind benefits do not benefit from them since their cash
salary is reduced by the tax saving, the nontaxation of in-kind benefits will inevitably
produce windfall gains for someone-whoever can capture the tax savings: perhaps
the employer, or the producer of the in-kind good or service. Finally, even if
employees who receive nontaxed in-kind benefits paid an implicit tax in the form of
reduced cash salaries, these implicit taxes would not, of course, result in government
revenues. Thus, tax revenues must be recouped in some other way, and this may lead
to inequities.
B. Vertical Equity
In addition to horizontal inequities, the nontaxation of in-kind benefits creates
vertical inequities. The nontaxation of in-kind benefits is subject to the upside-down
effect that is common to all exemptions from tax, as dramatically illustrated by
Stanley Surrey in his repeated attacks on tax expenditures. ‘ For example, the
nontaxation of a gym membership with a value of $2,000 saves an employee who
earns $100,000 and who is in the forty per cent tax bracket $800 of taxes, but saves a
taxpayer who earns $30,000 and who is in the twenty-five per cent tax bracket only
$500 of tax.
than
low-income
More significantly, the nontaxation of in-kind benefits reduces the progressivity
of the tax system because high-income taxpayers receive more nontaxable in-kind
benefits
taxpayers. Although whether or not high-income
individuals receive a disproportionate number of nontaxable in-kind benefits is
sometimes contested, it would seem logical to assume that in-kind benefits-if they
are untaxed-will constitute a greater proportion of total compensation in higher-
income occupations.25 Higher-income
likely have both a greater
opportunity
tax-favoured
their compensation packages
to structure
employees
to receive
24 Stanley S. Surrey, Pathways to Tax Reform: The Concept of Tax Expenditures (Cambridge, Mass.:
Harvard University Press, 1973).
” The Organisation for Economic Co-operation and Development’s report collected some statistics
on the income level of recipients of in-kind benefits. It concludes that the provision of in-kind benefits
“in terms of monetary value per recipient tends to increase as income increases … ” (Organisation for
Economic Co-operation and Development, The Taxation of Fringe Benefits (Paris: OECD, 1988) at 23).
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
265
compensation and the bargaining strength to do so. This may be the case both because
higher-income employees are more likely to be able to bargain individually (and
therefore obtain their preferred mix of cash and in-kind compensation), and because
they are more able to sacrifice cash payment for in-kind benefits. Moreover, if in-kind
compensation is not taxed, the incentive to receive it will increase with the taxpayer’s
marginal
structuring the form of the compensation package of their members. But it is highly
unlikely that low-income non-unionized employees are able to have any say over the
form of their compensation.
tax rates. Unions also undoubtedly have some bargaining power in
Even if high-income taxpayers receive most nontaxed benefits, some economists
have contended that there is ground for doubting whether vertical equity, or the
progressivity of the tax system, would be significantly improved if all in-kind benefits
received by high-income persons were taxed. Charles Clotfelter argues that for two
reasons “most public finance economists would deny that the treatment of in-kind
compensation is fundamentally a question of vertical equity.”26 First, he claims that in
the same way that market adjustments might reduce the money incomes of those
receiving untaxed, in-kind compensation and consequently erase horizontal inequities,
market adjustments might also erase vertical inequities. Employers might be able to
substantially reduce the cash salaries of those high-income individuals receiving a
significant number of nontaxed in-kind benefits. Second, Clotfelter claims that, in any
event, the potential to adjust the rate schedule to reflect any desired degree of
progressivity makes vertical equity of less concern when considering the beneficiaries
of tax expenditures or tax loopholes.
Clotfelter’s arguments are not persuasive. High-income individuals are likely to
have considerable bargaining power in setting their compensation packages, and there
is no reason to assume that their employers, instead of the high-income individuals
themselves, will benefit from tax concessions for in-kind benefits. Thus, in the gym
membership example referred to above, if the employee is a high-income employee
and is valuable to the employer, the employee may well approach the employer and
suggest that instead of a $100,000 salary, the employer could provide the employee
with a cash salary of $98,000 and a $2,000 fitness membership. The employer would
presumably be indifferent, and in this example, the high-income employee would
capture all of the tax savings.
Clotfelter’s second argument is even less persuasive. The value of the tax-free in-
kind benefits received by high-income individuals likely varies enormously. It is hard
to imagine how any conscientious legislator could sensibly take the receipt of these
benefits into account in setting the rates for all taxpayers. A simple increase in the top
marginal rate, for example, would tax all high-income earners more heavily on their
taxable income, regardless of their receipt of in-kind benefits. For a taxpayer who
26 Clotfelter, supra note 19 at 54.
266
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
receives a significant portion of her income in in-kind benefits, her tax liability may
not increase very dramatically. Moreover, there are so many political constraints
preventing changes to the progressivity of the rate scale that any effort to compensate
for the tax-free income received by some high-income individuals is likely to be
unsuccessful.
Finally, there is a perception of unfairness when some taxpayers, particularly
high-income taxpayers, are able to receive nontaxed in-kind benefits, even if the tax
savings they might obtain are fully compensated for by a reduction in salary.
Taxpayers who have to pay for their vacation travel, automobile, commuting and
parking, education, and entertainment out of after-tax dollars resent seeing other
taxpayers arranging their affairs to receive tax-free compensation for these costs of
living. The moral legitimacy of, and therefore compliance with, the income tax is
threatened when taxpayers feel that others are able to take advantage of the system.
C. Neutrality
Another important criterion for judging a good tax system is neutrality. The tax
system should not affect people’s choices. According to the neutrality criterion, it
should be assumed that people make choices that are in their own best interest and
therefore, to the extent possible, their choices should remain after tax what they would
be in a world without taxes.
In terms of the provision of in-kind benefits, if cash salaries are fully taxable but
in-kind benefits that are valued by employees are not taxable, both employers and
employees can be made better off after-tax by converting cash compensation to in-
kind compensation. For example, if an employee in the forty per cent tax bracket
belonged to a gym club with an annual fee of $2,000, she would have to use about
$3,333 of her salary pre-tax to join the club. If the provision of a health club
membership were a nontaxable in-kind benefit, her employer could provide it for her
(instead of paying her $2,000) and negotiate to reduce her cash salary by, say, $800.
Both parties would be better off. The employer’s salary costs would be reduced by
$800 (assuming that the actual cost of the club membership to the employer is
$2,000) and the employee’s after-tax income would be increased by about $320.
As a result of the nontaxation of in-kind benefits-and the potential bargaining by
employers and employees to take advantage of the resulting subsidies-a number of
misallocations of resources will occur.27 First, compensation packages will be
distorted since employers will be induced to offer more in-kind compensation and less
cash salary than they would in a tax-free world. Second, labour costs will be reduced
in those occupations especially amenable to the provision of in-kind benefits; thus,
27 See generally Clotfelter, supra note 19, and “Federal Income Taxation of Employee Fringe
Benefits”, Note (1976) 89 Harv. L. Rev. 1141 [“Federal Income Taxation”].
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
there will be excessive labour demand in those occupations. Third, resources will be
shifted to industries producing goods and services used for nontaxable in-kind
compensation; for example, if health club memberships are untaxed, more resources
will be devoted to health clubs (and fewer to sidewalk cafds) than there would be in a
world where people’s choices were uninfluenced by taxes. Fourth, reflecting the
increased demand because of their nontaxation, the price of goods or services that are
provided as in-kind benefits will be driven up; they will therefore be more expensive
for individuals who do not receive them as part of their employment. Finally, the
undertaxation of in-kind benefits will cause social waste because employees will be
better off after-tax consuming nontaxable in-kind benefits, even though the value of
the benefit to them does not equal its cost.’ In the above example of the health club
membership, if the employees are required to purchase the membership out of after-
tax income, employees will not join a fitness club with a $2,000 annual fee unless it
has a value of $2,000 to them. However, if the employer provided the membership in
a nontaxable form and employees were in the forty per cent tax bracket, employees
would be better off joining the club and taking a $2,000 reduction in salary if joining
the club were worth any amount over $1,200 to them. If taxpayers were induced to
join fitness clubs that have a cost of $2,000 but a value to them of only $1,200, $800
of society’s resources would be wasted.
D. Administrative Practicality
Those who generally support the nontaxation of in-kind benefits frequently note
the administrative difficulties of taxing them. The administrative difficulties are of two
kinds: tracking issues and valuation issues. An employer may have a tedious,
challenging, or potentially impossible task if required to keep track of every in-kind
benefit received by every employee. In addition to tracking issues, the value of some
in-kind benefits is hard to determine since there may be no identical good or service
for sale in the market. Thus, employers may have difficulty determining how much to
withhold and remit from an employee’s paycheque based on the increase in income to
the employee from the receipt of the in-kind benefit. Also, determining how other
taxes and premiums must be accounted for can be difficult-for example, an
employer will need to determine if goods and services tax is due or whether an
additional premium should be submitted on account of Canada Pension Plan
contributions. Therefore, the compliance costs of collecting a tax on in-kind benefits
28 This point was emphasized by Calvin Johnson, who presents the example of an employee who
consumes a $50 lunch that is only worth $25 to him. Commenting on the economic waste involved in
this rational decision, Johnson states that “[i]n consuming a $50 lunch which is worth only $25 to
him, the employee wastes $25-as surely as if he had burned dollar bills. But as long as the lunch is
exempt from tax the employee’s choice is rational, because the resources he wastes are less than the
tax he would pay on cash” (Calvin H. Johnson, “The Case for Taxing Fringe Benefits” (1979) 9 Tax
Notes 43 at 43).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
could be high. Although these administrative difficulties undoubtedly arise when
some kinds of in-kind benefits are provided, for most kinds of in-kind benefits bright-
line tests can be formulated that reduce the administrative cost of imposing a fair tax
on those benefits and that address the difficulties of determining their value.
introduction
to this paper. In addition,
E. Social Policy Considerations
Finally, social policy considerations might suggest that some in-kind benefits
should not be taxed. This is the justification that is generally accepted for permitting
employers to provide some forms of social insurance benefits tax-free. Based on
social policy justifications, many taxing statutes provide specific exemptions for
pensions and various other forms of social insurance. These benefits are widely
considered to be spending programs delivered through the tax system, as discussed in
the
taxing bodies will often provide
administrative concessions for social policy reasons in their approach to enforcing
legislation, or courts will interpret legislation in a way that recognizes social policy
concerns. However, where such concessions are given for social policy reasons, they
should be evaluated as tax expenditures and not technical tax measures and therefore,
the proper analytical questions are: what government purpose is being served by the
provision? What other policy instruments might have been used to achieve this
purpose? Is the provision target-efficient? Is the provision easy to administer and
comply with? Does it systematically disadvantage any group of people? Although
these questions will not be addressed in this paper, as measures to advance social
policy goals, the nontaxation of in-kind benefits will often fail all of the traditional
criteria of a sensible government spending provision. For example, the concessions
are unfair since the implicit government subsidy that taxpayers receive depends upon
their marginal tax rates, hence larger benefits are provided to higher income than
lower income employees; the concessions are invariably target-inefficient since they
are usually only provided to unionized or other employees who have some bargaining
strength; and, like in all government spending programs delivered through the tax
system, the government is less accountable for the concessions and has less control
over them than it does in direct spending programs.29
II. Determining the Boundaries of Taxable In-Kind Benefits
The income tax legislation contains only a general charging provision to address
the taxation of most in-kind benefits, but no specific guidance as to how to distinguish
a taxable in-kind benefit from an employer-provided good or service that should not
29 For the classic, and now widely accepted, analysis of the inequities and inefficiencies created
when government spending programs are delivered through the tax system, see Surrey, supra note 24.
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
269
be subject to tax.’ Paragraph 6(1)(a) simply provides: ‘There shall be included in
computing the income of a taxpayer for a taxation year as income from an office or
employment … the value of board, lodging and other benefits of any kind whatever
received or enjoyed by the taxpayer in the year in respect of, in the course of, or by
virtue of an office or employment … “” It has been left to the courts and the Revenue
Agency to develop the matrix of rules required to tax the full array of in-kind benefits
that employers typically provide to employees. In crafting these rules, judges and
administrators have to carefully balance the considerations that lie behind the
traditional
tax policy evaluative criteria of equity, neutrality, and administrative
practicality. In this part, guidelines that should be used in fashioning these rules are
set out under each of these evaluative criteria. 2 A number of existing guidelines that
are clearly inappropriate are then briefly reviewed.
A. Equity
An equitable policy relating to the taxation of in-kind benefits would ensure that
two employees who consume the same value of personal goods and services are taxed
the same way. The role of the guidelines derived from the equity principle is to assist
in determining when an employee has derived a personal benefit from in-kind goods
and services provided by her employer. The guidelines suggest facts and
circumstances that tax administrators should consider in drawing a factual inference
about whether an employee has obtained a personal benefit.
Perhaps one of the most obvious considerations in deciding whether an employee
has derived a personal benefit from the provision of an in-kind good or service is
simply the nature of the good or service itself. Some goods and services are used
largely or entirely for personal purposes (e.g., food, clothing, and shelter); they would
have been acquired by the taxpayer even in the absence of employment. Although it is
possible to imagine circumstances where an employee would derive no personal
benefit from obtaining from her employer everyday clothes that might be worn
outside the work environment, it is reasonable to assume that most employees would
always derive personal pleasure or use from the provision of these kinds of goods or
services. As a result, these kinds of benefits should always be fully taxed in the hands
of the employee.
‘ There is, however, legislation governing the taxation of some specific benefits. See, for example,
subsections 6(19)-(22) of the Income Tax Act, supra note 17, which govern reimbursements for loss in
the value of housing; subsection 6(15), which applies to employee debt forgiveness; or section 7, which
addresses employee stock options.
3 Income Tax Act, ibid.
32 In the mid-1970s, two outstanding articles were published on the development of guidelines for
distinguishing between personal and business expenses: Daniel 1. Halperin, “Business Deduction for
Personal Living Expenses: A Uniform Approach to an Unsolved Problem” (1974) 122 U. Penn. L.
Rev. 859; and “Federal Income Taxation”, supra note 27.
270
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
In contrast, some other goods and services are rarely used for personal enjoyment
and are essential for employees to discharge their employment-related duties. These
kinds of goods and services should always be regarded as conditions of employment
and should not be taxed. Tools of a trade are an obvious example. Even though some
eccentric individual may purchase a stethoscope or rent a backhoe for personal
pleasure, this is so unlikely that the provision of these kinds of tools should never give
rise to a taxable in-kind benefit. The lack of personal use of these goods and services
by most people provides strong evidence that they do not provide any personal benefit
to the employee who receives them.
Some goods and services both provide individuals with personal satisfaction and
can be used to earn income. In the context of employment-related activities, it is often
difficult to tell whether an employee is deriving a personal benefit from these dual-
purpose goods and services. Education, travel, and entertainment are only a few of the
goods and services that might in some contexts provide a personal benefit and in other
contexts be used solely to earn income. The following considerations would appear to
be relevant in drawing an inference as to whether employees are deriving a personal
benefit from these goods or services that are provided in an employment-related
context.
to disguise compensation
First, if a benefit is widely provided in a particular industry in a non-
discriminatory fashion within each work environment, it might be inferred that the
employees are deriving no personal benefit from the provision of the good or service,
but instead that solely an income-earning aim is being served. Employers are unlikely
to attempt
to employees by providing benefits
indiscriminately to them. Of course, in some cases, it might be that certain personal
benefits have simply become a compensation norm and they are, therefore, widely
provided. However, even if it is the case that employees derive some personal benefit
from the provision of a particular widely provided good or service, if the benefit is
widely provided in a non-discriminatory fashion, any inequities created by not taxing
it are not likely to be significant. In other words, if most employees in a particular
occupation receive offices with windows, there is no great horizontal inequity in not
taxing the value of a window as a fringe benefit. On the other hand, if expensive
artwork is rarely provided to employees, then horizontal and vertical inequities are
created if the imputed rental value of employer-provided artwork is not taxed to the
employees who receive such artwork since other employees would have to decorate
their offices with artwork purchased out of after-tax income.
In addition, the requirement that the benefit be provided in a non-discriminatory
fashion within one work environment ensures that, to the extent the provision of the
benefit will be inequitable between employees in separate work environments, the tax
savings of the benefit are more likely to be capitalized in the salaries of the
employees, therefore resulting in less interoccupation inequities. For example, if all
employees in office A receive free coffee, their salaries should be reduced to take into
account the price of the coffee. Employees in office B, who do not receive free coffee,
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
should have a slightly higher salary. As reviewed above, the capitalization of the price
of the benefit in the employees’ salaries will be imperfect and should not be relied
upon to alleviate inequities as a general rule. The capitalization effect will, however,
in a non-
make the inequities less significant when the benefit is provided
discriminatory fashion.
Second, the more important the good or service in the direct performance of the
work of employees, the less likely it is to be providing a personal benefit to
employees. The ultimate question that must be answered is, of course, whether or not
employees are deriving a personal benefit from the provision of a particular good or
service, not whether the good or service is being provided for employment-related
purposes. However, the fact that the good or service is necessary for the discharge of
employment-related activities is relevant in drawing an inference about whether it is
also providing a personal benefit to employees. If employees could not do their job
without the particular good or service, it is less likely to be serving a personal
purpose. This inference is strongest if the good or service does not appear to be
necessary for employees to do their job. In this case, the inference that it is providing
a personal benefit to employees is compelling.
Third, if a good or service provided to employees has a luxury element, there is a
strong inference that employees are deriving some personal benefit from it. That is to
say, if the good or service is more expensive or lavish than that which would appear to
be required to earn income, it may be inferred that the employees are enjoying some
personal benefit from the provision of the good or service. For example, employees
might require vehicles to discharge their employment responsibilities, but if they are
being provided with luxury automobiles, they may be assumed to be receiving a
personal benefit.
Fourth, if a good or service is being provided to employees because of some
personal decision that they made, it can be assumed that it is providing them with a
personal benefit. The most obvious examples are commuting and childcare costs. All
expenses that originate in a personal decision are assumed to be the result of that
personal decision and are treated, therefore, as personal expenses for tax purposes. It
is generally assumed that employees are able to make a personal decision about where
they would prefer to live. Therefore, if they choose to live some distance from their
place of employment, their commuting expenses are assumed to be personal
expenses. If an employer pays for these commuting costs or provides commuting
services, the employee will receive a personal benefit that should be included in
income. Of course, it is unrealistic to assume that all employees freely choose where
to live. Housing costs, zoning bylaws, and a host of considerations over which
employees have little control often determine where they live. However, it would
obviously be impossible to determine on an individual basis precisely why individual
employees chose to live in particular locations. All commuting costs are therefore
deemed to be personal expenses. The same reasoning applies to childcare expenses.
Employees, like everyone else, presumably make a personal, not an employment-
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
related, decision to have children. Therefore, the tax system should consider the
expenses of childcare to be personal expenses. If an employer provides childcare
facilities for employees or otherwise pays for the employees’ cost of childcare, the
employees have received a taxable benefit.
B. Neutrality
Tax rules should be drafted so that to the extent possible the choices that
individuals make are not affected by tax considerations. This suggests that the more
likely it is that not taxing a particular in-kind benefit will cause employees and
employers to change their compensation practices, the more important it is that the
benefit be taxed. Put another way, the easier it is for an employer to substitute an in-
kind benefit for cash compensation, the stronger the argument in favour of taxation.
The failure to tax these benefits at their fair market value33 will inevitably lead to
inefficiencies in the allocation of resources. Of course, it is impossible to draft rules
that are completely neutral. Despite the best of intentions, on occasion the decision to
tax or not to tax particular in-kind benefits will affect the decision of whether or not to
substitute the benefit for cash compensation. In these cases, tax authorities should
consider whether the additional provision of the in-kind benefit is justifiable from a
policy perspective.
C. Administrative Practicality
Ultimately, rules that depend upon objective facts and circumstances have to be
used to assist decision-makers who are required to determine whether an employee
has received a taxable in-kind benefit and to determine the benefit’s value. In many
cases, it has been the perceived administrative complexity of taxing in-kind benefits
that has led to their undertaxation.
Rules governing the taxation of in-kind benefits should be reasonably cost-
efficient to administer, easy to comply with, consistent in their application, and
difficult to avoid or evade. Often, particularly for in-kind benefits that serve both an
income producing and a personal purpose, bright-line rules are required. For example,
rules may be required that do not purport to measure precisely the value of the
personal consumption that a particular employee might enjoy on a trip that combines
employment-related responsibilities and a vacation. Instead, in attempting to arrive at
this judgment, the rule might depend on a small number of readily verifiable facts and
circumstances, such as an arbitrarily defined number of days that the employee spent
on employment-related activities as compared to vacation activities. These bright-line
tests, which are intended to act as proxies for theoretically more accurate but difficult
” See Part IM, discussing why fair market value is the proper measure of valuation of in-kind
benefits.
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
to apply tests, may give rise to some inequities that could be avoided if a more
comprehensive facts and circumstances test were applied. Nevertheless, in many cases
the administrative advantages of using such bright-line tests outweigh the small
inequities sometimes created. Administrative practicality also counsels that in-kind
benefits that only have a small value should generally be ignored. Finally, as a
decision-making rule in this area, where an in-kind benefit is provided and the
personal value of the benefit is uncertain, the employee should be taxed. ‘ Failing to
tax in-kind benefits that provide employees with personal benefits creates inequities
and inefficiencies.
D. Occasionally Referred to but Inappropriate Guidelines
Over the years, the courts and tax administration have sometimes referred to tests
for determining whether an in-kind benefit should be taxed that are inappropriate. For
example, until fairly recently, one of the most frequently referred to doctrines relating
to in-kind benefits was that a benefit should not be taxed unless it could be converted
into cash. It is obvious that an employee who receives a good or service from her
employer that she would otherwise have to purchase with after-tax income has
received a benefit, whether or not that benefit can be converted into cash. There is
simply no reason to conclude that an employee’s inability to resell a benefit means the
benefit has no value. At best, it might be argued that an inability to resell a benefit
might reduce its value to the employee because one of the property rights associated
with the benefit (free transferability) has been restricted.
Occasionally it has been suggested that if an employee has no choice about the
receipt of a benefit, the employee should not be taxed on the value of the benefit.
Again, this makes little sense. If the benefit relieves the employee of an expense she
would normally incur for a personal purpose, it is logical to infer that she received
some personal benefit from it even though it might have been received involuntarily.
At best, the fact that it was received involuntarily might affect the value of the benefit.
In any event, in most cases the provision of the benefit is unlikely to be “involuntary”
to the employee in the long run. If the employee does not value the benefit equally to
the amount of cash salary she will have to give up to attain the benefit, or equally to
the amount of tax she will have to pay for the benefit, then the employee will bargain
for a better contract without the benefit. Indeed, if the employee values the benefit at
less than its actual value, the tax system should encourage the employee to bargain to
stop receiving the benefit thus avoiding the economic inefficiency of the benefit’s
provision.
‘ This is also the position favoured by Halperin, supra note 32 at 894-95, and Johnson, supra note
28 at 45. See also Boris Bittker, who argues that “the business necessity of borderline expenditures is
hard to prove or disprove, while their personal component is usually clear, with the result that
deductions in this area cannot be adequately policed and will therefore breed exaggeration, fraud, and
public discontent’ (Bittker, “Comprehensive Tax Base”, supra note 7 at 953).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
Another test that is sometimes used in determining whether an employer-provided
good or service should be taxable is whether or not it was provided for the employer’s
convenience. If the benefit was provided for the employer’s convenience,
this
inappropriate guideline would suggest that it should not be taxed. The problem with
the way this test is often stated is that it confuses the ultimate question that must be
answered in deciding whether an in-kind benefit should be taxed with the facts and
circumstances that might be relevant in inferring the answer to the question. In
deciding whether an in-kind benefit should be taxed, the question always is whether
or not the employee derived a personal benefit from its provision. In answering this
question, a relevant fact to consider might be whether the benefit was provided for the
employer’s convenience. If it was provided for the employer’s convenience, it might
be less likely that the employee derived a personal benefit. Certainly it makes it more
likely that the employee derived a personal benefit if the employer had no reason for
providing the benefit other than to compensate the employee. However, while whether
the benefit was provided for the employer’s convenience might be a relevant fact in
determining whether the employee derived a personal benefit, it should not be treated
as the test itself.
Employers can often provide some goods or services to employees at very little
cost to themselves. It is sometimes argued as a result that because these benefits are
provided at no substantial cost to employers, they should not be taxed in the hands of
employees. However, the obvious reason for discarding this test is that it is the
employee’s income that is in issue. The employer’s cost of providing these goods is
irrelevant to this issue. It is sometimes suggested that the justification for the
nontaxation of goods and services that an employer can provide to employees at no
substantial cost is that it encourages the consumption of goods and services that
would otherwise be wasted. There are, however, four reasons why this justification is
untenable.” First, the nontaxation of goods or services that can be provided to
employees at no cost to employers gives an incentive for employers to create such
additional kinds of benefits to compensate employees. Second, the ability to provide
no-extra-cost goods or services to employees tax-free reduces the incentive to find a
mechanism for selling those items on the market. Third, economic distortions created
by the tax-free provision of such benefits may be more significant than the potential
waste of goods or services that are not consumed. Fourth, it is unlikely that any goods
or services that could be provided by an employer are truly costless. In addition to the
opportunity costs, there are likely real costs. For example, where an airline employee
receives a free flight in an unused space,
incur additional
administrative costs, baggage-handling costs, gasoline costs, meal costs, and potential
liabilities.
the airline will
” See Joseph M. Dodge, The Logic of Tax: Federal Income Tax Theory and Policy (St. Paul, Minn.:
West Publishing, 1989) at 299-300; “Federal Income Taxation”, supra note 27 at 1162-63.
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
is taxable
to
test
the employee. The principal purpose
The principal purpose test is the final test reviewed in this section that is
occasionally employed by tax administrators but that fails as a test for the correct
taxation of in-kind benefits. Under a principal purpose test, if the principal purpose of
the provision of the good or service by the employer is business, then the benefit is
exempt from tax altogether. Conversely, if the principal purpose of the provision of
the good or service is to benefit the employee personally, then the full value of the
is normally
benefit
inappropriate for five reasons. First, it can be easily manipulated. The principal
purpose test normally relies on a large number of factors that can be over or
underemphasized by taxpayers or decision-makers to justify a sought-after result.
Second, it presumes the existence of a decision-making process that may not have
occurred. Third, in theory, under the principal purpose test, a slight change in facts
could result in significant tax differences. For example, an employee who takes a trip
motivated forty-nine per cent by business might be taxed on its full value, while
another employee motivated fifty-one per cent by business would not be subject to
tax. Fourth, and perhaps most importantly, the test is far from a suitable proxy for the
personal benefit of the good or service provided to the employee. The employer’s
purpose is, in and of itself, simply not relevant except to the extent to which it can be
used to draw an inference about the personal benefit to the employee. In most cases,
this inference would be weak. In any event, the principal purpose test is commonly
employed to find a good or service either fully taxable or tax-free to the employee. A
more refined and accurate assessment of the personal benefit derived by the employee
is normally feasible. Finally, if objective criteria are used as indications of the primary
purpose of providing a particular in-kind benefit, they are often easily avoided. For
example, if an inference about the primary purpose of a trip is based on the number of
days spent at a particular location, employees can always arrange to have their
business days outnumber their personal days.
III. Determining the Value of Taxable In-Kind Benefits
One of the reasons that taxing in-kind benefits has appeared to pose such a
challenge for the income tax is that there is no agreement as to the appropriate method
of valuing them. Some judges and legislators have assumed that the value of in-kind
benefits should be the amount that an employee could receive by reselling the benefit.
Others have suggested that the appropriate value is the cost of the benefit to the
employer. However, in theory, it is easy to see why neither of these methods can be
correct. The purpose of taxing in-kind benefits is to ensure that employees pay tax on
the value of all compensation they receive by virtue of their employment. The “resale
value” method assumes that employees do not receive anything of value from a
benefit they cannot convert to cash. The “cost to the employer” method assumes that
the value of the benefit to the employee will equal the cost of the benefit to the
employer. Both of these empirical assumptions are wrong. Employees may receive a
huge personal benefit from employer-provided goods and services even though they
cannot sell the goods and services, and there is no reason for supposing that the value
of a benefit to an employee should be in any way related to its cost to the employer.
276
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
More plausibly, a number of commentators have suggested that the theoretically
correct method of valuing in-kind benefits is to determine their subjective value to
individual employees, that is, the value of the cash compensation an employee would
give up to receive the benefit. 6 If this were the correct method of valuing in-kind
benefits, then the taxation of in-kind benefits would truly be perplexing. It would be
impossible to determine this value in most cases and even if it could be determined,
taxing two employees differently based upon their subjective assessment of the value
of an employer-provided in-kind benefit could lead to strange results. It might mean,
for example, that lawyers who were accustomed to dining out would be taxed at a
much lower rate on firm-provided meals than law clerks. Fortunately, the correct
income tax value of employer-provided in-kind benefits is not their subjective value to
employees, but simply their fair market value.
The fair market value of employer-provided goods and services that an employee
consumes is the correct measure of income because one important purpose of the
income tax is to redistribute economic resources. Therefore, it makes sense that the
base upon which the tax is levied is the objective value of the economic resources
consumed by the taxpayer, and not the taxpayer’s subjective valuation of those goods
and services. Indeed, no one since Simons has seriously suggested that the tax system
should be used to try to equalize the subjective utility that individuals derive from
goods and services they consume. 7 Instead, most theories of distributive justice are
based on the assumption that what should be redistributed is the resources that
individuals have available for consumption, and not the pleasure they derive from that
consumption.
The insight that the tax system should measure income in a fashion that reflects
its primary purposes-and in particular its redistributive purpose-was one of
Simons’ great contributions to tax policy debates. He argued that what should be
subject to tax is the “exercise of control over the use of society’s scarce resources.” 8
Parenthetically, it appears as though Simons himself did not fully appreciate the
36 See especially Halperin, supra note 32 at 880; International Fiscal Association, The Taxation of
Employee Fringe Benefits: A Report Based on the Proceedings of a Seminar Held in Florence, Italy,
in 1993 During the 47 Congress of the International Fiscal Association (The Hague: Kluwer Law
International, 1995) at 41-42; Avery Katz & Gregory Mankiw, “How Should Fringe Benefits be
Taxed?” (1985) 38 Nat’l Tax J. 37 at 38; William A. Klein, “The Deductibility of Transportation
Expenses of a Combination Business and Pleasure Trip-A Conceptual Analysis” (1966) 18 Stan. L.
Rev. 1099 at 1103; Joel S. Newman, “Transferability, Utility, and Taxation” (1981) 30 U. Kan. L. Rev.
27 at 42; Organisation for Economic Co-operation and Development, supra note 25 at 16; Popkin,
supra note 23 at 442. These commentators recognize, however, that the subjective method of valuing
in-kind benefits is administratively impractical.
“‘ See Michael J. McIntyre, “What Should Be Redistributed in a Redistributive Income Tax?:
Retrospective Comments on the Carter Commission Report” in W. Neil Brooks, ed., The Quest for
Tax Reform (Toronto: Carswell, 1988) 189 at 205-206.
38 Simons, supra note I at 49.
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
277
significance of his arguments about the importance of focusing on the redistributive
purposes of the income tax in defining the concept of income in his treatment of in-
kind benefits. That Simons contemplated an objective value for the measurement of
income is clear because he defined income as the “market value of rights exercised in
consumption.” 9 When discussing the measurement of personal income during a
period, Simons refers to market values, stating that “this gain may be measured and
defined most easily by positing a dual objective or purpose, consumption and
accumulation, each of which may be estimated in a common unit by appeal to market
prices.” Later he reiterates that “[t]he essential connotation of income, to repeat, is
gain-gain to someone during a specified period and measured according to objective
market standards.”‘ Despite this clarity about the need to determine income by
reference to market values, Simons’ discussion of the Fliigeladjutant suggests that in
the context of in-kind benefits he loses his focus on the importance of an objective
standard. He writes:
[t]he problem of Kleinwachter’s FlUgeladjutant is insoluable and certainly is
not amenable to reasonable solution on the basis of simple rules which could
be administered by revenue agents. Obviously there are many instances where
taxpayers are too favorably treated. The sporting-goods salesman, who lives at
the best hotels and clubs and spends much time entertaining good customers
“on the company,” might well be taxed on something more than his salary-
providing he doesn’t dislike such life, as the Fligeladjutant did the operas!”
Why does the sporting-goods salesman’s enjoyment of his job matter when an
objective measure of income is being applied? Why should Simons be concerned
about redistributing the enjoyment of an opera? As suggested above, these issues can
be resolved appropriately only if the fair market value of in-kind benefits is adopted as
the correct standard. Noting that no one has seriously suggested that employees
should pay tax on the value of their consumer surplus when their subjective value of
an in-kind benefit exceeds its fair market value might reinforce the intuition that the
fair market value of goods and services consumed by employees is the correct method
for valuing in-kind benefits.
Some commentators have argued that the tax criterion of neutrality supports the
subjective valuation of in-kind benefits. 2 Only if tax is levied on the employee’s
subjective value of the in-kind benefit will the employee remain neutral between the
receipt of cash compensation and in-kind benefits. Assume Xs employer offers her a
gym membership in a recreational facility valued in the market at $2,000, but
available to the employer at a discount. Assume also that A would only have paid
” Ibid. at 50 [emphasis added].
40 Ibid. at 51 [emphasis added].
“Ibid. at 123.
42 See “Federal Income Taxation”, supra note 27 at 1144; and John S. Nolan, “Taxation of Fringe
Benefits” (1977) 30 Nat’l Tax J. 359 at 361.
278
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
$1,200 for the membership. In the absence of tax, A would choose the membership if
the cash compensation offered in lieu of the benefit were less than $1,200. This choice
is preserved if the benefit is taxed at its subjective value. If, however, A is taxed on the
fair market value of the benefit, A would only choose the gym membership if cash
compensation less than $667 were offered in lieu of the benefit (assuming a forty per
cent tax rate).43 Therefore, the adoption of the fair market value has changed Xs
compensation choice in the presence of tax.
While it is true that adopting a market value for in-kind benefits might alter pre-
tax behaviour, the pre-tax behaviour in this case is undesirable. In the example
provided above, A chooses to receive a benefit valued at less than its fair market
value. Arguably, society’s scarce resources would be better allocated if she chose the
cash compensation and purchased something that she valued at its fair market value,
leaving the gym membership to be purchased by someone who values it at its fair
market value. If the gym membership is valued at its fair market value for tax
purposes, A may ultimately choose the membership over cash compensation (at the
point where she is offered $667 or less as cash compensation), but the possibility that
A will waste society’s scarce resources is reduced when this approach is adopted.
Finally, as a pragmatic matter, taxing regimes must (and generally do) rely only
on objective measures of income in assessing taxpayers’ liability to be administered
effectively. The subjective value of an in-kind benefit is impossible to determine, and
taxpayers would have an overwhelming incentive to misrepresent their subjective
value. Proponents of a subjective value in theory inevitably concede that it would be
impossible to adopt in practice. Also, in most cases it is reasonable to assume that the
value of an in-kind benefit to an employee equals the fair market value of the benefit.
Most employees who receive significant nontaxed in-kind benefits, such as high-
income employees and union members, negotiate for the benefits they receive.
Presumably, they only negotiate for benefits they value as much as the benefit’s fair
market value. Even if a benefit is imposed on employees, it is reasonable to assume
that employers provide in-kind benefits with compensatory value to employees to
ensure employees remain loyal and demand less cash compensation.
” If the fair market value of the membership were subject to tax, A would pay $800 in tax (40 per
cent of $2,000). This leaves A with $400 of after-tax value ($1,200-$800). Therefore, A would choose
cash compensation any time she were left with more than $400 after tax. If A received $667 cash, she
would pay $267 in tax and be left with $400 after tax. Therefore, if A is taxed on the fair market value
of the benefit, after tax A is indifferent between receiving the gym membership and $667 in cash.
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
279
IV. Evaluation of Present Law and Practice
This part of the paper deals specifically with the approach to the taxation of six
in-kind benefits and makes suggestions for the proper taxation of each. At a general
level, the taxation of all these benefits presents the same issues: a determination of the
extent of the personal consumption element associated with provision of the benefit,
and the need to formulate a rule that can be administered that will distinguish between
those cases where that personal benefit is sufficient to justify taxation and those where
it is not. The six benefits have been chosen because they illustrate some of the
common difficulties that arise in the taxation of in-kind benefits highlighted in the
discussions earlier in the paper. Education and travel provide illustrations of typical
dual-purposes benefits. Even though it has enormous income-earning potential,
university education is an inherently personal good and not taxing this good when
paid for by an employer leads to obvious inequities and perverse incentives.
Employer-provided travel benefits illustrate the need for arbitrary bright-line rules for
ensuring that employees are taxed on the value of their personal benefits. Clothing
(other than uniforms) is a good that everyone must purchase personally, whether
employed or not. Therefore, in most cases, the value of employer-provided clothing
should be included in income. Parking is a subset of the commuting expense rule, and
inclusion of the value of the benefit in income should be required because the expense
is the result of a personal decision. Tax administrators have had difficulties with
frequent flyer points primarily on administrative grounds, yet the inequities and
inefficiencies created by the nontaxation of flights taken when business-earned points
are cashed in is enormous, and a concession to administration is inappropriate in this
area. Finally, discounts on goods and services are discussed to provide an example of
how the justification for nontaxation where there is no additional cost to the employer
has inappropriately pervaded some areas of in-kind benefits taxation. Although this
paper focuses on whether each of these benefits should be taxed when received by
the appropriate
employees,
deduction of these expenses when they are incurred by people who earn income from
a business.
the same analysis could be applied in determining
A. Educational Courses Leading to a University Degree
Generally, it is not hard to distinguish between education provided by an
employer that has no personal benefit to employees and that, therefore, should not be
taxable, and education provided by an employer that does give employees a personal
benefit and that should be subject to tax. On the one hand, for example, if a law firm
pays for a tax associate to take a two-day continuing legal education course on the
taxation of fringe benefits, there seems to be little doubt that the course should be
treated as a nontaxable benefit. All the relevant facts and circumstances suggest that
there is little personal benefit in such a course. Few, if any, individuals take a course
on the taxation of fringe benefits to further their liberal education or for amusement;
the information provided in the course is directly required to earn income; also, the
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
course is likely offered to all employees working in related areas of legal practice.
Moreover, not taxing the value of these courses
the
compensation packages that law firms offer to their associates. Presumably, few
employees would choose to exchange cash compensation for a course on the taxation
of fringe benefits.
is unlikely
to change
On the other hand, if a law firm pays for a tax associate to take a weekend course on
the collected works of Margaret Lawrence, that course should be treated as a taxable
benefit. The personal benefit of enrolling in such a course is likely to be high: it is the
kind of course that individuals take regardless of the nature of their employment; there is
no immediate relationship between the course and the employee’s income-earning
capacity; and the course will likely be taken by only some employees. Moreover, if the
value of courses like this were not taxed, it is likely that employees would negotiate to
have them paid for by their employers in lieu of cash compensation.
Although most courses paid for by employers for the benefit of their employees
are relatively easy to classify as providing a personal benefit to the employee, some
educational courses provided by employers are classic dual-purposes benefits. The
most obvious example of a dual-purpose course-and one
that has caused
considerable controversy
in Canada in recent years-is a course leading to a
university degree. Many students who attend university undoubtedly do so in large
part to further their careers. Considerable evidence suggests that a university degree
can significantly increase an individual’s earning capacity. At the same time,
university courses provide students with large personal benefits. These personal
benefits include the acquisition of a more diverse body of knowledge about the world,
the development of critical thinking skills that are used in all facets of everyday life,
the expansion of intellectual powers generally, the elevation of social status, and the
feeling of self-accomplishment and personal satisfaction. In light of the fact that
courses leading to a university degree serve both of these purposes, what should the
tax treatment be when such courses are paid for by an employer? In Canada, this
question has arisen recently in the context of employers paying for the costs of MBA
degrees acquired by their employees. Given that the tuition for these degree programs
can exceed $65,000, the issue is not trivial. A brief review of the recent public debate
over the taxation of employer-sponsored university degrees will serve to raise many of
the issues relating to whether they should be considered a taxable benefit.
Prior to a change in its policy in the late 1990s, the Revenue Agency’s general
administrative position was that if fees for an educational course were paid on behalf
of an employee, the fees were a taxable benefit to the employee, unless the course was
taken primarily for the benefit of the employer and was taken at the employer’s
initiative.” The Revenue Agency would presume that the course was for the benefit of
” Revenue Canada, Interpretation Bulletin IT-470R (unconsolidated), “Employees’ Fringe Benefits”
(8 April 1988) at paras. 18 and 19:
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
the employer if it was taken during normal working hours and the employee was
given time off with pay to attend the course.4 ‘ Then, the Revenue Agency took the
position that courses leading to a university degree could never be taken primarily for
the benefit of the employer since the degree was a personal asset of the employee.6 In
a letter dealing specifically with the attainment of an MBA degree, the Revenue
Agency stated that:
Courses that lead to degrees or professional designations are normally viewed
as career enhancing studies of primary benefit to the student, even though the
employer obviously also benefits during the student’s period of employment
with that employer. In our view an MBA Program is of primary benefit to the
student, as it represents a means of enhancing one’s chances of a promotion in
the short term or enhancing one’s overall career opportunities in the long run.4″
In support of this position, the Revenue Agency won a series of cases in the 1990s
holding that employees had to include in their income the value of the tuition paid by
their employers for courses to obtain a Certified General Accountant designation, 8 to
complete an MBA,’9 and to qualify as a clinical child psychologist.’
In early 1998, the Revenue Agency’s assessing practice for courses leading to a
university degree became front page news when an employee of Ipsco Inc., a Regina
steel company, contested a $30,000 assessment he received from the Revenue Agency
that included in his income the value of a two-year MBA taken at his employer’s
expense. Ipsco Inc. waged a public battle against the assessment, expressing concern
18. Where an employer has paid tuition fees on behalf of an employee or has
reimbursed an employee, in whole or in part, for tuition fees paid by the employee
personally, the amount paid should be reported as income of the employee for the year
in which the payment was made.
19. An exception to this rule can be made where the course for which the fees were
paid was undertaken on the employer’s initiative and for the benefit of the employer
rather than the employee. This is usually presumed where a course is taken during
normal working hours with the employee being given time off with pay for that
purpose. On the other hand, if the course is taken on the employee’s own time, the
presumption is that the course is primarily for the employee’s benefit and the amount
paid by the employer is a taxable benefit to the employee.
, Ibid. at para. 19. Several letters issued by the Revenue Agency also noted that if the training was
taken to improve the employee’s chance of promotion or to prepare for an alternate job, those courses
were not considered to be taken primarily for the benefit of the employer. See e.g. Revenue Canada,
Memo 9208085, “Tuition Fee Reimbursement” (15 April 1992); Revenue Canada, Memo 9507635,
“Taxable Benefits” (29 June 1995).
46 See e.g. Revenue Canada, Memo 9507635, ibid.
4′ Revenue Canada, Memo 9609415, “Employee Benefits and Tuition” (25 April 1996). For similar
reasoning, see Revenue Canada, Memo 9521155, “Tuition Fee Reimbursement” (19 October 1995).
48 See Faubert v. Canada (M.N.R.) (1998), 98 D.T.C. 1380, [1998] T.C.J. No. 21 (QL).
49 See Sami v. Canada (M.N.R.), [1995] 2 C.T.C. (N.S.) 2915, 10 C.C.PB. 10 (T.C.C.).
‘o See Yaholnitsky-Smith v. Canada (M.N.R.), [1991] T.C.J. No. 1125 (QL) (T.C.C.).
282
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
about the implications of the ruling for Canada’s competitive position in the world
economy and enlisting the support of members of the federal cabinet, including then
Industry Minister John Manley.” Briefs and letters objecting to the assessment by
associations such as the Tax Executives Institute and the Canadian Council of Chief
Executives were released to the public. 2 Business newspapers across the country
picked up the story. Headlines included “Income Tax on Courses Criticized”,
“Revenue Canada Goes after Workers Upgrading Education”, and ‘Tax on Training
Misses the Point”.”
Within weeks after the beginning of the publicity campaign, the Revenue Agency
relented. To curb the flood of bad publicity, it initially released a letter on 11 March
1998, stating that the treatment of education benefits was being reviewed.’ Two
months later, it published a technical news release stating that it had changed its
position on the taxation of employer-paid education and offering the following
justification:
[C]onsultations have shown that in our current environment, with rapidly
changing technology and a quickly expanding global market, it is necessary for
most individuals to constantly upgrade their knowledge and skills in order to
remain productive. Employers consider it to be an absolute necessity
to
encourage and support training of their employees at all organization levels.
They have also advised that most employer-paid training is directly related to
job responsibilities; however, some training is clearly for the principal benefit
of the employee.”
The Revenue Agency’s revised position was that, “[w]hen the training is taken
primarily for the benefit of the employer there is no taxable benefit, whether or not
” For details of the story, see Arthur Drache, “Revenue Eases Rules on Training Courses” The
Financial Post (16 June 1998) 32; see also Shawn McCarthy, “Ottawa to Relent on Training Taxes:
Rules to Be Issued Today Would Save Employees from Being Taxed for Work-Related Courses” The
Globe and Mail (7 May 1998) B9.
52 “Employer Payment or Reimbursement of Training Costs Under the Canadian Income Tax Act”
(May-June 1998), online: Tax Executives Institute
Patterson, “Stealth Tax on Training Must Stop: Revenue Canada’s Slant on Learning Threatens
Millions with Retroactive Tax for Gaining Knowledge at Employer’s Expense” (February 1998),
online: The Canadian Council of Chief Executives
” See “Income Tax on Courses Criticized” The Toronto Star (19 February 1998) D1O; Sandra
Cordon, “Tax on Training Provokes Anger: Revenue Canada Goes after Workers Upgrading
Education” Winnipeg Free Press (19 February 1998) B6; “Tax on Training Misses the Point,”
Editorial, The Financial Post (27 February 1998) 14; Kathryn May, “Ipsco Tilts at Taxman over
Ruling on Training” Hamilton Spectator (20 February 1998) D10; Elizabeth Church, Shawn
McCarthy & Gordon Pitts, “Tax Issue Poses Tough Question” The Globe and Mail (19 February
1998) B14.
-‘ Revenue Canada, Memo 9805328, “Employer-Paid Tuition” (11 March 1998).
15 Revenue Canada, Income Tax Technical News No. 13 (7 May 1998).
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
283
this training leads to a degree, diploma or certificate.” 6 In elaborating upon training
that would be regarded as taken primarily for the benefit of the employer, the Revenue
Agency stated that:
Courses which are taken for maintenance or upgrading of employer-related
skills, when it is reasonable to assume that the employee will resume his or her
employment for a reasonable period of time after completion of the courses,
will generally be considered to primarily benefit the employer and therefore be
non-taxable. For example, fees and other associated costs such as meals, travel
and accommodation which are paid for courses leading to a degree, diploma or
certificate, in a field related to the employee’s current or potential future
responsibilities in the employer’s business, will not result in a taxable benefit. 7
Numerous
to individual
letters from the Revenue Agency
taxpayers have
subsequently confirmed that not only MBAs but also other university degrees
normally will not be regarded as taxable benefits when paid for by employers.” In one
illustrative letter, an employer asked about the tax consequences of hiring students out
of high school and offering to pay for their university courses provided the students
work for the employer in their summers and for some period of time after completing
their university degrees. In response to the query, the Revenue Agency replied, “Since
these employees are being trained for specific jobs in the employer’s organization, the
benefits resulting from this arrangement would not be considered taxable.” 9
In addition to a variety of letters, the Revenue Agency has published at least one
ruling on this issue.’ The employees of the company applying for the ruling could
take university courses including courses in computers, psychology, sociology,
management, economics, art/design, English or French literature, languages, and
accounting. The employees were required to continue to work an average number of
hours a week for the employer, and the education could not consist of programs that
would simply permit the employees to meet the minimum education requirement for a
specific employment position at the company or to permit the employees to qualify
for an employment position that was not available at the employer. The stated purpose
of the education plan was to encourage employees to further their education, skills,
and abilities as they relate to their current or future employment responsibilities and to
56 ibid.
” See Revenue Canada, Interpretation Bulletin IT-470R (consolidated), “Employees’ Fringe
Benefits” (12 October 1999) at para. 18 [1T-470R].
” See e.g. Canada Customs and Revenue Agency, Memo 2000-0043607, “Employer-Paid Tuition”
(17 November 2000).
‘9 Revenue Canada, Memo 9903137, “Employer Paid University” (11 March 1999). For a similar
opinion, see Revenue Canada, Memo 9910065, “Employer-Paid Education Costs” (29 July 1999).
60 Canada Customs and Revenue Agency, Ruling 2001-0068203, “Taxable Benefits” (18 August
2001).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
(Vol. 49
ensure that the employer had a well-educated and productive workforce. The Revenue
Agency ruled that these programs could be provided to employees tax-free.”
The Revenue Agency’s new policy that employer-provided payments for courses
leading to a university degree are not a taxable benefit violates almost all of the
guidelines of an equitable, efficient, and administratively practicable fringe benefits
policy. A sensible approach to the issue appears to have been derailed because of the
Revenue Agency’s reliance on the test of whether the education obtained by an
employee was for the employer’s benefit. As explained above, this is always an
inappropriate test for the taxation of fringe benefits. The central question is not
whether the employer benefits from the provision of the services, but whether the
employee derives a personal benefit. In the case of university courses leading to a
degree, personal benefits are always present.
The Revenue Agency’s policy also creates numerous inequities. Most obviously,
it is unfair to those who are not able to negotiate to have their employers pay for their
university education. A university education is acquired by a substantial number of
employees in many industries and by all employees in many professions, yet this will
be a benefit that will undoubtedly be provided only to a small, select number of
employees. It is also unfair to those who acquire their university education before they
start working and thus do not have an opportunity to have an employer pay for their
expenses.
Moreover, the policy creates numerous perverse incentives. Since the benefit is
potentially so large, there appears to be little doubt that it will give rise to changes in
compensation packages. Employees who are in a position to take advantage of this in-
kind benefit often will be in a position to negotiate individual employment contracts.
In addition, permitting
the nontaxed provision of a university education will
encourage students to enter the workforce before entering post-secondary education.
To the extent that some university courses and degrees are more likely to be held to be
for an employer’s benefit, it will encourage students to enrol in employment-related
courses and discourage them from taking courses that provide them with a more
general
the liberal
education component from their programs to ensure that these programs qualify as
tax-free when paid for by employers. Since fees for many professional courses in
universities are now deregulated, providing this large subsidy for the fees will also
contribute to the upward pressure on fees, making it more difficult for unsubsidized
students to enter the programs. Finally, it will be difficult, if not impossible, for the
Revenue Agency to sensibly draw lines between those university courses and
liberal education. Faculties may be encouraged to remove
6″ Note
the employee for
that if the employer reimburses
the education expenses, that
reimbursement must be within a reasonably short time period after the course is taken. See Canada
Customs and Revenue Agency, Memo 2002-0146705, “Reimbursement of Tuition” (13 September
2002).
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
285
programs enrolled in by employees that can be said to be for the benefit of employers
and those that cannot.
The business interests that objected to the Revenue Agency’s initial policy that
employer-provided assistance for courses leading to a university degree was a taxable
benefit were correct in arguing that the government should be doing as much as
possible to assist workers in continually upgrading their skills and knowledge.
However, the Revenue Agency’s present policy in essence creates a government
subsidy program to achieve that end, and it is hard to imagine a more inequitable and
perverse educational program than the one now inherent in the nontaxation of
employer-assisted university degrees.
B. Combined Employment-Related and Pleasure Trips
Employees frequently take trips that are paid for by their employers. In taking
many of these trips, employees derive no personal benefit. An employer might require
employees to take trips, for example, to meet with customers or suppliers or to attend
business meetings. The employees’ time in many cases is occupied fully during
normal business hours at the destination, and they return home immediately after
conducting their employer’s business. Obviously, employees should not be taxed on
the value of these trips. This is the case even though some employees might
thoroughly enjoy spending a few days away from home conducting business,
occasionally in what might otherwise be regarded as a vacation destination, and might
spend their evenings enjoying the local tourist spots or visiting friends and relatives.
There is no reason that these incidental personal benefits of discharging one’s
employment responsibilities should be treated any differently from the many other
incidental benefits of employment. Of course, the Revenue Agency should be vigilant
in ensuring that the personal benefits of nontaxable trips are only incidental to the
employment-related purposes. In reading the cases in this area, one sometimes
suspects that employers can be somewhat ingenious at disguising vacations as
business trips.”2
Employers may also pay for trips for their employees that are intended to be
solely for the employees’ personal enjoyment. The full value of these trips should be
included in the income of employees on the grounds of equity. These trips represent
personal consumption for which most taxpayers have to pay out of their after-tax
income. Indeed, these trips are often incentive or reward trips that will serve their
purpose only if employees derive substantial personal pleasure from them. In
addition, since most employees likely take vacations each year, the failure to tax the
personal consumption component of employer-provided trips would likely result in
62 See e.g. Arsens v. Canada (M.N.R.) (1969), 69 D.T.C. 81, [1969] Tax A.B.C. (N.S.) 1; Marossi v.
Canada (M.N.R.), [1980] C.T.C. 2832 (T.R.B.); McMillan v. Canada (M.N.R.), [1993] 2 C.T.C. 2489,
[1993] T.C.J. No. 296 (QL) (T.C.C.).
286
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
free trips being substituted for cash salary. Under the present law63 and administrative
practice,64 the value of these trips is taxed.
Occasionally, on trips that are intended primarily as rewards for employees, the
employees might have to attend a few incidental business functions or otherwise
engage in employment-related activities. The Revenue Agency has indicated that
where this is the case, it will reduce the value of the trip that has to be included in the
employees’ income: “[T]he taxable benefit may be reduced if there is conclusive
evidence to show that the employee was involved in business activities for the
employer during the vacation.”65 This seems like an unnecessary concession. Even if
an employee has to attend some employment-related functions while on a vacation, it
is doubtful that those activities would detract from the personal value of the vacation.
The same rules that apply to an employee also apply to anyone who travels with
the employee, typically a spouse, and who has his or her travel costs covered or
subsidized by the employer. If the spouse is travelling primarily for personal reasons,
then the value of the spouse’s trip is included in the income of the employee. If,
however, the spouse is primarily engaged in business activities on behalf of the
employer, then his or her travel costs are not considered to be a taxable benefit to the
63 See Affetuso v. Canada (M.N.R.), [1981] C.T.C. 2450, 81 D.T.C. 389 (T.R.B.); Stevens v. Canada
(M.N.R.), [1993] 1 C.T.C. (N.S.) 2429,93 D.T.C. 291 (T.C.C.).
4 Travel benefits are discussed in IT-470R, supra note 57, at paras. 7 (travel benefits), 10-12
(holiday trips) and 15 (travel expenses of employee’s spouse). The detailed guidance on the taxation
of trips set out in IT-470R and described infra, has developed significantly from the single paragraph
originally included in Department of National Revenue, Information Bulletin No. 24, “Employees’
Fringe Benefits” (12 February 1964) [1964 Information Bulletin]. Paragraph 5 on page 4 of that
Bulletin simply stated, “A free holiday trip or a vacation with expenses paid given by an employer to
an employee for long or meritorious service, or any prize, whether in cash or in kind, in recognition of
job performance, constitutes a taxable benefit from the employment which should be measured by the
cash equivalent.”
Paragraph 7 of IT-470R sets out the general rule governing employee travel costs. It states that
“[a]n amount received, or the value of a benefit received or enjoyed, by virtue of employment in
respect of travelling expenses incurred by an employee, the employee’s family or both is a taxable
benefit … ” Paragraph 10 deals in particular with employer-provided vacations, stating, “[w]here an
employer pays for a vacation for an employee, the employee’s family or both, the cost thereof to the
employer constitutes a taxable benefit to the employee under paragraph 6(1)(a).”
651 T-470R, ibid. at para. 10. Paragraph 12 of IT-470R addresses the situation where the employee
acts as a host for an incentive award trip arranged for employees, suppliers, or customers. It states that
“[s]uch a trip will be viewed as a business trip provided the employee is engaged directly in business
activities during a substantial part of each day (e.g., as organizer of activities); otherwise it will be
viewed as a vacation and a taxable benefit, subject, of course, to a reduction for any actual business
activity.” See also Revenue Canada, Memo 9905737, “Taxable Benefit, Trip Paid by Employer” (21
April 1999).
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
trip reduced because the spouses were expected to engage
employee.’ In several cases, employees have been able to have the value of their
spouses’
in some
employment-related activities. Again, this seems to be an inappropriate concession.
Even if spouses have to engage in some employment-related activities, it is doubtful
that those activities would reduce the personal value of the trip to them. Indeed, this
concession seems simply to provide an opportunity for employers to structure trips so
that they do not give rise to a taxable benefit. Moreover, in this day and age, there
seems to be something archaic about expecting an employee’s spouse to attend
employment-related activities to further his or her career.
The difficult cases involving employee travel arise when a trip has a dual
purpose-partly business and partly personal. Take the simplest case. Assume that an
employer pays for an employee’s trip that requires a flight from Toronto to Vancouver
and for all related travel expenses. The employee spends three full days attending to
employment-related business affairs and then spends the next three days vacationing.
How much of the costs, if any, should be included in the employee’s income as a
taxable in-kind benefit?
The case law in Canada is not consistent on this issue. In a number of early cases,
the judges appeared quite willing to assess all of the facts and circumstances
surrounding the trip and make an overall, ad hoc judgment about what percentage of
the costs should be regarded as providing a personal benefit. For example, in Philp v.
Canada (M.N.R.), 7 the employees were managers of retail grocery stores. They were
provided with trips to Nassau, where they spent six days. On three of those six days,
they attended two-hour meetings. The Exchequer Court held that fifty per cent of the
cost of the trip should be included in the employees’ income as a fringe benefit. In
Ferguson v. Canada (M.N.R.),68 the taxpayer was invited to Athens by a supplier to
attend a sales convention at the supplier’s expense. While in Athens, the employee
had some free time and went on a few tours. The Tax Review Board held that ten per
cent of the cost of the employee’s trip should be included in income as an amount that
reflected the personal benefit of a primarily business trip. In Lewis v. Canada
(M.N.R.),69 the taxpayer received a trip to Nassau as a prize in a sales contest. Based
on very few reported facts, the value of the benefit was apportioned. Two-thirds of the
value of the trip was taxed, and one-third of the value of the trip, which was held to be
Paragraph 15 of IT-470R, ibid., adds that, “[w]here a spouse accompanies an employee on a
business trip the payment or reimbursement by the employer of the spouse’s travelling expenses is a
taxable benefit to the employee unless the spouse was, in fact, engaged primarily in business activities
on behalf of the employer during the trip.” See also Canada Customs and Revenue Agency, Memo
2002-0134225, “Employee’s Spouse Travel Benefits” (8 May 2002). See also Hale v. Canada
(M.N.R.), [1969] 1 Ex. C.R. 259, [1968] C.T.C. 477; Waffle v. Canada (M.N.R.), [1969] 1 Ex. C.R.
384, [1968] C.T.C. 572; Paton v. Canada (M.N.R.) (1968), 68 D.T.C. 197 (T.A.B.).
67 [1970] Ex. C.R. 496, [1970] C.T.C. 330 [Philp].
68 (1972), 72 D.T.C. 1097 (T.R.B).
69 (1970), 71 D.T.C. 4 (T.A.B.).
288
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
business, was not. In Hart v. Canada (M.N.R.), the employee of a farm operation
took a trip that included examining various agricultural operations in Australia and
New Zealand. The Federal Court, Trial Division, decided that the trip was one that
combined business and pleasure and allocated the costs of the trip half to business
(nontaxable) and half to pleasure (taxable). This allocation was accepted by the
Federal Court of Appeal.
A comparison of three cases (all decided under the informal procedure) decided
on similar facts provides a particularly good example of the arbitrariness of an ad hoc
allocation rule. In McMillan v. Canada (M.N.R.), Dagenais v. Canada (M.N.R.),72
and Cales v. Canada (M.N.R.),73 the employees, who were employed at Oliver
Industrial Supply Ltd., were provided with free trips to Fiji and Mexico by their
employer. The employees argued that they should not be taxed on the value of the
benefit because the supplier who provided the trip did not employ them and because
the trip was a business trip. The employees did discuss some business on these trips,
but no formal meetings were held. In McMillan, the court found that the trip was a
taxable benefit and required inclusion in income of forty per cent of the cost of the
trip. In contrast, in Cales and Dagenais the court found the benefit was taxable
remuneration and valued the personal component of the trip at eighty-five per cent of
its cost.
Instead of using an apportionment approach similar to that applied by the courts
where a trip has both business and personal aspects, the Revenue Agency takes the
position that if the main purpose of the trip is business, then no taxable benefit arises. ”
The Federal Court of Appeal endorsed this principal purpose test in its most recent
decision on travelling benefits. In Lowe v. Canada (M.N.R.),5
the employee’s
company was rewarding brokers who obtained new insurance business and sent the
taxpayer and his wife on the reward trip to New Orleans. In reassessing the employee,
the Minister allocated the cost of the trip between business and pleasure determining,
based on evidence about the events that took place throughout the trip, that thirty-
eight per cent of the employee’s cost could be allocated to business. The Tax Court of
Canada accepted the apportionment model, but found that only twenty per cent of the
cost of the employee’s trip was personal. In contrast, the Federal Court of Appeal
found that the employee did not receive anything of value in an economic sense. The
[Hart].
70 [1981] C.T.C. 91, 81 D.T.C. 5070 (EC.T.D.), aff’d [1982] C.T.C. 275, 82 D.T.C. 6237 (F.C.A.)
71 (1995), 9 C.C.PB. 213, [1995] T.C.J. No. 281 (Q.L.) (T.C.C.) [McMillan].
72 (1995), 7 C.C.PB. 59, [1995] T.C.J. No. 20 (Q.L.) (T.C.C.) [Dagenais].
71 (1995), 7 C.C.P.B. 96, [1995] T.C.J. No. 19 (Q.L.) (T.C.C.) [Cales].
71 IT-470R, supra note 57 at para. 11 provides, “In a situation where an employee’s presence is
required for business purposes and this function is the main purpose of the trip, no benefit will be
associated with the employee’s travelling expenses necessary to accomplish the business objectives of
the trip if the expenditures are reasonable in relation to the business function”
” [1996] 2 C.T.C. 33, 96 D.T.C. 6226 (EC.A).
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
289
court came to this conclusion by applying a principal purpose test, finding that the
principal purpose of the trip was business, not pleasure. The Federal Court noted in its
reasoning that its approach was consistent with the Revenue Agency’s position.76
The Revenue Agency’s position that a trip with business as its main purpose is not
taxable is not entirely unqualified. If an employee extends a trip that has business as
its main purpose “to provide for a paid holiday or vacation, the employee is in receipt
of a taxable benefit equal to the costs borne by employer with respect to that
extension.”” However, in these circumstances, the employee is not required to pay tax
on the value of the associated travelling expenses, for example, the airfare costs of
getting to the destination in the first place.
The principal purpose test is much too lenient with respect to these types of dual-
purpose trips. There is no reason for believing that an employee who travels mainly
for business receives no personal benefit whatsoever, or that an employee who is able
to attach a vacation to an employment-related business trip does not receive
significant benefits from the travel expenses incurred in getting to the destination.
Indeed, it could be argued that where an employee enjoys a vacation after conducting
employment-related activities at a particular destination, the full value of the airfare
incurred in travelling to the destination should be included in the employee’s income.
The fact that the employee takes a vacation at the location is a clear indication that she
personally values being there. However, an apportionment rule, although arbitrary,
would compensate for the fact that most people would not pay the full fair market
value of a flight to a destination they could not freely choose.
A sensible apportionment rule for the travel expenses would be based upon easily
verifiable facts, for example, by comparing the number of days that the employee
spent on employment-related activities with the number of days she spent on
vacation-related activities. Of course, this approach would require a number of
detailed, arbitrary rules and assumptions. For example, what if instead of three clear
employment-related days and three clear vacation-related days, the employee spent
each day partly on employment activities and partly on personal activities? A simple
solution would be to count the number of hours each day spent on business and then
to provide that for the purposes of the apportionment rule, seven hours equals one
business day. Thus, if an employee travelled from Toronto to Vancouver for five days
and spent fourteen hours on employment-related activities, two-fifths of the days
would count as business and three-fifths as personal. Such a rule may lead to arbitrary
results. For example, what if the employment activities occupied only two hours of
each day, but extended over a number of days, and the employee was not enjoying a
vacation, but was simply waiting for the next series of meetings? Or what if the
76 See also the earlier appeal level cases, which were decided based on an allocation: Hart, supra
note 70, and Philp, supra note 67.
” IT-470R, supra note 57 at para. 11.
290
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
employee spends an additional day in Vancouver at the employer’s request to receive
a reduction in the cost of the airfare? Again, an arbitrary rule might be developed-if
an employee stays an additional day to obtain a cheaper flight, such a day would
count as a business day.’
Combined employment-related and pleasure trips would appear to be an area
where there is a need for detailed, arbitrary rules to carve out the personal benefit that
employees derive from such trips. The rules will undoubtedly lead to some
inequitable results; however, overall, the results would be a good deal more
predictable and consistently applied than the present ad hoc apportionment rules and
would likely lead to more equitable results than the principal purpose test.
C. Clothing
Because everyone must wear clothes, there is an obvious personal expense.
However, some jobs have particular clothing requirements that have caused tax
authorities difficulty in determining whether or not the employee should be taxed
when an employer provides those clothes. For example, some employees are required
to wear protective clothing; many employees are required to wear uniforms; countless
employees are required to sport the clothing manufactured or sold by their employers;
and other employees are required to dress professionally in outfits that are more
expensive than they would otherwise purchase. If an employer provides these kinds of
clothing for employees, should the employee be required to pay tax on the value of
the clothes?
Under the current law, as a general rule, where an employer provides an employee
with clothing, the employee is taxed on its value. There would appear to be three
exceptions to this general rule. First, where employees are provided with special
clothing designed for protection, they will not be subject to tax. Second, where
employees are provided with distinctive uniforms, they will not be subject to tax.
These two exceptions are clearly set out in the Revenue Agency’s fringe benefits
interpretation bulletin:
An employee who is supplied with a distinctive uniform which is required to be
worn while carrying out the duties of employment or who is provided with
special clothing (including safety footwear) designed for protection from the
particular hazards of the employment, is not regarded as receiving a taxable
benefit.79
78 See Revenue Canada, Memo 9302375, “Extended Travel on Employer’s Business” (15 June
1993), where the Revenue Agency takes the position that the additional costs associated with the
Saturday stay may be deducted, but confirms that whether the benefit is taxable to the employee is a
question of fact to be determined in the circumstances.
71 IT-470R, supra note 57 at para. 29. Paragraph 30 deals with dry cleaning and permits an
employer to pay for the dry cleaning or other laundering of tax-exempt uniforms and special clothing
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
Third, where employees are required to wear particular clothing while performing
their duties and are unable to wear that clothing outside of the work environment, it is
possible that they will not be subject to tax when the employer provides that clothing.
This third exception was created by courts: for example, the supply of “plain clothes”
by a police department to police officers was held not to constitute a taxable benefit to
the recipient employeesY In a letter to the RCMP, responding to its request for
permission to provide tax-free plain clothes to its undercover police, the Revenue
Agency stated that to come within the third exception, the RCMP would have to
“meet the same factual situation” as the undercover police in the most recent case on
the issue, Huffman. The letter describes the facts in Huffman as follows,
In the performance of his duties, Mr. Huffman had to investigate industrial
accidents, drownings, fires, cave-ins and bodies found in fields and ditches,
including examining for fingerprints, footprints, blood stains and other physical
evidence. His clothes often became soiled, tom or contaminated with odours,
requiring frequent cleaning. It was necessary for him to wear a larger, looser
fitting jacket to accommodate the equipment he was required to carry
(notebook, badge and identification folder, billy club, pager, walkie talkie,
handcuffs and revolver, in a shoulder or waist holster).”
The general rule that employees should be taxed on the value of clothing provided
by their employers is appropriate. Where an employer provides employees with either
regular clothing or clothing that is similar to clothing that would be worn regularly,
but which is more expensive than employees would generally purchase (e.g., suits
worn by business people or professional clothing for teachers) employees should be
required to include the fair market value of the clothing in their incomes. Failing to
tax this kind of clothing would result in inequities since clothing would undoubtedly
only be provided to some employees. Although an employee might argue that she
would not purchase a suit in the absence of the employment, the provision of the suit
does relieve the employee of a personal expense. Although the clothing might be
more expensive than what the employee would normally wear, many people still
without tax consequences to employees. The Agency’s administrative position has been elaborated
upon in letters written in response to particular taxpayers, which take Huffman into consideration (see
infra note 80). See e.g. Revenue Canada, Memo 9801325, “Employer-Provided Clothing” (6 April
1998). See also Revenue Canada, Memo 9415455, “Employment Benefits-Special Clothing” (26
July 1994); Revenue Canada, Memo 9309165, “Clothing” (10 June 1993).
The Revenue Agency’s position on clothing has not changed since the 1964 Information
Bulletin, supra note 64, which stated at paragraph 4 that “[w]here an employee is supplied with a
distinctive uniform which he is required to wear while carrying out the duties of his employment or
where he is provided with special clothing designed to protect him from the peculiar hazards of the
employment, he is not regarded as getting a taxable benefit therefrom.”
80 See Shoveller v. Canada (M.N.R.), [1984] C.T.C. 2207, 84 D.T.C. 1195 (T.C.C.); Huffinan v.
Canada (M.N.R.) (1990), 71 D.L.R. (4th) 385, [1990] 2 C.T.C. 132 (F.C.A.) [Huffmnan].
” Revenue Canada, Memo 1991-157, “Plainclothes Allowance, Kit Upkeep Allowance for the
Royal Canadian Mounted Police” (16 September 1991).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
value that clothing. If an employer were able to provide some types of clothing tax-
free to employees, there would be a substantial incentive to change compensation
packages to provide clothing in lieu of cash.”
The first two exceptions from the taxation of employer-provided clothing
mentioned above-the provision of special clothing for protection and the provision
of distinctive uniforms-are also appropriate.” Protective clothing provided by
employers is analogous to providing employees with the equipment required to do
their job: for example, asbestos suits for those who work close to furnaces and space
suits for astronauts. This type of clothing provides employees with little personal
benefit and is unlikely to substitute in any significant way for personal clothing that
they would otherwise purchase. Moreover, it does not make sense to design a rule that
would discourage employers from providing employees with this kind of clothing.
Distinctive uniforms to employees-for example, workout clothing for aerobics
instructors, promotional shirts for servers, white uniforms for nurses, animal outfits
for mascots, and police uniforms for police officers-should also be exempt from tax,
but the case is not as obvious. On the one hand, as a result of the provision of a
uniform, employees are relieved from the expense of purchasing clothing that they
would have to wear at work and from the expense of wear and tear on their after-work
clothes. On the other hand, the horizontal inequities are not great since all employees
in particular industries likely either receive uniforms or not. Further, it is unlikely that
the tax-free provision of uniforms will cause vertical inequities. Uniforms are not
likely to be provided primarily to high-income employees. Also, presumably few
people would bargain to receive uniforms as part of their compensation package, so
the inefficiencies created by the nontaxation of employer-provided uniforms are
unlikely to be serious. The administrative problems caused by this exemption are not
severe since the category of clothing to which it applies is not hard to define. Finally,
if the provision of uniforms were taxed, in some cases it would be difficult to
determine the value of the uniform.
To ensure that the exemption for uniforms is not abused, however, strict rules for
its application should be developed and enforced. First, some aspect of the job should
require the clothing. Second, it should be a condition of employment that the uniform
cannot be worn outside of the workplace. ‘ Third, the uniform should be provided to
all employees of the particular group (in other words, in a non-discriminatory
82 Some commentators have argued that it might be reasonable for lawyers and accountants to
receive business suits tax-free from employers. See e.g. Vern Krishna, “Be Prepared to Pay Tax on
Your Perks as Well as Your Pay” The Globe andMail (16 September 2002) B10.
83 The distinctive uniform exception was supported by Canada, Douglas J. Sherbaniuk, Studies of
the Royal Commission on Taxation: Specific Types of Personal Income, no. 16 (Ottawa: Queen’s
Printer, 1967) at 69.
” The Canada Customs and Revenue Agency contemplates these requirements in some of its letters.
See e.g. Revenue Canada, Memo 9801325, “Employer-Provided Clothing” (6 April 1998).
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
293
fashion). Finally, it should be identifiable as a uniform-either because it would not
be possible to wear it outside of the employment place (e.g., it is a gym outfit for a
fitness instructor or a mascot uniform) or because it is printed with an obvious logo.
Where the “uniform” is simply a particular style or colour of pants and shirt, but
without any other identifying features, the outfit should not qualify for the exception. 5
Finally, the third exception, which permits clothing to be received tax-free if it is
required by the taxpayer’s employment and cannot be wom outside the work
environment, should be abandoned. The only possible explanation for this exception
is that the courts felt some special disposition towards plainclothes police officers. All
sorts of employees, particularly employees in agricultural and construction industries,
have to wear special work clothes that have features that make them inappropriate to
wear after work and that tend to wear out quickly. There is no obvious bright line that
distinguishes these clothes from the clothes wom by undercover police officers.
D. Subsidized Parking
As a component of their commuting cost, employees who drive to work often
need to pay for parking. In most cities, the cost of parking can be substantial; for
example, in the City of Toronto, a parking pass in the downtown core can cost up to
$500 a month. 6 Moreover, it may be difficult for employees to find convenient
15 The Australian government has grappled with this issue in the context of whether the cost of
corporate uniforms can be deducted under subsection 51 (1) of the Income Tax Assessment Act 1936.
In determining whether the uniform cost is deductible, the tax administration will look at a variety of
factors, including whether the objective of the uniform is to enhance the public image of the employer
and to act as an indirect form of advertising, whether the clothing may only be worn on official duty,
whether the uniform has a distinctive and unique look, whether the uniform is readily identifiable as
belonging to a corporate uniform, whether the number of colours and fabrics in the uniforms are
limited, whether there are only a limited number of styles of the uniforms, whether there are readily
identifiable logos, and whether the uniform is intended to last for a number of years. See e.g.
Australian Taxation Office, Income Tax Ruling IT 26/41, “Income Tax: Corporate Wardrobes and
Corporate Uniforms” (27 June 1991).
6As reported in The Financial Post,
One of the most common perks enjoyed by executives is the coveted parking space.
This seems like a freebie for the executives, but the Canada Customs and Revenue
Agency believes otherwise. The taxman has long believed parking provided by a
company constitutes a taxable benefit to the worker. The amount of this benefit is based
on the going rate for the space. And that rate can be quite high, especially in Canada’s
biggest cities. For example, a reserved underground space in Toronto’s BCE Place
approaches $500 a month. Multiply that by 12 months and the employee is facing a
taxable benefit of close to $6,000 a year, which, at the top marginal tax rate, would cost
him close to $3,000 in tax (Jamie Golombek, “Hey Mr. Taxman, Stay Away from My
Parking Space” The Financial Post (24 February 2001) C6).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
parking close to their place of employment. For these reasons, employers frequently
provide employees with free or subsidized parking.
As a general rule, employer-subsidized parking is treated as a taxable benefit and
employees are required to include its fair market value in their income.” Indeed,
employees will be held to have had a benefit conferred on them whether or not the
parking spot is used. In Richmond v. Canada (M.N.R.), the taxpayer’s employer
provided him with a parking spot, but as the employee lived close to the office, he
generally chose to walk to work; nevertheless, the court held that he had received a
taxable benefit.88 The value of the benefit was the value of parking in downtown lots
similar to the lot available to the employee. Although the fair market value of the
parking spot has been adopted in most cases as the appropriate value of the benefit, in
a recent case, the Tax Court of Canada deviated from this valuation method. In
Stauffer v. Canada (M.N.R.),89
taxpayers were employees of the federal
government who received reduced-rate parking at the University of Saskatchewan.
The court accepted the cost of the parking to the employer as the value of the benefit
to the employees-instead of the fair market value of the parking spaces.
the
There are at least three exceptions to the general rule that employer-provided
parking is a taxable benefit. First, employees are not subject to tax where they have to
“scramble park”. In other words, if an employer has more employees who are given a
right to a parking space than it has parking spaces (so employees have to scramble for
the parking spaces), the employees are not subject to tax on the value of the spots they
87 For example, the Tax Court of Canada held in Monteith that where a taxpayer was provided with
a reserved spot, the fair market value of the spot must be included in the taxpayer’s income: Monteith
v. Canada (M.N.R.), [1998] 2 C.T.C. 2281, 98 D.TC. 1306 (T.C.C.) (informal procedure). Free
parking is not addressed in the Canada Customs and Revenue Agency’s Interpretation Bulletin.
Instead, the parking policy is set out in the Canada Customs and Revenue Agency’s “Employers’
Guide-Taxable Benefits (2001-2002)” at para. 2.16 [“Taxable Benefits”]:
Employer-provided parking generally constitutes a taxable benefit to the employee,
whether or not the employer owns the lot. The amount of the benefit is based on the
fair market value of the parking minus any payment the employee makes to use the
space…. If you cannot determine the fair market value, do not add a benefit to the
employee’s remuneration. This could happen in the following situations: a business
operates from a shopping centre or industrial park, where parking is available to both
employees and non-employees; or an employer provides scramble parking (i.e., there
are fewer spaces than there are employees who require parking, and the spaces are
available on a first-come, first-served basis) [emphasis in original].
88 [1998] 3 C.T.C. 2552, 98 D.T.C. 1804 (T.C.C.) (informal procedure). Almost all of the cases on
parking benefits have been decided under the informal procedure, and they are therefore not binding
decisions. The only exception is Saskatchewan Telecommunications v. Canada (M.N.R.) (1999), 99
D.T.C. 1306,22 C.C.P.B. 74 (T.C.C.) [Saskatchewan Telecommunications].
89 [2002] 4 C.T.C. 2608, [2002] T.CJ. No. 494 (QL) (T.C.C.) (informal procedure).
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
use.’ Second, employees are not subject to tax where the fair market value of the spot
cannot be determined.’ Third, employees are not required to pay tax on the value of a
parking spot if they are regularly required to use their vehicles for employment-
related purposes. 2 The Revenue Agency recognizes the above three exceptions to the
general rule that employer-provided parking is a taxable benefit.
In a recent Tax Court of Canada case, a fourth exception might have been created.
In Chow v. Canada (M.N.R.), 3 the employer provided its employees with free parking
on a first-come, first-served basis because they were required to work either rather
early (beginning at 5 a.m.) or rather late (ending at 8 p.m.). If the employees did not
drive their cars, the employer reimbursed the employees for taxi expenses. The court
held that the parking was not a taxable benefit to the employees because the employer
was able to save taxi costs when employees brought their own cars and parked them.’
In a response to this case, the Revenue Agency noted that “it was heard under the
informal procedure and the decision was based on specific facts. We feel that this
decision will be limited in its application because of the particular facts.” 5
Commuting costs-such as the depreciation of the commuting vehicle, the cost of
fuel, vehicle insurance, and vehicle repairs-are personal expenses since they
originate in the personal decisions of employees to live at a distance from their place
of employment. Parking expenses are no different from other costs of commuting.
The inequities created by not taxing parking benefits are particularly serious since the
benefits are easily provided to only some groups of employees-for example,
executives and other high-income employees. In addition, but just as importantly, not
taxing parking benefits can create perverse incentives. The true cost of driving to
work is not reflected in the cost of automobiles, gas, parking, and other costs related
to commuting. Driving in most large cities generates large social costs, such as
increased pollution and traffic congestion. Instead of receiving an implicit subsidy,
employees who drive to work should bear an additional tax cost to compensate for
these external costs of their commuting.
90 Only a few of the Revenue Agency’s letters address the meaning of “scramble parking”. In the
Revenue Agency’s view, where “the number of people working per shift is close to the total parking
spots available … [and] it is likely that not all employees would bring their cars” the parking will not
be scramble parking: Canada Customs and Revenue Agency, Memo 2000-0022565, “Scramble
Parking” (6 October 2000).
” “Taxable Benefits”, supra note 87.
12 Saskatchewan Telecommunications, supra note 88.
[2001] 1 C.T.C. 2741, 2001 D.T.C. 164 (T.C.C.) (informal procedure).
9 Canada Customs and Revenue Agency, Income Tax Technical News No. 22, “Employee
Benefits” (11 January 2002).
” Ibid. While the value of the case may be limited because it has no precedential weight, it does not
appear that the fact pattern itself is particularly restrictive. In fact, many employers could likely argue
that providing free parking “primarily benefits” the employer, particularly where the employer would
otherwise pay for taxis.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
In light of these compelling reasons for taxing parking privileges, there should be
no exceptions to the general rule that parking benefits provided to employees are
taxed at their fair market value. The scramble parking exception is presumably
justified on the grounds either that it is difficult to determine the value of the benefit to
all employees (what is the value of a parking spot you may only be able to obtain
sometimes?) or that it is difficult to track which employees actually receive the
benefit. These justifications are not persuasive. Employees who receive a parking
spot, even if they have to scramble to get it, still receive a benefit. The Revenue
Agency could easily require employers to keep track of who actually parks in the lot
each day. If this solution were perceived to be too administratively burdensome,
employees could be taxed in proportion to the number of employees who potentially
use the space. In other words, if there are one hundred employees who commute
using vehicles and there are only fifty parking spaces available, the Revenue Agency
could require employees to be taxed as though they received a parking spot every
other day.
It is hard to imagine the circumstances in which the second exception-which
applies where the fair market value of the spot cannot be determined-might be
appropriate. In most cases, parking lots are plentiful and comparative parking prices
are easily obtained. Furthermore, even if determining the fair market value is difficult
because there are no comparable parking lots, almost any reasonable estimate of value
would be closer to the real value than the assumption that the parking privileges have
no value. Of course, if the employer were providing employees with parking that
would otherwise be free-which could conceivably be the case at a remote industrial
location or a small town where the parking is available to everyone free of charge-
and if providing space for parking had no opportunity cost to the employer, it would
have no fair market value, or the value would be so small that as an administrative
matter it should be ignored. In all other cases, the employer should have to make a
reasonable estimate of the value of free parking provided to employees.
to use
The employment-related purpose exception is also unjustified. This exception
could be based on only two possible grounds. First, it might be justified on the basis
that if employees have
their automobiles during working hours for
employment-related purposes, they derive no personal benefit from having parking
privileges. Second, it could be said that the personal benefit of receiving a parking spot
is diminished to a nominal amount for employees who are required to use their vehicles
during their employment since they have no choice as to whether to commute to work
and as to where to park. They must bring their cars to work, and they must park close to
their employer’s place of business. However, neither of these justifications is credible.
Commuting costs, including the costs of parking, are personal because employees who
commute are assumed to have made a personal decision to live at a distance from their
place of employment. The fact that they are required to drive their cars to work for
employment-related purposes does not change the personal nature of the commuting
expenses. Also, the involuntary nature of the vehicle use does not mean that the
employees do not value the spot at its fair market value.
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
E. Trips Taken with Frequent Flyer Points
Many employees are required to travel by air as part of their employment-to
participate in meetings, attend conferences, or market their employer’s goods and
services. These employees are often members of frequent flyer plans that provide
travellers with points for each trip taken. The points may be based on miles travelled,
dollars spent, or a combination of the two. Employees hold the memberships in these
plans as individuals (in fact, airlines do not permit employers to hold plans in the
name of the company). Eventually, employees are able to cash in their accumulated
points and receive free flights or other awards.
Taxing authorities have had difficulty determining how to tax frequent flyer points
earned on business travel. Many jurisdictions have abandoned their attempts to tax
these benefits in the face of perceived administrative and political pressures. 6 In the
the Internal Revenue Services struggled with the difficulty of
United States,
developing and enforcing measures for taxing business-travel earned frequent flyer
flights,97 and recently announced that it plans to stop trying. In Australia, the Tax
Commissioner initially ruled that employees were required to include in income the
value of a free flight taken on points accrued as a result of work-related travel.”
However, the Federal Court subsequently held that such benefits were not granted in
respect of the employee’s employment and, therefore, were not taxable income.’
In Canada, the Revenue Agency has always insisted that the fair market value of
the airline tickets received for cashing in points accumulated while travelling on
96 Taxing employees on the value of flights taken by cashing in business-earned frequent flyer miles
is unpopular. Giffen v. Canada (M.N.R.), [1995] 2 C.T.C. 2767, 96 D.T.C. 1011 (T.C.C.) [Giffen], a
case on the taxation of frequent flyer points when redeemed, must be one of only a few Tax Court of
Canada cases to be reported on CBC’s The National. The focus of Ian Hanomansing’s report on The
National (CBC television broadcast, 29 April 1996) was Canadians’ lack of awareness about the
Revenue Agency’s position, and the likelihood that most taxpayers do not actually report or pay tax
on their benefits.
” See Kathy Krawczyk & Lorraine Wright, “How Should Frequent Flyer Miles Be Taxed?” (1998)
79 Tax Notes 1029. See also M. Bernard Aidinoff, “Frequent Flyer Bonuses: A Tax Compliance
Dilemma” (1986) 31 Tax Notes 1345; Sharon Alice Pouzar, “Notes & Comments: Frequent Flyer
Awards as Taxable Income: Time to Pay the Taxman” (1998) 5 Tex. Wesleyan L. Rev. 55. All of these
commentators review the uncertainties surrounding the tax status of frequent flyer miles in the United
States and urge clarification.
” See U.S., Internal Revenue Service, “Frequent Flyer Miles Attributable to Business or Official
Travel” (Announcement 2002-18), which confirmed that frequent flyer points earned on business
travel would not be subject to tax when cashed in for personal use.
” Australian Taxation Office, Tax Ruling TR93/2, “Income Tax and Fringe Benefits Tax: Benefits
Received Under Frequent Flyer and Other Similar Consumer Award Type Programs” (7 January
1993). Now withdrawn.
‘0o Payne v. Australia (Commissioner of Taxation) (1996), 66 EC.R. 299, 96 A.T.C. 4407 (EC.A.).
298
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
employer-paid trips is to be included in an employee’s income.”‘ This position was
upheld in what has now become one of the most frequently referred to Canadian cases
on fringe benefits, Giffen.’ 2 Similarly, where the employee’s family uses the points,
the fair market value of the benefit received by the employee’s family is to be
included in the employee’s income. If the employer does not control the number of
points accumulated under a plan (which is generally the case), the employee is
responsible for keeping track of the points earned and used and reporting the fair
market value of any tickets awarded on the points earned on employment-related trips.
Taxing employees on the value of the flights they take when they cash in
employment-earned frequent flyer points is correct from both from an equity and an
efficiency perspective. From an equity perspective, employees clearly value their
frequent flyer points earned on business travel.’ 3 They plan when to use them on
personal flights and delight in the free vacations they are able to take. “34 Frequent flyer
miles, however, are not awarded to all employees, or even many employees. Also, not
all employees who earn awards are able to use them. Some employers require their
employees to use the frequent flyer points only for business flights. Moreover, the
awards tend to be garnered by high-income employees who are required or able to fly
as a result of their employment. None of the concerns about employees’ being forced
to consume certain in-kind benefits apply to frequent flyer points. Even though the
employees may be required to fly as part of their employment, they are not required to
‘0’ See IT-470R, supra note 57 at para. 14, which states:
Under this program, which is usually sponsored by an airline, a frequent air traveller
can accumulate credits which may be exchanged for additional air travel or other
benefits. Where an employee accumulates such credits while travelling on employer-
paid business trips and uses them to obtain air travel or other benefits for the personal
use of the employee or the employee’s family, the fair market value of such air travel or
other benefits must be included in the employee’s income. Where an employer does
not control the credits accumulated in a frequent flyer program by an employee while
travelling on employer-paid business trips, [the employer will not be required to
determine the value of the benefit and report that benefit on the T4 slip,] and it will be
the responsibility of the employee to determine and include in income the fair market
value of any benefits received or enjoyed.
102 Giffen, supra note 96.
’03 See Adams v. Comark Inc., [1992] 5 W.W.R. 306, 42 C.C.E.L. 15 (Man. C.A.), where an
employee refused to abide by an employer’s change in policy, which would require all frequent flyer
points be used on business flights. In that case, the court found that the value of the frequent flyer
points earned by the employee on business-related travel was about ten per cent of the employee’s
salary.
fact, in one study conducted in the United Kingdom, the researcher found that the frequent
flyer miles were generally overvalued by individuals. See Catherine Liston-Heyes, “Pie in the Sky?
Real Versus Perceived Values of Air Miles” (2002) 25 J. Consumer Pol’y 1 at 20.
‘0In
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
cash in or use their frequent flyer points for personal travel. The flights have a market
value (the price of the flight), and so do the points themselves. 5
From an efficiency perspective, the case for taxing frequent flyer points is strong.
In addition to the general economic inefficiencies created by the nontaxation of fringe
benefits, a number of particular inefficiencies arise when frequent flyer points are not
taxed. Presumably, the prices of tickets sold to business people are inflated to take into
account the fact that many business people receive free flights from the accumulation
of frequent flyer points.’ 6 In this way, the airlines are able to maximize profits by
overpricing business flights (where businesses will bear the additional costs in part
because employees receive the perk of frequent flyer points) while providing
subsidized tickets to passengers who might otherwise not pay the full fare for travel. 7
In other words, businesses pay more than what might be the fair market value of the
tickets because there is a bonus for employees who receive the frequent flyer points.
The system itself encourages employees to travel inefficiently. Employees are
rewarded for taking longer flights, flying on more expensive tickets, or flying at peak
times.”‘ Gene Steuerle, a senior fellow at the Urban Institute, argues that airlines
would be more efficient if they did not offer frequent flyer programs at all, but instead
used more direct methods of implementing price discrimination. He states that “[t]he
worst aspect of the competition is that it encourages employees to purchase more
expensive travel as a means of increasing their own compensation. No firm would
think of awarding bonuses to employees purchasing more expensive inputs for the
firm. Yet this is exactly what frequent flier miles do … The non-taxability of the
,o A recent article in The Economist reports,
The world has a new international currency: frequent flyer miles. Launched exactly 21
years ago, they are a lot like money. Collectors check their mileage statements as
keenly as their bank statements. American courts often place a value on mileage
balances in the course of divorce settlements. In a recent poll of frequent travellers,
two-thirds said that they see frequent-flyer miles as the next best thing to actual cash …
(“Airline Miles: Frequent-Flyer Economics” The Economist (4 May 2002) 15 at 15).
As argued by Richard Bird, “few would doubt that the cost of the giveaway has been factored
into the price of the merchandise and services purchased to earn the bonus or reward” (Richard W
Bird, “The Legality of Frequent Buyer Plans” (2002) 81 Can. Bar Rev. 1 at 2).
‘ Jonathan Forman states that “[firequent flyer programs are basically just complicated discounts
for the purchase of multiple airline tickets.” This point also rebuts the argument that the frequent flyer
points are provided to taxpayers as a “gift” for their repeated patronage-someone must be paying for
that gift! (Jonathan Barry Forman, “Income Tax Consequences of Frequent Flyer Programs” (1985)
26 Tax Notes 742 at 742).
” One survey concluded that 25 per cent of frequent flyers admitted they took unnecessary trips.
That study was reported in David W. Arnesen, C. Patrick Fleenor & Rex S. Toh, “The Ethical
Dimensions of Airline Frequent Flier Programs” (1997) 40 Bus. Horizons 47 at 48. See also Keith
McArthur & Gordon Pitts, “Fliers, Airlines Love Their Point Programs: Business People Take
Unnecessary Trips, Carriers Make Money on Unsold Seats” The Globe and Mail (1 February 2003)
B1.
300
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
additional compensation adds further to the incentive, but is not the principal
component.”‘” The general inefficiencies created by frequent flyer point systems have
been the subject of considerable study.'”
The only plausible argument supporting the nontaxation of flights taken with
frequent flyer points earned on employer-related business is the difficulty of valuing
them. But these administrative concerns do not outweigh the equity and neutrality
considerations. Flights taken by employees using frequent flyer points are difficult to
value because airlines offer such a wide range of prices for the same trip. Airlines
develop a broad range of prices in order to price discriminate among customers with
different elasticities of demand for their services (e.g., students, business persons,
vacationers, and last-minute
travellers). As a result of these various pricing
techniques, the fair market value of a trip taken by an employee using frequent flyer
points is admittedly not obvious.
In Giffen, the Tax Court of Canada offered a workable solution to the valuation
problem. The court accepted a value that best reflected the amount the taxpayer would
have paid to receive a ticket on the same flight, in the same class, and with the same
kinds of restrictions as the free ticket the taxpayer received.”‘ This holding is in line
with the Revenue Agency’s position, which simply provides that the employee has to
report the fair market value of any benefit received. In Giffen, there was an additional
administrative difficulty because one of the taxpayers used a first-class seat in his
personal travel. First-class seats usually are not discounted. However, the court found
an equitable way of valuing the seat by providing that the taxpayer was required to
include in his income the value of the first-class seat multiplied by the proportion of
the price of the most discounted seat in economy class to the price of a regular
economy seat fare.
Commentators who favour the nontaxation of frequent flyer points have argued
that Giffen will require an inordinate amount of work on the part of taxpayers to
,o Gene Steuerle, “Frequent Flier Miles: Cheating Employers Is the Issue” (1995) 69 Tax Notes
1539 at 1539. See also Gene Steuerle, “Frequent Flyer Miles: The Issue Is More than Taxes” (1993)
60 Tax Notes 121.
10 Other arguments address some of the difficulties with frequent flyer plans more generally,
including evidence that the plans significantly diminish competition because they create strong brand
loyalty. See e.g. Amesen et al., supra note 108 at 48-49. There are also ethical and accounting
concerns about the legality of frequent flyer plans. See e.g. Michael Y Hu, Rex S. Toh & Stephen
Strand, “Frequent-Flier Programs: Problems and Pitfalls” (1988) Bus. Horizons 52. Finally, for a
discussion of the possibility that the plans violate criminal laws, see Bird, supra note 106.
” After the case was decided, the Revenue Agency issued a statement commenting on the method
of valuation. The statement provides that “[t]he Department considers that the method of valuation
adopted by the Court was not unreasonable and did not warrant an appeal” (Revenue Canada,
Release 95-35, “Employee Benefits-Frequent Flyer Points” (17 November 1995) [emphasis in
original]).
2004]
K BRooKs – THE TAXATION OF IN-KIND BENEFITS
determine the value of their flights.’12 Tad Brown and David Wentzell suggest that to
determine the value for tax purposes of a business ticket, the taxpayer would have to
determine the cost of the full-fare business class ticket for that flight, the cost of a full-
fare economy class ticket for that flight, and the cost of the most heavily discounted
economy class fare on that flight.”3 Airlines may not provide this information.”‘
Commentators have also argued that it will be impossible for taxpayers to keep the
points they earn on personal and business flights separate.’ 5
While administrative difficulties exist, if the approach in Giffen is seen to be too
unwieldy, there are other alternatives to the valuation of frequent flyer points. For
example, airlines or travel agents who disclose reward tickets to passengers based on
their points under frequent flyer plans could be required to provide a fair market value
of that free flight to the taxpayer for tax purposes. Another alternative would be to
value frequent flyer points at their purchase price. In fact, anyone can purchase
frequent flyer points over the Internet.”‘ The cost of purchasing the number of
cashable points required to buy the flight identical to the one that an employee took
on her points would be the value of the employee’s benefit.”‘ To ensure that taxpayers
are only taxed on their work-derived points, taxpayers could keep two frequent flyer
plans–one to be used when business expenses are incurred and one when personal
expenses are incurred. Finally, employers could implement policies permitting
employees to redeem their points earned through work-related travel only on work-
related travel.”‘
2 See W.G. Tad Brown, “No Free Trip”, Comment (1996) 44 Can. Tax J. 149; Bruce D. McCarley
& Sheri J. Evans, “Recent Developments in the Taxation of Employment Income” in British
Columbia Tax Conference: Update on 1995-1996 Developments and Tax Planning Strategies
(Toronto: Canadian Tax Foundation, 1996). In contrast to the Canadian practitioners who have
commented on this issue and who are generally in favour of nontaxation, at least some American
practitioners have argued in favour of taxation. See e.g Aidinoff, supra note 97.
“,3 Brown, ibid. at 152.
” McCarley & Evans (supra note 112 at 11-29) similarly suggest that this approach to valuation is
impractical, although creative.
” See e.g. Vern Krishna, who argues that the requirement that employees keep track of their
personal and business related points is “an entirely unreasonable expectation and most taxpayers will
simply ignore Revenue Canada’s call to turn Canada into a nation of bookkeepers” (Vern Krishna,
“Around the Courts: Frequent Flyer Points” (1996) 6 Can. Curr. Tax 69 at 70).
16 The Economist reported the average price of a frequent flyer point to be somewhere between two
and nine cents (“Airline Miles: Frequent-Flyer Economics”, supra note 105).
“‘ The best price for consumers who purchase air miles from Air Canada over the Internet from the
Aeroplan web page is three cents per mile. A return flight from Toronto to Vancouver requires
“cashing in” 25,000 air miles. Therefore, the cost of a purchased air miles flight from Toronto to
Vancouver is approximately $750.
. The federal government recently changed its policy to permit its employees to collect frequent
flyer points for personal use. The government was quick to note that the employees would be required
to pay tax on the value of the flights they subsequently take. In deciding to permit employees to
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
To date, the Revenue Agency has resisted pressure to revise its assessing position,
and it should continue to resist these pressures.’9 The inequities and inefficiencies
created by
the
administrative difficulties are not insurmountable. In fact, most of the inequity and
inefficiency in this area is created because of the non-enforcement of the Revenue
Agency’s position.
the nontaxation of frequent flyer points are significant, and
F Discounts on Goods and Services
It is often the policy of an employer to provide employees with the product or
service sold by the employer at a discount. In some circumstances, the ability to
purchase goods at a discounted price may even be a critical part of the employment
contract. Discounted prices for merchandise or services purchased by employees can
serve the needs of both the employer and the employee: the employer may benefit
from the employees’ using company products while the employee benefits from the
lower price of the good or service.
Generally, employees are not required to pay tax on the discount they receive on
goods or services from their employer. The only exceptions to this general rule are
when a particular employee or select group of employees has an extraordinary
arrangement with the employer or where an employee can purchase merchandise for
less than the employer’s cost.’
collect frequent flyer points, the government noted the many additional perks that frequent flyers
receive—expedited check-in, use of the airline lounges (which include free food and beverages), as
well as free personal flights. Strangely, in this case, it was Walter Robinson, the federal director of the
Canadian Taxpayers Federation, who worried “that the policy change could result in higher travel
costs with taxpayers footing the bill.” The inefficiencies created by frequent flyer plans became a
significant concern for Robinson in this context, even though the benefit would be taxed: Keith
McArthur, “Bureaucrats to Receive Travel Perk” The Globe and Mail (1 June 2001) A4.
“‘ In fact, there has been very little discussion of the taxation of frequent flyer points in Canada
since the release of Giffen (supra note 96) and the short flurry of activity afterwards. One might
assume this is because the Revenue Agency does little to enforce the law in this area.
,”01T-470R, supra note 57 at para. 27, which provides:
Where it is the practice of an employer to sell merchandise to employees at a discount,
the benefits that an employee may derive from exercising such a privilege are not
normally regarded as
taxable benefits. However, this does not extend to an
extraordinary arrangement with a particular employee or a select group of employees
nor to an arrangement by which an employee is permitted to purchase merchandise
(other than old or soiled merchandise) for less than the employer’s cost. Furthermore,
this treatment does not extend to a reciprocal arrangement between two or more
employers whereby the employees of one can exercise such a privilege with another by
whom the employees are not employed. A commission received by a sales employee
on merchandise acquired for that employee’s personal use is not taxable. Similarly,
where a life insurance salesperson acquires a life insurance policy, a commission
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
303
For the purposes of the Revenue Agency’s administrative policy, however,
discounts generally are distinguished from discounts in the transportation industry.
Airline passes available to airline employees are not taxable unless an employee
travels on a space-confirmed basis and is paying less than fifty per cent of the
economy fare. Where the employee travels under these conditions, she will be taxed
on the difference between the amount paid and fifty per cent of the economy fare.
Employees of bus or rail companies are not taxed on the use of passes, and retired
employees of transportation companies are not taxed on pass benefits at all.’2′
received by that salesperson on that policy is not taxable provided the salesperson owns
that policy and is obligated to make the required premium payments thereon.
The policy articulated in paragraph 27 is the same as that set out in paragraph 1 of 1964 Information
Bulletin, supra note 64, which stated that
[t]he benefits that may be derived by an employee from exercising such a privilege are
not regarded as taxable benefits. This does not extend to an extraordinary arrangement
that may be made with a particular employee or select group of employees nor to an
arrangement by which an employee is permitted to purchase merchandise (other than
old or soiled merchandise) for less than the employer’s cost.
The Revenue Agency has denied the extension of this policy to discounts on homes provided to the
employees of residential construction companies: Revenue Canada, Memo 9318945, “Employee
Discounts-Sale of Homes to Employees at a Discount” (26 November 1993). Similarly, discounts to
employees of automobile insurance companies on automobile insurance have been held to be taxable
as have wavers of banking fees: Revenue Canada, Memo 1991-103, “Employee Discounts-
Automobile Insurance Premiums” (January 1991); Revenue Canada, Memo 9520365, “Employee
Benefit from Free Banking Services” (12 September 1995). Promotional items and items sold at less
than cost are also taxable: Revenue Canada, Memo 9607447, “Promotional Beer” (8 May 1996);
Revenue Canada, Memo rrrr284, “Taxable Benefits–Sale of Merchandise to Employees at Less than
Employer’s Cost” (30 May 1990).
121 IT-470R, ibid. at paras. 42-44. Those paragraphs state:
42. Airline passes available to airline employees will become taxable only if the
employee travels on a space-confirmed basis and is paying less than 50 per cent of the
economy fare available on that carrier for that trip on the day of travel. The value of the
benefit will be the difference between 50 per cent of the economy fare and any amount
reimbursed to the carrier for that trip.
43. Employees of bus and rail companies will not be taxed on the use of passes.
44. Retired employees of transportation companies will not be taxed on pass benefits
under any circumstances.
Letters to specific taxpayers are consistent with the position taken in the Interpretation Bulletin. See
e.g. Canada Customs and Revenue Agency, Memo 2002-0116934, “Airline Passes” (4 February
2002); Revenue Canada, Memo 9907048, “Taxable Benefit, Free Airfare” (27 May 1999).
The position set out in IT-470R (ibid.) is much more restrictive than the original exemption set
out in 1964 Information Bulletin (ibid. at para. 2): “Where, in the transportation industry, an employee
is given the privilege of a free pass for himself and his family on vehicles operated by his employer,
he is not regarded as receiving a taxable benefit.”
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
When employees purchase their employer’s goods and services at a discount, they
have received a personal benefit. The nontaxation of this benefit, therefore, results in
inequities. Such benefits might be widely provided to employees
in particular
industries; however, the benefits are not required for employees to do their jobs and
they are obviously not available to the great majority of employees who are not in
industries that traditionally offer such benefits. In addition, the nontaxation of
discounts on employer goods and services may lead to changes in compensation
packages, and employees will be encouraged to purchase more of the discounted
good or service than they would normally purchase. Finally, there are no significant
administrative barriers
to the taxation of employee discounts. Presumably, the
employer knows the retail price of the good or service for sale and can keep track of
the number of goods or services purchased by a particular employee at a discount.
This is no more than what is required in their regular business practice.
The Revenue Agency should reconsider its position on employee discounts.
Choosing to value discounts only where the discount is greater than the cost to the
employer ignores the value of the benefit to the employee.’22 Presumably, this position
is justified on the basis either that employees are likely to value the goods and
services of their employers less than the general population, or that employees are
required to purchase these goods and services and therefore the value should be
discounted because its receipt is involuntary. For many of the people who purchase
their employer’s goods or services, it is more reasonable to assume that the fair
market value is the best approximation for these employees’ valuation of the particular
good or service. For example, it seems more reasonable to assume that a person who
works for a computer company would like computers and would value them at their
fair market value than it would be to make that assumption about the general
population. Also, although it may be advantageous for employers to have employees
using their goods or services, that aid to employers does not diminish the value of the
good or service to employees.
The case against the nontaxation of discounts is most compelling in the airline
industry, where the most generous policy applies. In that industry, presumably,
employees accept lower salaries because of the benefit of low-cost (and in retirement,
free) flights. One would imagine that the kind of people who are drawn to work in the
airline industry are probably people who enjoy travel and who value travel benefits
“2 Other commentators have proposed valuation approaches for discounts other than fair market
value. For example, William Vickrey has suggested that an arbitrary percentage, 40 per cent or 60 per
cent, of the fair market value could be used. Like the Revenue Agency, Vickrey fails to justify this
suggestion, other than on purely administrative grounds. Vickrey assumes that the value of these in-
kind benefits must be less than fair market value (but with no justification for that assumption) and
from that conclusion suggests the arbitrary percentage of fair market value as appropriate (William
Spencer Vickrey, Agenda for Progressive Taxation (New York: The Ronald Press Company, 1947) at
42).
2004]
K BROOKS – THE TAXATION OF IN-KIND BENEFITS
305
highly.2 Thus, the policy of the nontaxation of benefits from discounted or free
flights effectively results in a government subsidy of salaries to employees of airlines.
Who actually obtains the benefit of this subsidy-employers or employees-will
depend on the relative bargaining strength of each group.
Generally, discounted goods or services purchased by employees should be taxed
at their full fair market value in the hands of the employee.2 ‘ If the good or service is
not worth the full fair market value to the employee, then she should not be
encouraged to purchase it. The fair market value of most goods and services should
be easy to determine as generally they will be goods and services provided by the
employer
in the marketplace. Where there are restrictions on the discounted
merchandise that the employee may purchase-for example, where an airline
employee can only purchase tickets on a standby basis-then those additional
restrictions should be reflected in the fair market value. Indeed, at present, the
Revenue Agency’s approach to valuation of airline employees’
travel in vacant
seats-where the Revenue Agency says there is no taxable benefit to the employee
“in view of the difficulty in calculating the amount of employee benefit under the
circumstances'”-appears inconsistent with its position on the value of trips taken
with frequent flyer points. It is hard to believe that the value cannot be calculated, and
one suspects that this exemption is based entirely on political expediency.
Conclusion: Confounding Kleinwiichter-Delimiting the Concept
of Income
The potentially daunting task of taxing in-kind benefits was illustrated in the
introduction to this paper by reference to Kleinwichter’s conundrum: how to impose
tax equitably as between an ordinary military officer, who experiences an austere
military lifestyle while on the job, and a Fliigeladjutant to the sovereign, who receives
the same salary as the ordinary military officer, but who is able to enjoy many aspects
of the sovereign’s extravagant lifestyle while on the job. Simons despaired that the
problem posed by Kleinwichter’s conundrum was hopeless.
The Fliigeladjutant receives lodging in the palace, dines at the royal table, has
access to the royal horses for sport, is assisted by servants, and attends the theatre and
opera with the sovereign. To make the tax solution to the problem even more
disheartening, Kleinwachter asks us to assume that the Fliigeladjutant detests opera
and hunting. How can these differences in the personal consumption of the ordinary
military officer and the Flugeladjutant be reflected in the taxable income of each? The
23 This assumption is also made in “Federal Income Taxation”, supra note 27 at 1163, which
similarly advocates for the taxation of retail discounts and free flights to airline employees.
24 See also Sherbaniuk, supra note 83 at 67-68, and Ireland, Commission on Taxation, First Report
of the Commission on Taxation: Direct Taxation (Dublin: The Stationery Office, 1982) at 192.
” Canada Customs and Revenue Agency, Memo 2002-0116934, supra note 121.
306
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
answer is, of course, that no tax system will ever accomplish this goal perfectly.
However, it is possible to sensibly and fairly delimit the concept of income in the
context of the taxation of in-kinds benefits by developing guidelines based upon the
traditional tax policy criteria. In their application to specific types of in-kind benefits,
these guidelines result in the development of a matrix of detailed rules that
appropriately balance equity, neutrality, and administrability.
Can Kleinwachter’s conundrum be resolved on the basis of the guidelines
suggested in this paper? The quarters in the palace and the food at the royal table
should be subject to tax. Each provides the Fifigeladjutant with a clear personal
benefit. These types of in-kind benefits are perfect examples of benefits that would
have to be acquired in the absence of employment: everyone has to eat and be lodged.
In addition, they are not provided widely to employees. If they were not taxed,
compensation packages in many jobs could easily be adjusted to include analogous
benefits. Admittedly, they do not have a readily determinable fair market value: meals
that are required to be eaten with a sovereign and year-long lodging in a palace are not
commonly bought and sold. Nevertheless, the forced consumption of these goods and
services does not make them worthless. A reasonable value could be assigned to them
by reference to similar meals and lodging.
The FhIigeladjutant should also be taxed on his use of the royal horses for sport.
This is the kind of service for which many individuals pay substantial amounts
outside of an employment setting, and the use of the horses for sport would not appear
to be required by the Fliigeladjutant’s employment. If he does not enjoy the use of the
horses enough to be willing to pay tax on the value of the time he spends riding, he
can always decline the benefit altogether.
Whether the Fifigeladjutant should be taxed on the value of the servants he uses
will depend on the use he makes of them. Do they simply assist him in discharging his
responsibilities to the sovereign, or are they available to assist him with his personal
responsibilities such as washing and pressing his ordinary street clothes, running
errands, and assisting with personal grooming? In this latter case, the services of the
servants should be a taxable benefit. These are personal activities for which every
taxpayer should have to pay out of their after-tax income.
Whether the Flfigeladjutant should be required to include the value of the tickets
to the theatre and opera in his income will depend upon his responsibilities while
attending these events. On the one hand, if he is required to protect the sovereign at
these events, by being fully alert to possible threats and by keeping a watchful eye on
the audience, his position is similar to that of a critic at the theatre or opera or a sports
broadcaster at a sporting event. In this case, the value of the tickets should not be
taxable. It might reasonably be assumed that the nature of the activities he is required
to perform while attending the theatre and opera detracts substantially from his
personal enjoyment. Moreover, the enjoyment he might derive is little different from
the enjoyment that many employees experience from their work. On the other hand, if
he merely attends as a companion, the value of the tickets should be included in his
2004]
K. BROOKS – THE TAXATION OF IN-KIND BENEFITS
307
income. It can be assumed that simply being required to attend with the sovereign
does not sufficiently detract from the entertainment
to justify nontaxation. His
situation in this case is little different from that of an employee who has to accompany
clients to sporting and entertainment events. The value of attending those events
should be included in the income of the employee. The fact that the Fliigeladjutant is
required to attend these events as part of his employment is beside the point. If he
derives a personal benefit from the events, the value of the benefit should be included
in his income.
Finally, whether the Fliigeladjutant has a personal preference for any of these
perks is irrelevant to the question of taxation. His enjoyment (or not) is not the
measure of his income; “the market value of rights exercised in consumption” is the
measure of his income, and that measure operates without regard for his personal
tastes. If the FIigeladjutant does not enjoy the personal benefits he receives from his
employment, or at least if their value to him is not equal to the tax he has to pay on
their fair market value, he should bargain for different remuneration. Ultimately, then,
Kleinwdchter’s conundrum presents reasonably solvable problems when the concept
of income is appropriately delineated.
This paper has shown that a sensible set of guidelines, derived from the general
principles underlying the income tax, can be used to formulate reasonable rules for
the taxation of common in-kind benefits-such as the provision of educational
courses leading to a university degree, combined employment-related and pleasure
trips, clothing, subsidized parking,
trips taken with frequent flyer points, and
discounts on goods and services. The present tax law and administrative practice
governing the taxation of in-kind benefits are often inequitable, in many cases lead to
socially wasteful employee compensation, and frequently reflect a profound
misunderstanding of basic tax principles. The courts and the Revenue Agency should
use guidelines such as those formulated in this paper to develop a rational and
consistent set of rules applicable to the full range of in-kind benefits that employers
provide to employees.
