Citation: 2008TCC350
Date: 20080612
Docket: 2006-2517(IT)G
BETWEEN:
1338664 ONTARIO LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Woods J.
[1] The issue in
this appeal is whether a family-owned corporation was correct to report gains
and losses from securities’ transactions on capital as opposed to income
account.
[2] In its returns
of income for taxation years ended May 31, 2001 and 2002, the appellant, 1338664 Ontario
Limited, reported capital gains in excess of capital losses from securities’ transactions
in the amounts of $341,750 and $511,640, respectively. Both amounts have been
reassessed as business income.
[3] The assumptions
relied on by the Minister of National Revenue in making the assessments, as set
out in the reply, are reproduced below.
10. In so reassessing the Appellant, and also in confirming the
reassessment, the Minister proceeded upon the same assumptions of fact as
follows:
a)
the Appellant was incorporated in February, 1999, and reported to be in
the business of flooring and carpeting work, with its fiscal year ending
May 31st;
b)
the Appellant’s sole shareholder for the year ending May 31, 2001, was
the Gus George Family Trust;
c)
for the year ending May 31, 2002, the Appellant’s sole shareholder was
Gus George;
d)
at all material times, Gus George was the Appellant’s President and sole
employee;
e)
Gus George, having had traded actively in securities in his personal
capacity, was very experienced and knowledgeable in stock markets;
f)
the Appellant ceased all its flooring and carpeting activities in its
2000 fiscal year, and no such activities were conducted in its 2001 and
2002 taxation years;
g)
for its 2001 and 2002 taxation years, the Appellant’s only activity was
in buying and selling securities;
h)
for its 2001 and 2002 taxation years, 100 per cent of the Appellant’s
revenue was generated from its securities transactions;
i)
the Appellant conducted its own research, and provided instructions to
its brokers at the Toronto-Dominion Evergreen Investment Services (the “TD”)
and the Canadian Imperial Bank of Commerce Wood Gundy (the “CIBC”) to buy and
sell publicly traded securities;
j)
for its fiscal year 2001, the Appellant had securities trading accounts
with TD in both Canadian and United States (“US”) funds, and it added another
securities trading account in Canadian funds with CIBC in its 2002 fiscal year;
k)
the Appellant conducted 207 and 324 securities sale transactions in its
2001 and 2002 taxation years respectively;
l)
in the 2001 fiscal year, the Appellant disposed of 272,900 share in
Canadian currency where 100 per cent of those securities were owned for less
than 30 days, and 69 per cent of which were owned for less than 7 days;
m)
in the 2001 fiscal year, the Appellant disposed of 1,141,870 shares in
US currency where 65 per cent of those securities were owned for less than
30 days;
n)
in the 2002 fiscal year, the Appellant disposed of 761,420 shares in
Canadian currency where 81 per cent of those securities were owned for less
than 30 days, and 44 per cent of the shares sold from the TD account and
80 per cent of the shares sold from the CIBC account were owned for less
than 7 days;
o)
in the 2002 fiscal year, the Appellant disposed of 1,275,671 shares in
US currency where 64 per cent of those securities were owned for less than
30 days;
p)
the proceeds from the Appellant’s securities transactions exceed their
costs in amounts of not less than $341,750.00 and $511,640.00 for its 2001 and
2002 taxation years respectively; and
q)
In the 2001 and 2002 taxation years, the Appellant did not hold its
securities with a long term view for dividend distribution but to gain from the
quick purchase and sale of those securities.
Analysis
[4] It is the
position of the respondent that the appellant’s net gains derived from
securities’ transactions are income from a business, and are required to be
included in computing income under section 3 of the Income Tax Act.
[5] In general
terms, the test for determining whether securities’ transactions constitute a
business is whether the taxpayer is engaged in a scheme for profit‑making
or whether there is merely an enhancement of value: Irrigation Industries
Ltd. v. M.N.R., 62 DTC 1131 (SCC); Hawa v. The Queen, 2006 TCC 612,
2007 DTC 28.
[6] To the same
effect, in Salt v. Chamberlain, 53 TC 143 the English Chancery Division
suggested that for share transactions to constitute a trade, “something” must
be provided by the trade to earn the income. At page 152:
[…]
The matter is usefully summarised in the speeches of Lord Wilberforce and
Lord Simon of Glaisdale in Ransom v. Higgs 50 TC 1, at pages
88 and 95. Lord Wilberforce says this, at page 88:
“ ‘Trade’ cannot be precisely defined, but certain characteristics can
be identified which trade normally has. Equally some indicia can be
found which prevent a profit from being regarded as the profit of a trade.
Sometimes the question whether an activity is to be found to be a trade becomes
a matter of degree, of frequency, of organisation, even of intention, and in
such cases it is for the fact-finding body to decide on the evidence whether a
line is passed.”
He goes on to
say:
“Trade involves, normally, the exchange of goods or of services for
reward – not of all services, since some qualify as a profession or employment
or vocation, but there must be something which the trade offers to provide
by way of business. […]
[Emphasis
added; footnotes omitted]
[7] It is a matter
of degree as to whether share trading activity has crossed the line from
passive investing to being a business. The difficulty often lies in determining
where the line should be drawn.
[8] Counsel for the
appellant, citing Canadian, United
Kingdom and United States’
jurisprudence, suggests that securities’ transactions are generally presumed to
be on capital account. This may be the law in the United Kingdom and the United States,
but the matter has not yet been settled in Canada (Robertson v. The Queen, 98 DTC 6227 (FCA), at
note 18). I would also note that the application of such a presumption in Canada could
have very harsh consequences for a taxpayer, depending on the circumstances,
because the tax relief for capital losses under the Income Tax Act is
quite limited.
[9] The application
of some sort of presumption, though, can be helpful in promoting certainty where
the legislation does not provide much guidance. In circumstances such as these,
I think it is useful to bear in mind the principle which is often described as
“the tie goes to the taxpayer.” This catchy phrase implies that the principle
only applies where the facts are extremely close to the line, but Estey J.’s
famous pronouncement from Johns‑Manville Canada Inc. v. The Queen,
85 DTC 5373 (SCC) suggests a wider application. His comment reads as
follows, at page 5384:
[…]
Such a determination is, furthermore, consistent with another basic concept in
tax law that where the taxing statute is not explicit, reasonable uncertainty
or factual ambiguity resulting from lack of explicitness in the statute should
be resolved in favour of the taxpayer.
[10] I turn now to the
facts of the present case.
[11] Mr. George
originally began investing in the stock market in his own name but the activity
was transferred to a family-owned corporation on the advice of his accountant.
[12] I would describe
Mr. George as a savvy investor, who uses both margin accounts and short sales
as part of his strategy.
[13] The majority of
the securities acquired by the appellant during the relevant period were held
for less than 30 days, and often the hold period was less than one week.
Mr. George testified that he was not focused on the length of the hold period,
but on making a profit. He said that his strategy was to hold a security until
it rose eight to ten percent and he was prepared to hold it up to one year. The
fact is, though, that in many cases the gains were made within one week.
[14] My impression is
that Mr. George is a relatively sophisticated investor, but he is also casual
investor, in the sense that he has made no real study of the stock market and
he relies to a great extent on recommendations from friends and acquaintances
who are not in the brokerage industry.
[15] Based on the
assumptions of the Minister, the number of securities’ transactions undertaken
by the appellant appears to be exceptionally high, 207 and 324 respectively
during the two taxation years at issue. However, these figures give a markedly
false impression of “busy-ness.”
[16] The appellant
submits that the Minister’s calculations overstate the actual number of trades
because it was often necessary for a single trade order to be completed through
several transactions. This makes sense, and although it would have been
preferable for the evidence to be corroborated by an independent witness, I
will accept it.
[17] The appellant
suggests that a more probative calculation would be the number of corporations
whose securities were sold on a average monthly basis, which is four. This
appears to be a reasonable approach, based on my cursory review of the trading
summaries that were entered into evidence.
[18] As for the time
spent on this activity, Mr. George testified that he spent very little time on
a daily basis, as his main occupation was as owner of a renovation business. He
said he relied on the recommendations of others and did not spend much time
researching himself. He did not read newspapers, but he did make use of chat
lines on the internet to obtain information about some companies.
[19] Counsel for the
respondent submits that Mr. George spent significantly more time on this
activity than he admitted, and she invited me to make this finding based on the
large management fees that he received from the appellant.
[20] I do not agree
with this submission. It would not be necessary for Mr. George to spend
much time on this activity if he depended on the recommendations of others.
Further, I do not think that the size of the management fees implies anything
about the time spent. This may simply have been an efficient way for the appellant
to distribute the stock market gains to Mr. George. It is perhaps conceivable
that the family trust, which was the sole shareholder of the corporation for
the 2001 taxation year, could have complained if the fees paid to Mr.
George were excessive, but there was no evidence or argument on this point.
[21] Counsel for the
respondent also submits that the short hold periods are themselves conclusive evidence
of a business-like approach. The short hold periods may tend to point in this
direction, but I think it is important to have specific evidence as to how the
profits were actually made. As suggested in Salt v. Chamberlain, for
trading activity to be a business, “something” of a business-like nature should
be contributed by the taxpayer. What was the “something” in this case?
[22] Mr. George’s
testimony on this point was vague. He stated that he sometimes bought shares of
a corporation shortly before its financial statements were released, and that
in a very few instances he purchased shares on the strength of takeover
rumours. He said, though, that it was mostly “gut feeling.”
[23] This evidence is
in my view unsatisfactory. Mr. George may not have applied a rigourous
methodology to the trading activity, but the names of the corporations in which
the appellant invested did not fall from the sky.
[24] It would have
been helpful to have more detailed evidence as to how the securities were
selected. On what basis did Mr. George apply a gut feel? I invited Mr. George
at the end of his testimony to provide further detail on this but he did not
shed much light. The respondent, though, should bear part of the blame because
this evidence went virtually unchallenged on cross-examination.
[25] In the
circumstances, the solution that I propose to adopt, which is admittedly
arbitrary, is to consider that shares held for extremely short hold periods
were likely earned from the application of a business-like strategy and that
shares held for a longer period were not. An example of a business-like
approach would be research as to when financial statements are about to be
released. It does not matter whether the research was undertaken by Mr. George,
his broker, or an acquaintance. It is the fact of a business-like approach
being taken that is important.
[26] I have concluded
that it is appropriate in this case to apportion the gains on a 50/50 basis
between income and capital. There is not a satisfactory rationale for this
breakdown, except that it does appear to be a rough division of securities held
for less than one week.
[27] In the result,
the appeal will be allowed, and the assessments will be referred back to the
Minister of National Revenue for reconsideration and reassessment on the basis
that one-half of the net gains from securities’ transactions are on income
account and the balance are on capital account.
[29] In light of the
divided success, there will be no order as to costs.
Signed at Ottawa, Canada this 12th day of June 2008.
“J. Woods”
Email this Content