Citation: 2008TCC51
Date: 20080222
Docket: 2006-334(IT)G
BETWEEN:
DAVID HOWARD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan, J.
[1] The Appellant,
David Howard, is appealing the assessment of the Minister of National Revenue
of his 2000 taxation year. The issue is whether certain losses incurred by the
Appellant from a share disposition were capital or business losses.
[2] In assessing and
confirming Mr. Howard's assessment, the Minister assumed the facts set out in
paragraph 24 of the Reply to the Notice of Appeal. The assumptions shown in
bold type are challenged by the Appellant as inaccurate or incomplete:
a) The
Appellant is a chartered accountant.
b) The Appellant was employed with [Cell-Loc Inc. ("Cell-Loc")]
from May 1, 1999 – December 13, 2000.
c) The Appellant was Vice-President and Chief Financial
Officer of Cell-Loc.
d) Cell-Loc had a stock option plan for directors, officers
and employees.
e) The Appellant received stock options by virtue of his
employment.
f) In 1999 and 2000, the Appellant purchased 38,100 Cell-Loc
shares on the open market and by exercising stock options, as set out in Schedule
"A" to this Reply.
g) The Appellant exercised stock options, as set out in the
Schedule "A" to this Reply, to realize the compensation benefit
offered by Cell-Loc.
h) The Appellant did not acquire the Cell-Loc shares with
the intention of selling them as soon as possible for a profit.
i) As of June 30, 2000, the total number of Cell-Loc shares
outstanding was 20,892,305.
j) Between March of 2000 and December of 2000, monthly volume
of trades of Cell-Loc shares averaged 2,732,369 shares per month.
k) The Appellant was unable to sell the shares because of a
trading blackout as an insider.
l) Further, the Appellant was encouraged to hold his share
position in order to communicate confidence to the marketplace.
m) At the first opportunity, which was immediately after his
employment with Cell-Loc ended, the Appellant sold 38,100 Cell-Loc shares, as
set out in Schedule "A" to this Reply.
n) The Appellant prepared and filed his 2000 tax return.
o) The Appellant reported a capital loss of $801,788 in 2000,
as a result of the disposition of the shares, as set out in Schedule
"B".
p) The Appellant purchased and sold other security
investments, and reported the gains and losses on account of capital.
Background
[3] Mr. Howard was
the only witness to testify. I found him candid and convincing in the
presentation of his evidence. Mr. Howard received his Bachelor of Commerce in
1992 and in 1995, his Chartered Accountant designation. In 1996 he left KPMG,
where he had articled, to take a position as Vice-President (Finance) with
Position Inc., a small private technology company and one of his former clients.
His primary role was to prepare an initial public offering of that company's
stock.
[4] After two years,
its goals achieved, Position Inc. was sold. Mr. Howard found new work as a
consultant with yet another former client, Cell-Loc Inc. Like Position Inc.,
Cell-Loc was a burgeoning technology company. When Mr. Howard started his
consultancy work in November 1998, Cell-Loc had a small staff of about 20,
mainly software developers and one or two administrative people. It had no
commercially viable product, no customers and no revenues. What it did have was
a newly developed initial prototype of its technology for locating wireless
devices. Mr. Howard's role was to update Cell-Loc's business plan to reflect the
(then) current state of its technological development.
[5] At
that time, Cell-Loc's shares were trading at around $1.60 per share on the
Venture Stock Exchange. During his time as a consultant, Mr. Howard was
sufficiently impressed with Cell‑Loc's potential for growth that he purchased
2,100 Cell-Loc shares.
[6] In May 1999, Mr. Howard
became a Cell-Loc employee. He was paid an annual salary of $105,000 and granted
104,000 Cell-Loc share options. As the company's Controller and Vice-President
(Finance), he was responsible for overseeing all aspects of Cell-Loc's
accounting and financial reporting as well as ensuring compliance with stock
exchange and securities commission requirements. Equally important to his role
were his duties in promoting the sale of Cell-Loc shares in the investment
community.
[7] In June 1999, he
began his promotional work, initially with "friendly" investors (those
who had been involved in Cell‑Loc's first public offering) and in
particular, Kelly Reid of the firm Goepel McDermid. Things went so well
that by September 1999, Cell-Loc was ready to take the next step in Mr. Howard's
business plan: raising $10 million in financing on Bay Street. At
that time, Cell‑Loc's stock was trading aggressively up and within days
of their arrival in Toronto, the company had outstripped its original objectives,
securing some $50 million in financing at a fixed price
of $17 per share. Over the fall, Mr. Howard busied himself fulfilling the
conditions attached to the Bay Street deal, while at the same time continuing to promote
Cell-Loc stock to the now quite interested investment community. By early 2000,
market interest stimulated by the Bay
Street deal had driven the share price
up into the $20‑$40 range. Analysts came calling from Wall Street,
ultimately predicting that if listed on the New York Stock Exchange, Cell-Loc
shares could be trading at $150 per share in the next 12 months. In this
environment, Mr. Howard decided the time was right for Cell‑Loc to embark
on the next aspect of its business plan, the securing of the $2 billion
needed for a network system to support Cell-Loc's wireless locator technology.
[8] Thus it was that
on March 7, 2000, Mr. Howard found himself on the floor of the New York
Stock Exchange and Cell-Loc, the darling of Wall Street. Shares were then
trading at a heady $50-60 per share. All signs were pointing "north",
to use Mr. Howard's vocabulary. What happened next can be explained no more
eloquently than by Mr. Howard himself:
Q Okay.
And during that trip, what happened?
A During the trip, we were very well received. Our initial
meetings were with Goldman Sachs and JP Morgan and Solomon Smith Barney Monday.
Tuesday, we had Goldman Sachs was touring us around the New York Stock Exchange
so we could get a feel for the -- if – that American Stock Exchange.
On that very day that we were touring through the Exchange, that's when
the stock market crash, as we've come to call it, began. Particularly in
technology stock, there was tremendous selling on technology stocks with very
little buying. Prices were plummeting 20, 40, 50 percent, you know, in one day,
had everybody just scrambling on the -- on the trading floor. It was actually
quite the scene.
So, all of a sudden, this -- the stock market itself had become
incredibly volatile, and no matter how good your company is or how good your
stock is, you are now riding the waves of this horrible storm in the market and
now you're -- the pricing of your stock is now just subject to the ebbs and
currents of the -- of the market and less so on really, the fundamental aspects
of your company and the stock.
So by the time that week was over, we had met with everybody we had
planned to meet. Again, the response was very positive. They threw every aspect
of support that they could at us. We wanted to deal with these guys because
some of their clients were the big players in the telecommunications and
internet space such as Google and Verizon and players like that, which would be
ultimate customers or business partners of ours, so they -- they offered
everything they could but money because they -- they didn't want to do a deal
when the market was so incredibly volatile. They wanted to wait until things
stabilized again and there was a reliable environment in which to make their
investments.
[9] From that day
until June 2000, there was great volatility in technology stocks in general; the
price and volume of Cell-Loc shares fluctuated accordingly.
Confident, however, that the quality of its product and the soundness of its
business plan would permit the company to weather the storm, Mr. Howard and
Cell-Loc carried on as planned. On March 28, 2000, Cell-Loc shares were duly
listed on the Toronto Stock Exchange. A launch of the company's commercial
product set to coincide with Calgary's Stampede Week, went forward in July 2000. The activation
of the first segment of Cell-Loc's infrastructure network in Texas proceeded
on schedule in August. Meanwhile, throughout this period, Mr. Howard
continued with his promotional activities in the investment community. Despite everyone's
best efforts, however, by December 5, 2000, the Cell-Loc shares had declined to
what Mr. Howard described as a "solid $4.00".
On December 13, 2000, Mr. Howard lost his job, a victim of the general
downturn in the high tech industry and Cell-Loc's need to cut costs
accordingly.
[10] By that time, Mr.
Howard had acquired 43,100 Cell-Loc shares.
Initially, he financed his purchases using funds from his line of credit and money
borrowed from his father. However, following the company's triumph on Bay Street, in
December 1999 Mr. Howard had decided to enhance his purchasing power by opening
a margin account through his broker, Kelly Reid. In this way, he was able to
use his existing Cell-Loc shares (at that time, steadily increasing in value)
as security to finance additional acquisitions. When the value of Cell-Loc
shares began to plummet after the upset on the New York Stock Exchange in March
2000, Mr. Howard was forced to exercise some of his options to shore up
the value of his margin account. As market conditions worsened, his broker
began exercising his right to force the sale of the Cell-Loc shares in Mr.
Howard's margin account. By the end of 2000, Mr. Howard had disposed of more
than 30,000 Cell-Loc shares.
[11] Mr. Howard described his circumstances in the first few
months of the new year as follows:
Q Okay. Describe to me the circumstances surrounding the
filing of your 2000 tax return.
A Well, 2000 had been a roller-coaster year. By the time the
year was out, I had no -- no longer had any employment, thus no paycheque. My
wife was pregnant. The entire technology industry was in a state of -- of --
they were battening down the hatches in order to ride out the storm. There was
no more capital moving in on technology companies or technology sales. Layoffs
were occurring left and right.
Technology companies had very little cash resources, so they were
controlling spending down to every last penny. There was really many
technologies company had gone bankrupt by this time. There was no demand for
somebody of my expertise in as a financial officer of technology companies.
(A), they couldn't afford me or it wasn't commensurate with their down-sizing.
So trying to find a new job in early 2001 was extremely difficult, so I
was living on whatever savings I had. Obviously my investments, the value of my
investments had been just decimated. Obviously my -- my scheme of profiting on
Cell-Loc stock had proven unsuccessful, and, well, I was actually quite a --
quite a rattled state of mind not knowing where I'm going to pay my mortgage
next month.
Q Okay.
Did you hire somebody else to prepare your tax return?
A No, I couldn't afford. I didn't have any extra cash to
afford accountants and lawyers, et cetera. Adding to this, in late February of
2000, I received my T4 from Cell-Loc, and it showed my salary income, and it
showed this -- this gigantic number of stock option, taxable stock option
benefit that I must claim on my tax return.
It was, you know, mentally or I guess spiritually challenging for me to
deal with the circumstances I was in, but long story short, I knew I had to
file a tax return because I didn't want to get offside with failing to file tax
returns and going down that whole -- that whole scene with CRA.
I've always had a good history of filing my own tax returns. I'd always
prepared them using Quick Tax software, so in late October or late, sorry,
April, I decided to do the same, let me just file this return the way I usually
do, and, so, I did. I sat down. Plunked -- grabbed all my receipts, plunked in
all the numbers into the boxes in the software, and it spit out this tax
return.
I -- I knew there was something wrong with the tax return because it
made no sense how I could have such a gigantic or such a large income, a
taxable income, yet at the same time I had suffered such substantial loss that
I actually have no profit with which to pay the taxes that came out of this tax
return, so there was -- there was obviously some sort of disconnect, but by
this time, it was April 30th. Something had to get filed. I didn't want to get
offside, so I signed it and filed it.
[12] Not
surprisingly, the Minister assessed Mr. Howard's 2000 tax according to the
return as filed.
[13] After receiving
the assessment, Mr. Howard, now employed and still troubled by the way he had
reported his 2000 income, sought professional assistance from KPMG. His tax
accountant quickly confirmed his fears that he had incorrectly reported various
aspects of his income, the most significant error occurring in the Cell-Loc
share disposition. KPMG prepared an amended income tax return which, among
other relatively minor changes, claimed a Disposition Loss of $739,043.06 and a
Write-Down Loss
of $257,779.51.
[14] Unmoved by either
the amended return or Mr. Howard's quite reasonable attempts to explain his
circumstances,
the Minister confirmed Mr. Howard's losses as on account of capital, as
originally reported.
Analysis
[15] Mr. Howard's primary position is that he was a "trader or
dealer" in the business of selling Cell-Loc shares;
alternatively, that he was at the very least, involved in an "adventure in
the nature of trade". The distinction matters since, if Mr. Howard's activities
amounted to an adventure in the nature of trade, he would be precluded by
subsection 10(1.01) from claiming a "Write-Down Loss" deduction.
[16] The
Respondent's position is that Mr. Howard was not in the business of selling
Cell-Loc shares.
[17] The definition of
"business" is set out in subsection 248(1) of the Act:
"business"
includes a profession, calling, trade, manufacture or undertaking of any kind
whatever and, except for the purposes of paragraph 18(2)(c), section
54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or
concern in the nature of trade but does not include an office or employment;
[18] Whether Mr.
Howard's activities in respect of his Cell-Loc shares amounted to a "business"
is a question of fact; of assistance in making this determination are the factors
established by the Federal Court of Appeal in Vancouver Art Metal Works Ltd.
v. R.:
...
I have no
doubt that a taxpayer who makes it a profession or a business of buying and
selling securities is a trader or a dealer in securities within the meaning of
paragraph 39(5)(a) of the Act. As Cattanach, J. stated in Palmer v. M.N.R.,
[1973] C.T.C. 323, 73 D.T.C. 5248 (F.C.T.D.) at page 325 (D.T.C. 5249),
"it is a badge of trade that a person who habitually does acts capable of
producing profits is engaged in a trade or business". It is, however, a
question of fact to determine whether one's activities amount to carrying on a
trade or business. Each case will stand on its own set of facts. Obviously,
factors such as the frequency of the transactions, the duration of the holdings
(whether, for instance, it is for a quick profit or a long term investment),
the intention to acquire for resale at a profit, the nature and quantity of the
securities held or made the subject matter of the transaction, the time spent
on the activity, are all relevant and helpful factors in determining whether
one has embarked upon a trading or dealing business.
[19] Whether Mr.
Howard was in the "trading or dealing" business depends on whether
his activities were those of a "trader or dealer" within the meaning
of subsection 39(5) of the Act. This is also a factual determination. In
Kane v. R., Noël, J. held that the Vancouver Art Metal Works
Ltd. factors apply equally to an individual carrying on business as a
trader or dealer in securities, or engaged in that activity as an adventure in
the nature of trade. What distinguishes the "trader or dealer",
however, is a taxpayer's "… particular or special knowledge of the market
in which he trades"; in this way, "… he distinguishes himself from
the common risk takers who 'play the market' regularly or sporadically based on
commonly available investment advice and information".
[20] In reaching this conclusion, Noël, J. also considered
the taxpayer's level of involvement in the company's management and financial
operations:
In the case at hand, the plaintiff had a special knowledge of the
market in which Orell shares were traded. He was one of the directors of the
corporation, its president, an insider by virtue of his holdings and a promoter
as that term is defined in the B.C. Securities Act. But more
importantly, he was directly involved in the mining ventures of Orell and
in organizing its public financing offerings. As such he was in a position to
anticipate market reaction to Orell's ongoing activities. That is the context
in which the plaintiff bought and sold Orell shares. His trading activities
were not only stamped with the usual badges of trade which characterize the
dealings of common risk takers, but they were conducted by reference to, and
were driven by, the special knowledge which the plaintiff had of the market in
which the Orell shares were traded. Those in my view are the activities of a
trader or dealer in securities as that term is used in subsection 39(5) of the
Act. [Emphasis added.]
[21] In the present case, Mr. Howard was even better placed
to acquire a "special knowledge" of Cell-Loc's operations and
financial prospects. That special knowledge
had as its source his dual role as a manager and promoter. Mr. Howard described
his involvement as Controller and Vice-President (Finance) in Cell-Loc's
management as follows:
A The
management of Cell-Loc, it was -- was the group of vice presidents, myself
included, as well as the president. Each vice president was responsible for
various aspects of the company. That'd be a vice president of hardware
development, of software development, of sales or marketing. Later on, there
was a vice president of human resources, vice president of operations, so all
these people were in charge of their various departments.
An important role
in the management of the company is the coordination of all the activities of
all these departments to ensure that collectively, we are working together to
meet the business plans, the business objectives of the company. To do so, we
would meet. The seven vice presidents and the president, we would meet weekly
to discuss the individual performance of each other's department, challenges,
successes, objectives, accomplishments, frustrations, et cetera, and as a
group, we would (a) coordinate the responsibilities of our departments amongst
each other, and (b) do what we could to assist the departments of others in
accomplishing their objectives.
[22] As part of this
management team, Mr. Howard was well aware of the strengths and weaknesses
of each department and was able to assess how they affected its bottom line:
Q So
where was your estimate of the share price coming from?
A My estimate was based on, well, two sources of information.
Internally, I knew how successful we were in accomplishing the business plan. I
knew about the business plan. Where we were going. What we were expecting to
achieve. I knew what our successes and challenges were internally towards
achieving those objectives. I knew as -- as the head of accounting and finance,
I know how everybody is spending their money. I mean, anything that anybody's
doing within the company ultimately has an impact or flows through the
accounting department, so I have this great intimate knowledge as to where
we're focusing our actions, what successes, how rapid our successes are, and
how well we're doing at achieving our plan.
[23] It was also Mr. Howard who was responsible for the preparation of Cell‑Loc's long-form
prospectus:
Q Okay. Go back to the joint book of documents. Can I ask you
to turn to Document 5, Tab 5. So can you describe to me what this is and who
prepared it?
A This document is what we call a long-form prospectus. This
is a regulatory filing required by the Securities Commission in order to
qualify any new issuances of shares from the company's Treasury, which, as I
said, is -- is my responsibility, for distribution to shareholders. So this
would -- this authorizes the issuance of new shares to the investment
community.
Q Okay. And who at Cell-Loc was responsible for that?
A I -- I prepared this document. This is very much my
responsibility.
Q Sorry, just to clarify, you were responsible for preparing
it, but did you -- there was outsiders, or, you know, is there a law firm or?
A Oh, well, okay. There would be other parties. I would engage
a team of people for accumulating all of this information. Some of the
information would be legal-type information that would come from our
securities' counsel. Some of this information would be historical information,
which would come from either my knowledge or knowledge of other parties in the
company.
Q Okay. So while it was your responsibility, you didn't
necessarily write the whole document?
A I did not personally write the entire document. I wrote many
sections and was responsible for virtually every number in this document, and
the document bears my signature on page 66.
Q Okay. Can you turn to page 28 of this document.
A Just to be clear, if there was any deficiencies in this
document, it was on my head. Page 28, yes.
[24] Such in-depth information assisted Mr. Howard in his
duties promoting Cell-Loc shares to
potential investors. It put him in a prime position to keep abreast of the
company's standing in the investment community and to assess how that might
affect the share price:
… Externally
now, from the investment community, I know how well-received our stock is, the
market conditions in which they're trading, what sort of buy and sell volumes
are, bids and asks. I know what analysts' assessments and conclusions are about
our stock, so as to where -- where do I get a sense as to where our stock is or
its valuation is today and into the near future, I have -- see what sort of
trajectory we're on internally towards achieving our objectives, and,
externally, I have experts in the investment banking field telling me that, you
know, this $20 stock's going to $50 or this $50 stock's going to $150.
[25] Armed with such information
and equipped with the professional expertise to analyze and apply it to his own
Cell-Loc shareholdings, Mr. Howard possessed the kind of "special
knowledge" of the "trader or dealer" contemplated in the Kane
decision.
[26] The next step is to consider the evidence pertaining to
the applicable factors established in Vancouver Art Metal Works. Not every factor must be satisfied; it is the combined
effect of those present that is important.
Time Spent on Activity
[27] I
accept Mr. Howard's evidence that he devoted virtually all of his time to
monitoring and assessing the performance of Cell-Loc shares. He described his
activities in the spring of 2000 as follows:
Q Okay. Between the period of time when you first increased
your margin security by exercising options in March and in June when you began
buying more Cell-Loc shares, what attention were you paying to the market for
Cell-Loc shares?
A Oh, the market. Paying attention to the market was my daily
living and breathing focus. By this time, in fact in late '99, the -- the
controllership responsibilities, as I said the accounting portfolio under my --
my department was substantially all handed off to another chartered accountant
who -- who reported to me, but he was responsible for all the accounting and
financial reporting, et cetera, freeing me up to be 100 percent dedicated to
investment banking, market, market intelligence, dealing with analysts,
promoting the stock, making decisions and modifying planning regarding
corporate finance deals, i.e., new issuances of shares from Treasury, raising
the capital required, making preliminary discussions with investment bankers
about what deals would look like because if they wanted more Cell-Loc stock,
they had to deal with me.
[28] The Respondent
submitted that because Mr. Howard was required by his employment
responsibilities to devote himself to tracking the financial health of Cell-Loc
and promoting its shares, little weight should be given to this evidence. I am
not convinced by this argument; there was nothing to prevent him from simultaneously
using the same special knowledge and exploiting it for the purposes of his own business
of trading in his own Cell-Loc shareholdings.
[29] Nor am I persuaded by the Respondent's submission that
because there were certain times in 2000
when Mr. Howard was unable or unwilling to sell his shares, he could not have
been intending to resell them for a quick profit. Mr. Howard was unable to
sell his Cell-Loc shares during "blackout" periods imposed by the
Securities Commission. These were rare occurrences of two or three days' duration
and applied equally to other "insiders" who, like Mr. Howard, held Cell-Loc
shares. His unwillingness to sell - even at times when the share price was
increasing - was rooted in his informed opinion that the Cell-Loc shares had
not yet reached their optimal value. Given his objective of driving up the
share price, Mr. Howard felt it would be counter-productive to dispose of his
own Cell‑Loc shares while actively promoting their acquisition to prospective
investors. His own Cell‑Loc shareholdings inspired confidence in would-be
purchasers. The greater the investment in Cell-Loc shares, the greater his profit
margin when, ultimately, Mr. Howard did decide the time was right to sell. Not
selling his shares at such times is indicative of his professional integrity
and prudent management rather than an intention to treat the Cell-Loc shares as
a capital investment.
[30] In these circumstances, Mr. Howard used his knowledge and expertise to devote 100 per cent of
his time to exactly the sort of activities that were held in Kane to be
those of a "trader or dealer". Everything he did as part of his
employment duties was directly transferable to and useful in his business activities
selling his Cell-Loc shares.
Nature
and Quantity of the Shares Held
[31] First, there is
no presumption that corporate shares are held on account of capital. In 2000, Mr. Howard held Cell-Loc shares and a small number of non‑Cell-Loc
shares (referred to herein as "Other Shares"). He treated the
Other Shares as a capital investment because unlike the Cell-Loc shares, he
had "no great insight into or ability to influence" the Other Shares. He felt their value was more likely to be realized
over the long-term rather than in a quick turn-around. He reported them on
account of capital in his original filing and in his amended return.
[32] The Cell-Loc
shares were quite a different matter. As Controller and Vice‑President (Finance),
Mr. Howard knew that the Cell-Loc shares were not currently paying, or expected
to pay dividends any time soon. While not enough in itself to be determinative of an
intention to trade, when taken as part of his overall special knowledge
of the promising short-term performance potential of the Cell-Loc shares, this
fact is consistent with his direct evidence that his intention was to acquire as
many Cell-Loc shares as he could reasonably afford with the idea of turning
them for a quick and substantial profit at the opportune moment.
[33] As for the quantity of shares held, the Respondent relied on Irrigation Industries
Ltd. to argue that the test is not whether the number of shares held is
significant to the taxpayer but rather, whether the number of securities held
is such that they could only have been bought on account of a business or
trading intention. I do not take that to mean, however, that in considering the
Vancouver Art Metal Works factors, the Court is precluded from
considering all the circumstances of the taxpayer's shareholdings. In Robertson
v. R., the Federal Court of Appeal restated the Irrigation Industries
Ltd. test as follows:
...
The Tax Court judge applied the proper test, namely whether the appellant,
at the time of purchase, intended to resell the shares as soon as possible for
a profit.
[34] Mr. Howard held
far more Cell-Loc shares than Other Shares which, as already noted, he treated
as a capital investment. Mr. Howard impressed me as a prudent fiscal
manager, not one to be overly comfortable carrying huge debt in risky ventures.
The money that he owed to his father and his other creditors weighed on his
mind:
Q So how did you decide in June when you were buying Cell-Loc
shares, how did you decide how many Cell-Loc shares to buy, how many
transactions?
A Myself personally? I -- in which period, I'm sorry?
Q In June of 2000.
A The $130,000 worth of stock that I acquired, that was as
much as I could comfortably incur the debt for. i.e., I had the better part of
$200,000 worth of debt accumulated by this time. That was about as much as I
could personally stomach.
[35] The
43,100 Cell-Loc shares ultimately purchased by Mr. Howard represented, for a
man of his means and risk tolerance, a significant acquisition. When in 1998 he
first began to acquire shares as a consultant at Cell-Loc, he was a young man starting
his career. Later, as an employee with Cell-Loc, he enhanced his shareholdings,
using his savings, line of credit and money borrowed from his father. In
December 1999, when Cell‑Loc's prospects began to exceed dramatically all
reasonable expectations, he increased his share acquisition capacity by opening
a margin account. At their apex in March 2000, the Cell-Loc shares held by
Mr. Howard were valued at some $1.2 million, by most people's
standards, nothing to sneeze at. His debt load was made bearable because of his
confidence that he would be able to realize a profit in the short-term and
repay his creditors.
Frequency
of Transactions
[36] The Respondent submitted
that there were too few transactions in 2000 for Mr. Howard to claim that he
had been in the business of selling Cell-Loc shares: 16 share purchases and 20
sales, 17 of which were initiated by his broker under the margin account
agreement.
[37] I see no magic in
any particular number of transactions. It seems to me that, depending on the
circumstances, even one transaction could be a sufficient "frequency"
of transactions. A trader's decision to buy or sell does not hinge on
satisfying a notionally sufficient number of transactions. Mr. Howard watched
the market, constantly assessing and reassessing Cell-Loc's performance in
order to gauge when he could best realize the greatest profit. The Minister's position seems to be
based in part at least, on the notion that to be in business of selling shares,
a taxpayer must sell on the first occasion his shares are worth a penny more
than the purchase price – that holding on to the shares beyond that point is a
clear indicator of the taxpayer's intention to treat them as a capital
investment. A more accurate portrayal of the activities of a trader (and one
consistent with the approach taken in Kane) is that of Miller, J. in Sandnes v. R.:
... The trader
attempts to maximize profit at the earliest opportunity. Presumably, this would
entail a close scrutiny of the market to ensure purchases and sales at optimal
moments.
[38] This was precisely what Mr. Howard was doing. These were
the considerations that dictated the frequency of his transactions in the extraordinary market conditions that prevailed in
2000, described during cross-examination as follows:
Q In 1999 before your employment at Cell-Loc, you acquired
some small numbers of shares that totalled 2100.
A While I was a consultant, that's correct.
Q That's right. And I think –
A They were at about $1.60. I expected, you know, if we -- I
expected on the Venture Exchange, we might see upwards of $10.
Q I think at the discovery you said somewhere in the 7 to $10
range, so that –
A That's right.
Q -- sounds like the same thing?
A Yes.
Q But you, in fact, didn't sell those shares when it reached
that price?
A That's correct. We -- the stock rocketed past $10 and was
already at $20 and climbing from there.
Q And I think at discovery, you told me you thought at that
point, maybe you'd hold out until they were $40?
A Yes, so I -- yes, revisit my plan. Things are proceeding
better than planned, so reassess. Something maybe the 40 to $50 range would be
appropriate.
Q And then they actually attained that value, and I think you
told me that then at that point, you thought perhaps $100 was an appropriate
sell point?
A Well, again, as we rocketed up to the 40 to $50 range, and
that was commensurate, again, with the same time these Wall Street analysts
were telling me they should be $150 stock.
Q Yes.
A So I'm thinking I'm not selling at 50. We're going to 150,
so just to comment, so along the way, I'm assessing whether it's a good time to
crystallize my profits on the stock.
[39] By
the same token, during the market's period of high volatility, Mr. Howard
postponed selling in anticipation of the Cell-Loc shares regaining their former
strength.
Intention
to Acquire Shares for Resale at a Profit
[40] Finally,
there is the taxpayer's intention. As mentioned above, I found Mr. Howard
to be a particularly compelling witness. He testified as to his intentions
regarding the Cell-Loc shares:
A I expected to buy them at this price, which I felt was a low
price, and I expected to sell them in the not-too-distant future at a much
higher price.
[41] However, the
taxpayer's direct evidence of his intentions is not determinative of the
matter; counsel for the Respondent cited McGroarty v. Minister of National
Revenue for the proposition that "[g]enerally speaking, the person's intention is to be ascertained from his whole course of
conduct". In that case, the Court underscored that "[t]he
characterization of earnings as income or capital gains is a question of fact
and must be assessed with regard to all the circumstances of the particular
case".
[42] The Respondent's position is that Mr. Howard's course of
conduct is not consistent with his stated intention to acquire the Cell-Loc
shares for resale at a quick profit. This argument is based, at least in part, on the fact that Mr. Howard
acquired many of his Cell-Loc shares by exercising options granted to him as
part of his remuneration from employment.
[43] Mr. Howard
does not dispute that his "decision to accept stock options was an
employment decision, not a business decision" or that the only way he could realize this aspect of his employment
compensation was to exercise the options. What he takes issue with is the relevance
of these facts to the determination of the nature of the proceeds realized upon
the disposition of the shares ultimately acquired by the exercise of those
options. I accept the argument of counsel for the Appellant that these are two
separate transactions, each with its own source of income.
[44] Drawing a clear
line between where one transaction ends and another begins is vital to the
analysis of the attendant tax consequences. As Hugessen, J. explained in Pollock
v. R.:
... While it
is perfectly true that one transaction cannot constitute for a taxpayer two
separate sources of income, this is clearly not what the Minister is seeking to
do. The tax under paragraph 7(1)(a), upon income from employment, is
triggered by the exercise of employee stock options, and both the timing
and extent of the remuneration deemed to have been received are fixed by that
event. That, however, does nothing to prevent the exercise of the options
constituting the starting point for another transaction which concludes with
the disposition of the shares and which may, in its turn, constitute
another source of income. ... The point, of course, is that the exercise of the
options, while it is the closing reference mark for the calculation of a deemed
remuneration from employment, may easily be the opening reference mark for some
other source of income.
[45] The Respondent also took the position that the fact that
Mr. Howard had amended his income tax return placed on him a more onerous
burden of proof. In support of its
position, the Crown cited the following passage in Rajchgot v. R. in which the Federal Court
of Appeal stated that:
...
[5] A
taxpayer who wants to change his reporting status in circumstances where it
becomes more tax efficient to do so bears a heavy onus. In this case, the Tax
Court Judge held that this onus has not been met. This is a decision that was
open to him on the evidence before him.
[46] There is nothing
inherently wrong with amending a return; indeed, the Act contemplates
and provides for that very contingency. In tax appeals, it is always the
taxpayer who bears the onus of proving wrong the assumptions upon which the
Minister's assessment was based. Whether as amended or originally filed, what a
taxpayer reports in his return must be capable of substantiation. In the
present case, Mr. Howard's evidentiary burden is to show that the claims in his
amended return are justified. As the Federal Court of Appeal noted above, it is
up to this Court to determine if that onus has been satisfied. In the present
case, I am satisfied that Mr. Howard has met his evidentiary burden.
[47] The effect of changing
the way in which a transaction has been reported was one of the factors
considered by Rip, J. (as he then was) in Rajchgot. Acknowledging that a prior filing
was "indicative" rather than
"determinative" of a taxpayer's intention, he went on to say that:
[37] ... There
should be some consistency in reporting share transactions. When a taxpayer all
of a sudden changes from reporting transactions from capital to income account
or from income to capital account there should be some evidence of the shares'
changes in status. In some circumstances it may help if shares owned as capital
and shares held on income account were held in separate brokerage accounts. The
taxpayer should be prepared to show something that distinguishes his capital
from income transactions, that his transactions are not similar. This act
should be done when he first makes a transaction that is not consistent with
previous transactions.
[48] In Rajchgot, after reviewing all of the evidence
in light of the Vancouver Art Metal Works Ltd. factors, Rip, J. found that there had been no change in the
taxpayer's original intention (as shown in prior filings), ultimately holding
that the taxpayer had not altered the "overall purpose in purchasing the
shares as capital assets".
[49] Mr. Howard's situation is quite a different story. He did not "all of a sudden" reverse an
established history of filing practices. Rather, his was a case of correcting
reporting errors in one taxation year at his earliest opportunity after filing.
I accept Mr. Howard's evidence that in the stressful weeks following his
termination at Cell-Loc, he was troubled by how to report the share
transactions properly but lacked the financial resources, technical tax expertise
and overall, the clear-headedness needed to deal adequately with the complexity
of his 2000 return. He was also worried about compounding his difficulties by
becoming a "late filer", something he had never been prior to the
Cell-Loc crisis.
[50] In all the
circumstances, I am satisfied that the return, as originally filed, did not
accurately reflect the Cell-Loc transactions in 2000 and is far from indicative
of an intention on Mr. Howard's part to treat the Cell-Loc shares as a
capital investment.
[51] Considered in light of the factors in Vancouver Art
Metal Works, the evidence persuades
me that Mr. Howard's course of conduct in dealing with his Cell-Loc shares was
consistent with his stated intention of acquiring the shares to resell for
profit at the earliest best opportunity. Applying the words of Noël, J. in Kane
to the present case, Mr. Howard's "trading activities were not only
stamped with the usual badges of trade which characterize the dealings of
common risk takers, but they were conducted by reference to, and were driven
by, the special knowledge which [he] had
of the market in which the [Cell-Loc] shares were traded". But for his special knowledge, I would have found that Mr. Howard was
engaged in an adventure in the nature of trade in respect of his dealings with the
Cell-Loc shares; however, his special knowledge and expertise with regard to Cell‑Loc's
operations, of the status of its shares and of the market in which they were
traded elevated his activities in the 2000 taxation year to those of a "trader
or dealer" in the business of selling his Cell-Loc shares. It is on that
basis that the appeal is allowed, with costs, and the reassessment is referred
back to the Minister for reconsideration and reassessment.
Signed at Ottawa, Canada, this 22nd day of February, 2008.
"G. A. Sheridan"
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