Kane v. The Queen, 94 DTC 6671, [1995] 1 CTC 1 (FCTD)

Noël J.:—Cyril Cecil Kane ("the plaintiff’) appeals from the decision of the Tax Court of Canada whereby the reassessments issued by the Minister of National Revenue with respect to his 1979, 1980 and 1981 taxation years were upheld.

At issue is whether certain transactions carried out by the plaintiff wherein publicly-traded shares of Orell Copper Mines Ltd. ("Orell") were bought and sold are to be treated on an income or on a capital account. Also at issue is the tax treatment applicable to the transfer of some of these shares by the plaintiff to various non-arm’s length parties.

Orell is what is commonly known as a junior mining company. During the relevant period, the plaintiff was a shareholder, director and the president of Orell. He is a certified general accountant by profession and carried on an accounting practice during the years in question. He also describes himself as a prospector by trade.

During the relevant period, the plaintiff devoted 50 per cent of his time to his accounting practice. The balance of his time was spent on the affairs of Orell, principally in dealing with mining ventures and activities, but also in administering its affairs and providing assistance in obtaining financing through underwritings. He was a promoter as that term is defined by the Securities Act of British Columbia.

He dealt extensively with both free and escrowed shares of Orell. The summary of transactions produced by the plaintiff indicates that in 1979, he sold 254,548 shares, in 1980 he sold 153,000 shares and in 1981 he sold 86,250 shares. Throughout the period, he more or less replenished his inventory of Orell shares by making frequent purchases. Among these sales are transfers of some 50,750 Orell shares by the plaintiff to related corporations. Also included are transfers of some 35,500 Orell shares by way of gift inter vivos to family members.

In conjunction with filing his return for his 1978 taxation year, the plaintiff had elected, under subsection 39(4) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”), to have all his transactions in Canadian securities treated on a capital account. This election was relied upon by the plaintiff in treating his transactions in Orell shares as well as in shares of other corporations traded on the Vancouver Stock Exchange on a capital account for the relevant taxation years.

By notices of reassessment the Minister of National Revenue disregarded the election insofar as the Orell shares were concerned on the basis that the plaintiff was a trader in these shares and hence was prevented, by virtue of subsection 39(5) of the Act, from electing to have the disposition of those shares treated on a capital account. The Minister assessed the Orell share transactions accordingly. By the same reassessments, the Minister included in the income of the plaintiff the fair market value of the Orell shares which he transferred to related corporations and to family members by virtue of subparagraphs 69(1 )(b)(i) and (ii) of the Act respectively.

Plaintiff argues that he was entitled to elect under subsection 39(4) of the Act, and that his transactions in Orell shares should accordingly be treated on a capital account. He argues, in the alternative, that part of the Orell shares which he sold in 1979 should nevertheless be treated on a capital account because they were received by him back in 1974 as a prospector in consideration for having transferred mining claims to Orell. According to him, these particular shares were acquired as an investment and should be treated as such.

In the further alternative he argues that the deemed receipt from related corporations arising from the transfer of Orell shares should be valued at an amount equivalent to his cost in these shares and that accordingly no income should be assessed in his hands as a result of those transfers. Finally, he argues that the deemed receipt arising from transfers by way of gift to family members should be treated on a capital account because these were obviously not made with a view to profit.

The alternative arguments can all be disposed of quickly. If the Orell shares are trading assets in the hands of the plaintiff, the fact that he may have viewed an otherwise undistinguishable portion of these shares as being held for investment purposes is irrelevant in the circumstances. First, the Orell shares were fungible in nature and therefore could not be segregated. Secondly, even if some shares were originally acquired as an investment, they would have lost their capital character when the plaintiff began trading in these shares. Thirdly, trading assets, once turned into a profit, give rise to income irrespective of the state of mind of the seller when he acquired these assets.

As to the tax treatment of the gifted shares, it is acknowledged that the gifts were not made with a view to profit. But that is not the issue. If the shares were held on an income account, section 69 of the Act compels the inclusion of their fair market value in income regardless of the plaintiffs altruistic intent in making these gifts.

With respect to the transfer of Orell shares to related corporations, there is no basis for the argument advanced by the plaintiff to the effect that his deemed receipt should be limited to his cost base in those shares as opposed to their fair market value at the time of the transfer. Section 69 simply provides otherwise.

I am more troubled by plaintiffs argument that he is entitled to rely on the election which he filed back in 1978 in treating his Orell share transactions on a capital account. The statutory authority under which the election was filed is as follows:

39(4) Except as provided in subsection (5), where a Canadian security has been disposed of by a taxpayer in a taxation year, and the taxpayer so elects in his return of income for that year,

(a) every Canadian security owned by him in that year or any subsequent taxation year shall be deemed to have been a capital property owned by him in those years; and

(b) every disposition by the taxpayer of any such Canadian security shall be deemed to be a disposition by him of a capital property.

(5) An election under subsection (4) does not apply to a disposition of a Canadian security by a taxpayer who, at the time the security is disposed of, is

(a) a trader or dealer in securities,

In The Queen v. Vancouver Art Metal Works Ltd., [1993] 1 C.T.C. 346, 93 D.T.C. 5116, the Court of Appeal confined the category of persons who are prevented from making this election to those who are registered or licensed dealers in securities and those who, without being licensed or registered, make it their business or profession to trade in securities. Falling outside this category are investors as well as those who are engaged in the business of dealing and trading in securities only by virtue of having embarked upon adventures in the nature of a trade as those words are used in subsection 248(1) of the Act.

In this instance, subsection 248(1) was relied upon by The Queen in support of her pleadings. The plaintiff was a "promoter” within the meaning of the Securities Act of British Columbia, but he was not a registered or a licensed dealer in securities. The reassessments in issue recognize so much in that the plaintiff's other transactions on the Vancouver Stock Exchange were treated on a capital account in conformity with the election which he filed. It is only with respect to the plaintiffs dealings in the Orell shares that the Minister has placed on him the label of "trader or dealer in securities" as this expression is used in paragraph 39(5)(a) of the Act. I am satisfied that plaintiffs dealings in Orell shares were profit motivated and constituted at least a series of adventures in the nature of a trade. However, according to the decision of the Court of Appeal, I must take the analysis one step further and determine whether, irrespective of this extended definition, the plaintiff was a trader or dealer in securities as this term is commonly understood.

In this regard, it is not sufficient that plaintiff s actions be akin to those involved in a trade, or business, or that they be of the same nature. The actions must on their own account be those of a person involved in the business of "trading" or "dealing" in securities within the plain and ordinary meaning of those words.

The Court of Appeal in Vancouver Art Metal Works Ltd., supra, said so much in the following terms at page 349 (D.T.C. 5118):

In my view, the words "trader or dealer" should be given their ordinary meaning. They normally refer to a person who deals in merchandise, is engaged in buying and selling or whose business is trade or commerce. In Black’s Law Dictionary (6th ed., West Publishing Co., St. Paul, Minn., 1990, page 399), a "dealer" is defined as "any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise, but does not include a bank, or any person insofar as he buys or sells securities for his own account, either individually or in some fiduciary capacity, but not as a part of a regular business”.

[Emphasis added.]

The Court concluded its discussion as follows, at page 351 (D.T.C. 5120):

In conclusion, a taxpayer does not necessarily lose his election right under subsection 39(4) when he buys and sells securities for his own account. However, he loses such right to elect when he becomes a trader or a dealer, that is to say when he professionally engages in the business of dealing in securities or when his dealings amount to carrying on a business and can no longer be characterized as investor’s transactions or mere adventures or concerns in the nature of trade.

The difficulty which arises from this decision is the distinction which now must be drawn between a person who is a trader or dealer in the true sense and one who is a trader or dealer only by virtue of having engaged in adventures in the nature of that trade. [1] In ascertaining the existence of a securities trading business, the Court of Appeal suggested the following approach at page 350 (D.T.C. 5119):

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. R., "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. (See /mperial Stables (1981) Lid. v. R., [1990] 1 C.T.C. 213, 90 D.T.C. 6135 (F.C.T.D.) confirmed by F.C.A. Division, No. A-996-90, February 17, 1992; Forest Lane Holdings Ltd. and Bonibo Holdings Ltd. v. R., [1990] 2 C.T.C. 305, 90 D.T.C. 6495 (F.C.T.D.); Karben Holding Ltd. v. R., [1989] 2 C.T.C. 145, 89 D.T.C. 5413 (F.C.T.D.); M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125, (Ex. Ct.); Tara Exploration and Development Co. v. M.N.R., 70 D.T.C. 6370 (Ex. Ct.).)

This approach, while useful in ascertaining the existence of a securities trading business as opposed to an investment, begs the question as to the legal basis on which such a business can be said to arise, once it is found to exist. The factors highlighted by the Court of Appeal have traditionally been applied indiscriminately to identify both persons who carry on a business in the true sense, as well as persons who are in business by virtue of having engaged in an adventure or adventures in the nature of a trade. Because they are badges or indicia of trade, they must be found to exist to a degree or another under either analysis before a conclusion as to the existence of a business for tax purposes can be reached. Usually, the distinction matters little as the tax treatment of profits or losses arising from a business is generally the same whether a business is found to exist as such or whether its existence is premised on the extended definition of the word "business". Hence, the courts have paid little or no attention to it. [2] However, the distinction must now be made in the context of subsection 39(5) of the Act.

What then can distinguish a person who is a trader or dealer in securities by virtue of having engaged in an adventure or a series of adventures in the nature of a trade, and a trader or dealer of securities as that expression is used in paragraph 39(5)(a) of the Act? As noted, factors such as the short duration of the holding, the intention to resell at a profit, the speculative nature of the securities bought, the volume of the transactions can be consistent with either finding. The distinction must therefore lie elsewhere. In my view, it is to be found by reference to the legislative intent in enacting the limitation embodied in paragraph 39(5)(a) of the Act.

It is recognized by all that paragraph 39(5)(a) was at least intended to prevent persons who are registered or licensed traders or dealers in securities from converting their income arising from that trade into capital gains. In the normal course, however, licensed dealers trade for the account of their clients and, in that context, paragraph 39(5)(a) is of no relevance to them. It is only of relevance to them when, from time to time, they choose to trade on their own account. In that context, it seems clear that the legislator did not intend individuals who, by their trade, have professional knowledge of the market in which they deal to benefit from the election.

I believe that in determining the availability of the election to one who trades in securities without being licensed or registered, the focus should be the same, namely, does the author of the transactions in question possess a particular or special knowledge of the market in which he trades? To the extent that he does, he distinguishes himself from the common risk takers who "play the market" regularly or sporadically based on commonly available investment advice and information. That it seems is the guiding line which must delineate the scope of the election contemplated by section 39(4) of the Act and the limitation embodied in paragraph 39(5)(a).

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.

For these reasons, the appeal is dismissed with costs against the plaintiff.

Appeal dismissed.