Richard Street v. Minister of National Revenue, 91 DTC 369, [1991] 1 CTC 2240 (TCC)

Christie, A.C.J.T.C.:—This appeal relates to the appellant's 1987 taxation year. At the times relevant to this appeal he was employed by SHL Systemhouse Inc. "Systemhouse"). In his return of income for that year he deducted $18,460 as an allowable capital loss in computing his income. The respondent accepted the $18,460 as being a capital loss, but disallowed the deduction because there were no capital gains in relation to which the deduction could be made. In his notice of objection the appellant stated:

I acquired some of the SHL shares in September 1987 with the intention of selling them a little over one month later in order to pay off my home mortgage of approximately $100,000. In October I borrowed approximately $100,000 from my broker to pay down the mortgage. A few weeks later I sold some of the SHL shares in order to pay off most of this loan.

He went on to say that he was entitled to deduct $36,920, being the full amount of the loss ($18,460 x 2). In his notice of appeal it is specified that the loss is related to an adventure in the nature of trade.

As indicated in the notice of objection, this litigation arises out of the acquisition and disposition of shares of Systemhouse. In 1984 the appellant received an option to acquire 20,000 shares of that company for $1 per share exercisable any time after August 31, 1987. Due to various actions taken with respect to the shares of Systemhouse, the option became one to acquire 8,000 shares at $2.50 each, which was exercised on September 1, 1987. At that time the market value of the shares was $29.37. On four occasions between October 22 and November 30, 1987, 5,000 of the shares were sold at differing prices below $29.37 but well above $2.50 resulting in a loss of $36,920 from the market value of the shares at the time of acquisition.

In his return of income for 1987 the market value of the shares at the time he purchased them less the amount paid for them ($234,960 — $20,000 =

$214,960) was included in the appellants employment income as required by paragraph 7(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act'). [1] Also in computing his taxable income he deducted one-half of the subsection 7(1) deemed benefit of $107,480 under paragraph 110(1)(d) [2] of the Act.

I am satisfied on the evidence, both written and oral, that at the time the appellant purchased the 8,000 shares it was his intention to dispose of a substantial portion of them early to liquidate debt. He exercised the option on the first possible day and commenced to sell the shares seven weeks after that. The sale of the 5,000 shares was completed five weeks later. I regard the acquisition and disposition of those shares as an adventure in the nature of trade.

But this conclusion does not entirely resolve the dispute. My understanding at trial was that the appellant sought to rely on paragraph 53(1)()3 [3] of the Income Tax Act in ascertaining the cost of the shares to him in calculating his business loss. This paragraph pertains to computing the adjusted cost base to a taxpayer of property which, in turn, relates to calculating capital gains and losses. It has no application to calculating income or loss from business or property. This is basically governed by Division B, Subdivision b of the Act which encompasses sections 9 to 37.1.

On the other hand counsel for the respondent contends that if the purchase and sale of the 5,000 shares was an adventure in the nature of trade, the cost of these shares for the purpose of calculating the profit or loss on the adventure is the actual price paid to Systemhouse by the appellant for them, i.e., $2.50 each. As already noted, while the shares sold below their market price of $29.37 on September 1, 1987, the sale price was well above $2.50 per share. Therefore, on this view of the matter there was no business loss.

The upshot of the positions taken by the respondent is this: if the purchase and sale of the 5,000 shares was on capital account, there were no capital gains in existence in 1987 to offset the capital loss; if what transpired was an adventure in the nature of trade, there was no business loss.

It seems to me that two quite separate taxable events were involved. First there was the acquisition of the shares under the stock option. The benefit arising at the time of exercising the option is deemed, under paragraph 7(1)(a) to have been received by the appellant by virtue of his employment with Systemhouse and in computing his taxable income he is entitled to deduct one-half of the benefit under paragraph 110(1)(d). Second there was the disposition of 5,000 of the 8,000 shares acquired. This is governed by other statutory considerations. If the sale of the 5,000 shares was on capital account paragraph 53(1)(j) comes into play and in computing the adjusted cost base of the snares there is added to the $2.50 paid by the appellant for each share the deemed benefit under paragraph 7(1)(a) pertaining to the shares. On the other hand if the acquisition and disposition of the 5,000 shares was on revenue account section 9 of the Act, as interpreted by Mr. Justice McNair in Pollock v. Canada, [1990] 1 C.T.C. 1%; 90 D.T.C. 6142 (F.C.T.D.), applies and in determining the cost of the shares to the appellant in this context the deemed benefit under paragraph 7(1)(a) is again added to the $2.50 paid for each share. Section 9 provides:

9. (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

(2) Subject to section 31, a taxpayer's loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

(3) In this Act, “income from a property” does not include any capital gain from the disposition of that property and loss from a property” does not include any capital loss from the disposition of that property.

In Pollock the appellant had realized substantial profits in 1979 and 1980 on the sale of shares he had acquired by exercising employee stock options granted to him by four corporations by whom he was employed. In his returns of income he treated the deemed benefits under paragraph 7(1)(a) of the Act in respect of the shares as having been received by virtue of his employment. The plaintiff treated his profits on the sale of the shares as capital gains. In reassessing the Minister treated the profits as income from an adventure or concern in the nature of trade. He relied on subsection 9(1) and the extended definition of “business” in subsection 248(1)4 [4] of the Act. The appeal from the reassessments was dismissed.

It was argued on behalf of the plaintiff that in determining profits realized the Minister must have added the deemed benefit under paragraph 7(1)(a) to the price paid by the plaintiff for the shares pursuant to paragraph 53(1)(j). McNair, J. dealt with this at page 202 (D.T.C. 6145-46):

According to him [counsel for the plaintiff], paragraph 53(1)() is the only provision of the statute allowing for such a computation, and the Minister's addition of the section 7 benefit in calculating the adjusted cost base of the shares confirms that those shares ought in fact to receive capital gains treatment.

In my opinion the submissions of plaintiffs counsel on this point are entirely lacking in merit. Firstly, I would observe that the Minister, who had admitted initially to including the deemed section 7 benefit in computing the adjusted cost base to the plaintiff of his stock option shares, subsequently withdrew that admis* sion and pleaded in his statement of defence that:

. . . the Minister of National Revenue deducted the cost of the shares, and not the adjusted cost base of the shares, in computing the amount of the gains realized by the plaintiff from the disposition of the said shares.

Counsel for the Minister submitted that paragraph 53(1)(j) is certainly not the only statutory provision in the Income Tax Act pursuant to which the section 7 benefit may be added in computing the cost of the shares, pointing out that in the case at bar the section 7 benefit was in fact included in computing the laintiff's cost pursuant to section 9 of the Income Tax Act. I consider that it was both fair and proper for the Minister to thus determine the plaintiffs profits from his business, assuming the plaintiff was indeed engaged in an adventure in the nature of trade. The mere fact that paragraph 53(1)(j) of the Act provides specifically for inclusion of the section 7 benefit in computing the adjusted cost base of shares acquired pursuant to employee stock options does not signify that the disposition of such shares is necessarily on capital account, nor does it preclude including the benefit under other sections of the Act.

I underscore these two points in that passage:

(i) the deemed benefit under paragraph 7(1)(a) was in fact included in computing the plaintiff's cost of the option shares pursuant to section 9 of the Act; and

(ii) McNair, J. considered that it was both fair and proper for the Minister to determine the plaintiffs business profits in respect of the shares in that way. [5]

The appeal is allowed and the matter is referred back to the respondent for reconsideration and reassessment on the basis that what happened regarded the 5,000 shares renders the matter an adventure or concern in the nature of trade. This results in the loss on their disposition being a business loss and deductible as such. In reassessing, the course of action followed and approved in Pollock shall be adopted.

Party-and-party costs to the appellant.

Appeal allowed.