Karben Holding Ltd. v. The Queen, 89 DTC 5413, [1989] 2 CTC 145 (FCTD)

Pinard, J.:—This is an appeal in the form of an action pursuant to subsections 172(2) and 175(3) of the Income Tax Act, S. C. 1970-71-72, c.63, as amended, brought by the taxpayer Karben Holding Ltd. after it was notified that the notices of reassessment by the Minister of National Revenue for the taxation years 1979, 1980 and 1981 had been confirmed.

The plaintiff is a company concerned with the administration of the property of a trust created under the will of Mr. Sidney Horwitz. At the relevant time, all the issued stock of the plaintiff was held by the estate of Sidney Horwitz and the plaintiff invested its capital in various securities, including publicly listed stocks and government bonds. The plaintiff reported capital gains for each of the years in issue, but the Minister of National Revenue treated the gains arising from the disposition of the securities held as having given rise to income from a business, instead of capital gains.

In addition, as part of the notices of assessment, the Minister refused to allow the deduction of automobile expenses including capital cost allowances claimed, and also disallowed the costs incurred by the plaintiff in connection with foreign exchange and alleged to constitute losses incurred as part of the investment activities of the plaintiff. At trial, however, learned counsel for the plaintiff indicated that his client had decided to discontinue its appeal with respect to such automobile expenses and foreign exchange costs.

Finally, with respect to the 1979 taxation year, the Minister reduced from $414,501 to $303,478 the non-capital losses incurred by the plaintiff in 1978 applicable to the 1979 computation of taxable income.

The plaintiff relies on sections 38, 39, 40, 9, 18(1)(a) and 111(1)(a) of the Income Tax Act. The plaintiff specifically alleges that the gains realized by it have been realized as part of the normal portfolio adjustments required by any prudent investor, and having been realized through activities consistent with those of an investor as opposed to the activities of a professional trader in securities or speculator, such gains constituted capital gains and not business income.

The Minister of National Revenue, on the other hand, submits that profits totalling $475,372 in 1979, $895,559 in 1980 and $693,278 in 1981, realized from the purchase and sale of securities, have been properly determined and taken into account in computing the plaintiff's income in accordance with the provisions of sections 3, 9(1) and 248 of the Income Tax Act.

Essentially, therefore, the Court must consider whether at the relevant time the plaintiff was a security trader and/or whether the profit made by the plaintiff on the sale of its portfolio shares was a capital gain or business income in view of sections 3, 9, 39 and 248(1) of the Act. It is recognized that the question is one of fact and that, further, the plaintiff has the burden of showing that the Minister erred in confirming the notices of reassessment in question.

The following facts were admitted at trial:

(a) the late Sidney Horwitz died on May 21,1976;

(b) by his last will and testament signed on November 26, 1975, the late Sidney Horwitz appointed his brother Elmer Horwood as trustee of his estate and executor of his will;

(c) article 6 of that will and testament provides that:

1. The Trustee shall until the final distribution of the capital of the Trust Property keep the Trust Property as it shall stand from time to time, invested.

2. Until the date of final distribution of all the Trust Property, the Trustee shall in his sole and absolute discretion either accumulate the income derived from the Trust Property to become part of the Trust Property or pay to any one or more of my brother, Elmer Horwood, my sister-in-law, Claire Horwood, my niece, Karen Beth Horwood and my nephew, Benjamin David Horwood (hereinafter collectively referred to as my "heirs") such part of the income derived from the Trust Property as my Trustee may in his sole and absolute discretion deem advisable;

3. Notwithstanding the provisions of paragraph 2 of this Article Six my Trustee may, in his most absolute and complete discretion, pay such amounts as it deems advisable firstly from the capital and re-invested capital of the Trust Property and then from the income of the Trust Property, if any, to any of my heirs namely, my brother, Elmer Horwood; my sister-in-law, Claire Norwood; my niece, Karen Beth Horwood; and my nephew, Benjamin David Horwood with the said payments to be made only at such time and intervals and in such proportions as may be deemed advisable by my Trustee.

(d) the heirs mentioned in that will and testament are entitled to receive the following proportion of the trust property:

(e) the plaintiff was incorporated in January 21,1977 and its certificate of incorporation indicates that there are no restrictions on the business the corporation may carry on;

(f) on or about January 28, 1977, the plaintiff acknowledged the purchase, as of May 26, 1976 from the estate of the late Sidney Horwitz, of the assets formally [sic] owned by Eurogroup Limited;

(g) the said assets of the estate of the late Sidney Horowitz were worth slightly over $1,000,000 U.S.;

(h) for the year ended on April 30, 1979 the plaintiff included the following as income in its statement of earnings:

but it treated its profit of $475,371.91 realized on the disposition of publicly traded shares and bonds as capital gain under the Income Tax Act;

(i) in the years ended on April 30, 1980 and April 30, 1981, the plaintiff included the following as income in its statements of earnings:

but it treated its profits of $895,559 in 1980 and $693,278 in 1981 realized on the disposition of publicly treated shares and bonds as capital gains under the Income Tax Act;

(j) for the period starting in 1976 to 1981, the operations of the plaintiff were similar and entailed the purchase generally on margin and the sale of shares and bonds within short periods of time;

(k) the plaintiff executed the following number of transactions for the indicated years:

The following relevant facts have also been established by preponderance of the evidence:

— some 12 to 18 months after Mr. Horwitz’s death, Elmer Horwood, for the plaintiff Karben Holding Ltd., retained the services of Jedbec Investments Limited ("Jedbec") who looked after the management of the portfolio of securities held by the estate;

— "Jedbec" was a corporation controlled by J. Elkin, who had been introduced to both Elmer and Claire Horwood by the late Sidney Horwitz sometime before his death;

— both Sidney Horwitz and Elmer Horwood had been most impressed by Mr. Elkin’s background and apparent qualifications as an investment counsel; Elmer Horwood had so much confidence in Mr. Elkin that shortly after the death of Sidney Horwitz he spent a considerable amount of time phoning friends and relations to strongly recommend the former as investment counsel;

— "Jedbec" was indeed given “carte blanche" to manage the portfolio of shares held by the Estate of the late Sidney Horwitz and provided its services for a fee, as clearly appears from the written agreement filed by the plaintiff as Exhibit P-8;

— with regard to the period for which the securities of the estate were held, the serious analysis by the witness Pierre Leduc, a Revenue Canada auditor, disclosed the following:

(a) the shares and bonds were held for the following average number of months:

(b) furthermore, the following chart indicates that 91 per cent of the securities were held for less than 12 months, and 57.6 per cent were held for less than 3 months:

— during the relevant years, both Elmer Horwood and J. Elkin worked in the same office, in Montreal; the former had the plaintiff buy a luxurious car that he himself used on a daily basis to go to that office; he also had the plaintiff pay him a salary totalling nearly half a million dollars for the same period of three years;

— at the relevant time, Claire Horwood knew practically nothing about the management of the portfolio of the estate, either before or after the death of her husband Elmer Horwood, which occurred some time in the middle of the year 1981.

It is clear that the plaintiff's income resulted from activities that were not restricted by its certificate of incorporation and that were performed through "Jedbec" as investment counsel. In that context, considering the volume of the plaintiff's transactions, the period for which it held its securities, the nature of such securities, the financing and the time spent on such activities, I have no hesitation in concluding that the plaintiff's income constitutes business income. In view of all the circumstances, it is clear to me that the plaintiff, through “Jedbec”, was buying and selling securities to make a profit (see Eidinger v. The Queen, [1987] 1 F.C. 363; [1987] 1 C.T.C. 36; 86 D.T.C. 6594 and Placement Bourget Inc. v. M.N.R., [1988] 2 C.T.C. 8; 88 D.T.C. 6274; [1988] 18 F.T.R. 126).

However, the plaintiff's main contention is that if J. Elkin, either personally or through the corporations he controlled, did in fact manage the portfolio of securities held by the estate in such a way as to allow the plaintiff’s gains to be considered as business income as opposed to capital gains, the investment counsel did so without the knowledge of Elmer Norwood, the trustee. Counsel for the plaintiff also emphasized that such management was inconsistent with "the main objective of preservation of the capital".

On the last point, it is alleged that the objectives set out at the time of the creation of the plaintiff were the preservation of the initial capital as well as the realization of a reasonable rate of return on the funds invested, that such objectives remained the same throughout the relevant period and that in order to achieve the main objective of preservation of the capital, the securities held were regularly monitored for signs of weakness. These allegations are not seriously supported by the evidence. On the contrary, I find that the terms of appointment of Elmer Horwood as trustee, in the will of the late Sidney Horwitz, as well as the terms of the written agreement between "Jedbec" and the plaintiff are so wide and so unrestricted that they clearly gave "carte blanche” to the trustee and the investment counsel respectively in their managing of the relevant portfolio of securities. Nothing prevented them from taking risks, from speculating or from buying and selling securities to make a profit, which in fact was done.

As for Elmer Norwood's alleged lack of awareness with respect to the real management of the relevant portfolio of securities, this is based essentially on Claire Norwood's testimony to the effect that her husband was not a businessman “because he was not aggressive enough" and that it was unlikely that J. Elkin ever advised him of the reasons for any action taken with regard to the management of the portfolio. Elmer Horwood himself, who died in 1981, could not testify to such facts and besides, J. Elkin was not called as a witness.

Now, Claire Horwood herself admitted she had blanks in memory with regard to specific facts during the relevant years. Furthermore, during cross- examination, she recognized that she did not know then what was going on with respect to the plaintiff's financial situation. She admitted that the only time she became aware of the money earned by the plaintiff was after her husband's death and that she found all that "very complicated". She mentioned that shortly before his death, her husband consulted a lawyer on a matter involving J. Elkin's or "Jedbec's" management, but the nature of the legal opinion then obtained for the fee of some $5,000 is not known. Finally, she recognized that she never gave any instructions to J. Elkin and that she did not cancel "jedbec's" contract, after her husband's death, in 1981.

I am not satisfied that the plaintiff has succeeded in proving any significant lack of knowledge by Elmer Horwood of "Jedbec's" management of its portfolio of securities. It would rather seem to me that the plaintiff, through its officer Elmer Horwood who had numerous opportunities to meet with J. Elkin at their common office, was duly informed by the latter, and that the former simply did not tell his wife about the considerable and sustained profits made for the plaintiff which, understandably, did not attempt to exercise its right to terminate its association with "Jedbec" at any relevant time. Elmer Horwood also received relevant broker and bank statements that he remitted periodically to the plaintiff’s chartered accountant who, in turn, contacted him or J. Elkin for needed information.

Consequently, the plaintiff has totally failed to discharge the burden on it of showing the Minister of National Revenue was wrong in the present case.

For all these reasons, the action must be dismissed with costs.

Appeal dismissed.