Citation: 2012 TCC 99
Date: 20120329
Docket: 2008-2035(IT)G
BETWEEN:
JAMES ZSEBOK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan J.
[1]
In 2001, 2002, 2003 and 2004, the
Appellant, James Zsebok, claimed business losses resulting from his online
share trading activities. The Minister of National Revenue disallowed the
losses on the basis they were on account of capital.
[2]
At the hearing, the appeal of the
reassessment of the 2002 taxation year was quashed upon the Appellant’s
acknowledgement that he had never served a Notice of Objection in respect of it
as required by subsection 169(1) of the Income Tax Act. However, the
parties requested that evidence pertaining to the 2002 taxation year be taken
into consideration in the disposition of the appeals for 2001, 2003 and 2004.
[3]
The Appellant and Loris Macor, the
chartered accountant who prepared his 2001 to 2004 income tax returns, were the
only witnesses. While there were certain gaps in the Appellant’s evidence it
was generally credible; more will be said about specific portions of his
testimony during the consideration of the factors set out below.
[4]
As for Mr. Macor, with some 30
years experience as an accountant, he had a clear understanding of the issue under
appeal. However, I agree with counsel for the Respondent that not much weight should
be given to his testimony. Mr. Macor’s close professional relationship with the
Appellant’s employer rendered his testimony less objective than it might
otherwise have been. Furthermore, Mr. Macor was not retained by the Appellant until
sometime in 2005 so he was in no position to speak to the Appellant’s intentions
in respect of his trading activities during the years 2001 to 2004. Whatever he
knew about the Appellant’s circumstances, he had gleaned from reviewing the
Appellant’s books and records long after the fact. Counsel for the Respondent
noted that Mr. Macor was not called as an expert witness; accordingly, his letter
to the Canada Revenue Agency dated March 7, 2007
in support of the Appellant’s position that he was engaged in a business
venture when carrying on his online trading is in no way determinative of the
issue before the Court – though I would add, I did not understand counsel for
the Appellant to have relied on his evidence for that purpose.
[5]
As is often the case when the
issue concerns a determination of capital versus income, it is not so much the
facts that are in dispute as how they ought to be interpreted.
Analysis
[6]
To succeed in his appeals, the
Appellant had the onus of proving that he was either a “trader” as defined in
subparagraph 39(5)(a) of the Act or alternatively, that he was engaged
in an adventure in the nature of trade. That determination will depend on the
Appellant’s circumstances considered in light of the factors enumerated by the
Federal Court of Appeal in The Queen v. Vancouver Art Metal Works Ltd., 93
D.T.C. 5116 at page 5119:
… It is,
however, a question of fact to determine whether one’s activities amount to
carrying on a trade or a business. … 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.
Was the Appellant a “Trader”?
[7]
To qualify as a subsection 39(5)
“trader”, the Appellant had to prove, in addition to the above factors, that he
had “a particular or special knowledge of the market in which he trades”, Kane
v. Canada, [1995] 1 C.T.C. 1 (F.C.T.D.) at paragraph 23. It is this
characteristic that distinguishes
a trader from one engaged in an adventure in the nature of trade.
[8]
While the Appellant had no
professional training in share trading, he did have some education in economics
and accounting. After graduating from university, he gained experience in
fiscal matters by working his way up through various companies from inventory
manager to chief financial officer. During this period, the Appellant also
started at least three business ventures of his own: a paint and wallpaper store,
a housing construction company and a kind of consultancy intended to assist other
businesses to secure financing. Only the housing company ever became fully
operational but it put a huge financial burden on the Appellant and his family
and ultimately failed. Although none of these ventures was successful, they do
demonstrate the Appellant’s tolerance for risk and capacity to work at other
endeavours while in full-time employment.
[9]
In 1997, the Appellant opened a
trading account (“Margin Account”) and a self-directed retirement savings plan
account (“RSP Account”).
[10]
In March, 1998, he began working
with the principal of his employer during the years under appeal, Mr. Khan. The
Appellant was candid in his admiration of Mr. Khan’s business acumen; indeed, he
seems to have served, if not as the Appellant’s mentor, certainly as a role
model. In 2001, Mr. Khan asked the Appellant to handle his company’s acquisition
of shares in a corporate take-over; he also entrusted the Appellant with
conducting the company’s foreign exchange trading. These tasks were in addition
to the Appellant’s regular employment duties.
[11]
In all the circumstances, I agree
with the submissions of counsel for the Respondent that the Appellant lacked
the special knowledge necessary to make him a “trader” as contemplated by Kane.
The most that can be taken from the evidence is that his employment duties
provided him with some experience in share trading, including exposure to
various internet tools that could be used to track the market. But he had no
specialized knowledge of the shares traded; as for the internet programs he
used, these were available to the general public simply by paying the requisite
subscription fee.
Was
the Appellant Engaged in an Adventure in the Nature of Trade?
[12]
More difficult to determine is
whether the Appellant was engaged in an adventure in the nature of trade. Faced
with the question in Baird v. R., 2010 FCA 35, the Federal Court of
Appeal noted:
28 The
present appeal has again highlighted the difficulty of determining … the
boundary between income and capital gains and, hence, the difficulty of
determining whether a taxpayer is engaged in an adventure in the nature of trade.
The taxpayer’s intention, at the time of acquiring the property at issue, is
always a highly relevant factor which can only be determined by examining the
taxpayer’s entire course of conduct. …
[13]
Turning, then, to the Appellant’s
intention, he was adamant that his sole intention in trading between 2001 and
2004 was to make a quick profit. Notwithstanding the care and vigour of counsel
for the Respondent’s questioning on cross-examination, the Appellant remained
unshaken on this point.
[14]
In argument, counsel for the
Respondent characterized the Appellant’s behaviour as “opportunistic
retroactive tax planning”. It is true that in not filing returns for 2001 to
2004 until January 27, 2006, the Appellant had the benefit of knowing the
overall outcome of his four years of trading activity before committing to a reporting
strategy. While I feel there is more to this story than what was revealed at
the hearing, the only issue before me is the correctness of the Minister’s
determination that the losses were on account of capital. For the reasons set
out below, I am satisfied that when considered in light of the factors
established in Vancouver Art Metal, the evidence of the Appellant’s
overall conduct is consistent with his stated intention to acquire shares for
resale at a quick profit. Because of the overlap in the evidence, some of these
factors have been dealt with together under one heading.
1.
The frequency of the transactions; duration of the holdings; and the nature and
quantity of the securities held or made the subject matter of the transaction
[15]
The Minister made the following
assumptions in respect of the frequency of the transactions:
…
(g) the total
number of days in which the Appellant traded securities was twenty-one days (21)
in 2001, twenty-four days (24) in 2003 and eleven days (11) in 2004;
(h) the
Canadian stock exchanges are open for trading activity an average of 255 days
per calendar year;
(i) the number
of days for which the Appellant was involved in trading activity represents
approximately 5% to 10% of days the stock markets are open and active;
…
[16]
At the hearing, counsel agreed
that for the purposes of calculating the number of trades, a transaction was
considered to have occurred where the Appellant had been required to pay a
commission on it. On this basis, counsel estimated the number of trades in each
year in the Appellant’s Margin Account and RSP Account as follows:
|
Year
|
Margin Account
|
RSP Account
|
|
2001
|
23
|
9
|
|
2002
|
48
|
1
|
|
2003
|
21
|
1
|
|
2004
|
1
|
1
|
[17]
However accurate they may be, these dry statistics do not paint a true
picture of the flurried nature of the Appellant’s trading behaviour. At the
hearing, counsel for the Appellant took the Appellant through over four years
of monthly trading reports for both the Margin Account and the RSP Account. He was then cross-examined
on the same material. Laborious as it was, this process provided a fuller picture
of the Appellant’s trading activities: his strategy was to identify highly
volatile shares trading in high volume with a view to maximizing his earnings
while playing the range. This objective is consistent with the Minister’s own assumption
that “the average duration of the holdings was sixty-two days (62) for 2001,
sixty days (60) for 2003 and sixty-two (62) days for 2004”. Indeed, many shares were
held for a much shorter than average period, often for only a few days or
hours. In these circumstances, there was no hope of earning dividends or
waiting for the investment to mature, often one of the indicia of a capital
holding.
[18]
The Appellant tended to trade in
only three stocks, with an average value of about $10. In 2001, the number of
shares purchased was 20,500, the number sold was 32,600. In 2002, 70,800
purchased, 22,700 sold. In 2003, 311,900 purchased, 345,000 sold. In 2004,
151,000 purchased, 66,000 sold.
[19]
Counsel for the Respondent cited Leng
v. R., 2007 TCC 59, 2007 D.T.C. 370 for the proposition that “[t]he fact
that a person buys and sells shares at a short interval is not, by itself,
conclusive that the person is a trader or that the venture was in the nature of
trade." [Emphasis added by counsel for the Respondent.] In the present
case, however, the Appellant’s conduct in this regard is but one of several other
factors supporting this conclusion.
[20]
Whenever the Appellant had enough
cash on hand or sufficient borrowing power, he was back in the market, hoping
to make a few pennies on each transaction eventually adding up to a big profit.
He had seen Mr. Khan use this strategy to great advantage in the company’s
foreign exchange trading. The Appellant, however, had nowhere near his
employer’s financial resources. He was heavily over-leveraged, a fact often
indicative of a speculative intent. Nevertheless, his trading continued apace,
until the range flattened or the Appellant’s funds ran out. Oftentimes, what
small gains he made during these trading skirmishes were wiped out by
commissions and borrowing costs.
[21]
With the possible exception of
Nortel, none of the shares traded by the Appellant was of the “blue chip”
variety. While acknowledging that dealing in such shares could be consistent
with an intention to trade, counsel for the Respondent argued that conclusion
was negated by the fact that the Appellant held the same kinds of shares in both
his RSP Account and his Margin Account. Because, generally speaking, an RSP
account is used for long-term capital investments, counsel argued that it could
be inferred that the shares in his Margin Account were also acquired with that
intention.
[22]
In my view, this is to look at
things from the wrong end of the stick. The fact is the Appellant did not treat
his RSP Account the way most investors would. So intent was he on trading that,
at one point, he withdrew money from his RSP Account to beef up his Margin
Account – with the unhappy result that not only did he lose the money but also
had to pay tax on it. During one of his particularly unsuccessful bouts of
trading, he had to take funds from his RSP Account to buy groceries and pay the
mortgage. However foolishly, the Appellant was essentially using his RSP
Account as a branch office of the Margin Account. Both were being used to
satisfy the Appellant’s get-rich-quick dreams.
[23]
Counsel for the Respondent further
submitted that certain shares traded in 2004, the Dimethaid shares, ought not
to be considered in determining whether the Appellant was in the business of trading.
Counsel noted the Appellant’s testimony to the effect that, unlike his other
share acquisitions, the Dimethaid shares had been purchased “with his heart”. Further,
the Appellant purchased 45,000 Dimethaid shares directly through his RSP
Account. Finally, the Dimethaid dispositions in his Margin Account were not
reported as part of his trading activities for 2004 and were ultimately
transferred from the Margin Account to his RSP Account in 2005. In these
circumstances, counsel for the Respondent contended it could be inferred that the
Appellant intended to keep the Dimethaid shares for the long term.
[24]
First of all, I am not persuaded
that the exclusion of the Dimethaid shares from the calculation of the
transactions has much impact on the Appellant’s overall course of conduct. Even
if I am in error on this point, however, there are other factors militating
against the Respondent’s position. First, although the Appellant acknowledged
that it was only the involvement of a friend in the company that caused him to
buy Dimethaid, he was also clear that he would have disposed of the shares had
they suddenly spiked in value. This did not happen.
[25]
The fact that some of the
Dimethaid shares were initially purchased through the Appellant’s RSP Account
is equally unhelpful to the Respondent’s position. As mentioned above, the
Appellant treated both his RSP Account and Margin Account as vehicles for
trading. As for the transfer of the Dimethaid shares from the Appellant’s
Margin Account to the RSP Account, that had nothing to do with an intention to
hold them for the long term. What motivated the transfer in 2005 was the
looming shadow of a Requirement to Pay that the Canada Revenue Agency
Collections Department had issued to the Appellant’s broker. To prevent the
proceeds of any disposition of the Dimethaid shares making their way back to
the Minister, the Appellant transferred them to his RSP Account.
[26]
In my view, the telling feature of
the Appellant’s conduct is the feverish nature of his trading activities. If
the tables were turned and he had managed to make the profits he dreamed of, I
cannot for one moment imagine the Minister characterizing his activities as
being consistent with an intention to acquire the shares as a long-term capital
investment. For the reasons set out above, the evidence in respect of these factors
favours the Appellant’s contention that he was engaged in an adventure in the
nature of trade.
2.
The time spent on the activity
[27]
The Minister assumed that the
Appellant was in full-time employment which required him to travel
internationally on a frequent basis,
the implication being that in these circumstances, he would not have had time
to be in the business of share trading. However, the Appellant’s uncontradicted
evidence was that his employment duties rarely took him outside of Canada between
2001 and 2004. Even if they had, however, given that all of his transactions
were conducted on-line, being out of the country would not have prevented him
from carrying on his activities via the internet.
[28]
Counsel for the Respondent also contended
that the Appellant over-estimated the amount of time he would have been able to
dedicate to his personal trading during his hours of employment. This, I doubt.
I accept the Appellant’s evidence that his work duties required him to keep an
eye on the stock market and provided him with the tools to do so. He spoke of
sitting at his computer, with multiple screens open providing constant updates
on the state of the market. Given his access to such tools and his capacity for
multi-tasking, the Appellant’s evidence that he could simultaneously monitor
employment and personal investment data was convincing. I accept as well that
he worked long hours either in the office or at home, in part, to keep abreast
of developments in the international market. In these circumstances, I have no
hesitation in concluding that the Appellant’s full-time employment was no
impediment to his personal trading. Quite the contrary: it not only provided
him with the tools and some skills, but also fueled his enthusiasm for the
activity.
[29]
While the Minister made no
assumptions in this regard, counsel for the Respondent noted that a review of
the share transaction history showed long periods of inactivity. When the
Appellant did not have sufficient liquidity to trade (for example, if he had
exceeded the borrowing limits on his Margin Account or had no cash balance in
his RSP Account), no trades were made. From this, counsel contended, it could
be inferred that the Appellant was not engaged in the business of trading.
[30]
The counter to this, however, is
that whenever the Appellant did have a penny to trade with, he was back online.
As soon as he made enough of a profit on his Margin Account to create even a
modest cash balance or to reinstate his borrowing power, he was, once again, trading
shares. His generous biannual employment bonuses were immediately ploughed into
his trading account, usually to his detriment. He did the same with contributions
made to his RSP Account. In my view, the Appellant’s periods of inactivity do
not signal a lack of intention to trade, simply a temporary lack of means.
3. Previous Reporting History
[31]
According to the Federal Court of
Appeal Rajchgot v. Canada, [2005] 5 C.T.C. 1 (F.C.A.),
“a taxpayer who wants to change his reporting status in circumstances where it
becomes more tax efficient to do so bears a heavy onus”. The Minister assumed at
subparagraph 10(n) of the Reply that for 1999 and 2000, the Appellant reported
losses and gains from disposition of securities as being on account of capital.
[32]
This is not, strictly speaking,
true. Notwithstanding the above assumption, the Minister does not dispute that
the Appellant himself did not file any returns for 1999 and 2000. As a result,
in 2002, the Minister arbitrarily assessed the Appellant’s 1999 and 2000
taxation years under subsection 152(7) of the Act. According to the
Minister’s records, the reconstructed arbitrary assessment for 1999 shows the
Minister assessed in respect of both income and capital gain amounts; there is
no clear indication of how the 2000 taxation year was assessed.
[33]
Sometime in 2004, the Appellant
asked a local accountant to prepare amended returns for 1999 and 2000. Draft
returns were prepared in which the share dispositions were reported on account
of capital. These returns, however, were never filed. Instead, in 2005, the
Appellant took them to Mr. Macor, the chartered accountant who testified at the
hearing. According to Mr. Macor, rather than conducting his own analysis of the
Appellant’s books and records, he simply reproduced the information in the
original draft returns. He could not explain why he would have taken such an
approach to a new client’s returns. He then sent the new draft returns to the
Appellant for his review, signature and filing. At the hearing, Mr. Macor
expressed surprise upon learning the Appellant had not filed these returns. The
Appellant offered no explanation for this failure, other than to say that a
protracted dispute with the Canada Revenue Agency over a GST assessment of the
1999 taxation year had initially prevented him from doing so. While I did not
find this very convincing, it does not alter the fact that the Appellant had no
filing history for 1999 and 2000.
[34]
Counsel for the Respondent urged
the Court to draw a negative inference from the fact that the Appellant never
objected to the Minister’s treatment of the gains/losses in the arbitrary
assessments to conclude that he must have meant to report the transactions on
account of capital. Given the insufficiency of the evidence – on both sides of
this dispute – regarding the reporting history, this is too much of a stretch.
While I do not condone the Appellant’s conduct, in the circumstances, I do not
see how a past reporting history can be imputed to the Appellant so as to
impose on him the additional onus contemplated by Rajchgot. Thus, the
Appellant’s previous reporting history does not detract from the Appellant’s contention
that he was engaged in an adventure in the nature of trade.
Conclusion
[35]
As acknowledged by the Federal
Court of Appeal in Baird, above, the boundary between income and capital
gains is not easily determined. The present matter is no exception. While left
with the uneasy feeling that the evidence does not tell the whole story, based
on what was before me, I am satisfied that the balance tips slightly in the
Appellant’s favour. As the Appellant has met his onus of showing he was engaged
in an adventure in the nature of trade, the appeals of the reassessments of the
2001, 2003 and 2004 taxation years are allowed, with costs, and referred back
to the Minister of National Revenue for reconsideration and reassessment on the
basis that, in those years, the losses realized by the Appellant on the
disposition of shares were on account of income. The appeal of the 2002
taxation year is dismissed for not having met the requirements of subsection
169(1) of the Act.
Signed
at Ottawa, Canada this 29th day of March 2012.
“G. A. Sheridan”
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