Imperial Stables (1981) Ltd. v. The Queen, 90 DTC 6135, [1990] 1 CTC 213 (FCTD), briefly aff'd [1992] 1 CTC 263, 92 DTC 6189 (FCA)

Martin, J.: —The plaintiff, which sustained losses in the amount of $961,259 in its 1982 taxation year as a result of certain stock market transactions, claimed them as deductions against its taxable income on the alternate grounds that it was in that year a trader or dealer in securities or that its stock and option trading transactions constituted a concern in the nature of trade. The defendant refused to allow the full deduction claimed on the basis that the losses were Capital losses.

The plaintiff company is the name given to the company continued by the December 1, 1981 amalgamation of Imp-Pac Lumber Ltd. ("Imp-Pac") and Imperial Stables Ltd. Imp-Pac was a lumber dealing company incorporated in the early 1970s on the instructions of Mr. George Culley. Culley was the only beneficial shareholder of Imp-Pac until around 1974 when three new shareholders were taken in. At that time Culley's percentage of the issued shares was reduced to 70 per cent with the remaining 30 per cent being held equally by one of his sons, a company employee and a Mr. John Montgomery.

Around 1980 Imp-Pac sold its assets for some $12,000,000 from which, after the company's debts were paid, Culley got about $4,000,000. Around the same time he caused Imperial Stables Ltd. to be incorporated for the purpose of starting a thoroughbred horse racing stable. It was about a year later that he caused the two companies to amalgamate and continue as Imperial Stables (1981) Ltd., the affairs of which are solely directed by Culley who is also the majority, if not, the only shareholder.

Although Culley admits to having one stock market transaction in the 1960s he did not get into the market either personally or through any of his companies in any significant way until the mid-19705. His entry into the market arose as a result of his relationship with Montgomery. Culley was aware that Montgomery bought and sold shares in the market and says it was around the time that Montgomery became a shareholder in Imp-Pac, in 1974, that they started buying and selling together.

In 1978 Culley declared a net capital gain of $546 on sales of $67,000 worth of shares in three companies. By 1980 he reported a capital gain of about $64,000 on sales of about $3,500,000 worth of shares in 15 different companies. In that same year he declared a capital gain of $34,000 as a result of commodity transactions in sugar and copper. Finally, apart from the transactions under consideration, in 1981 he declared a net capital gain of about $8,500 on sales of about $400,000 worth of shares in three companies.

There was also a net capital loss of about $10,000 declared by Imp-Pac for its 1981 taxation year when it disposed of shares in Seaboard Lumber Sales Co. Ltd. and Seaboard Shipping Co. Ltd. for a capital loss of $65,000, and shares of B.C. Forest Products Ltd. for a capital gain of $55,000.

Culley says that he and Montgomery started dealing together in the stock market around 1974. Evidence was introduced for share transactions in 1978, 1980, 1981 and 1982. I was not told whether or not Culley or any of his companies had share transactions during the years from 1974 to 1977 or during 1979 but presume there was nothing of any significance during those years.

Culley’s pattern of buying and selling, apart from the Imp-Pac transactions of 1981, was to get in and out of the market quickly taking relatively small profits or small losses. He could not be precise about the length of time the various shares were held but he did say they were always for the short term. The defendant's expert witness confirmed this for the 1980 share transactions by reason of the low interest expense of $15,000 on about $3,500,000 worth of sales.

Apparently it was possible, in 1980, to buy stock on a Monday and sell on a Friday without ever having to put up any money. In 1980 three of the share purchases in Montgomery's and Culley's joint account alone were in excess of $1,000,000 so that a very small movement in the price of the stock would give rise to a significant gain or loss.

In this respect it is interesting to note that of the 15 transactions which took place in 1980, seven resulted in losses and, if the expenses associated with the sales were deducted from the proceeds of the sales, a total of nine would have resulted in losses which ran from several hundred dollars to a high of about $35,000 in one transaction.

The 1980 statement of capital dispositions lists transactions in the shares of 15 separate companies. It does not indicate how many purchases and sales were made with respect with each company or when these transactions took place. There is Culley's evidence, however, which is more or less supported by the defendant's expert, that the stocks were bought for a short term and then sold.

My final observation before detailing the transactions under consideration is with respect to Culley’s 1981 declared capital disposition of shares. The net capital gain of $8,500 included a capital loss on the disposition of Dome Petroleum shares. That transaction represented the last joint share purchase made by Montgomery and Culley. Shares costing U.S. $176,000 were bought on June 9, 1981 and sold on June 17, 1981 for U.S. $175,000 for a loss of U.S. $1,000, one half of which was claimed as a capital loss by Culley in his 1981 tax return. Culley said that the stock was sold right away at a loss because Montgomery wanted to get out.

I arrive now at the point where the plaintiff entered the market on its own. As Culley directed the affairs of the plaintiff it will be more convenient to refer to him on the understanding that his actions are those of the plaintiff. At this point in June of 1981, Culley was without his lumber business and was in the process of getting into the horse racing business. He had about $4,000,000 and no debts and was looking forward to a change in his lifestyle.

Culley's stock broker, a Mr. Philip Henningson, of the Merrill Lynch Royal Securities Ltd. firm in Vancouver, was aware that Culley had come into a significant amount of cash and was anxious for him to invest some of it in the market. Henningson told Culley that he thought Dome Petroleum, which was then, early in July of 1981, listed at about U.S.$20, would rise in price to as high as $30 within 30 to 60 days.

As Culley described it, he decided to take a flyer in the market for a short period. He said he was thinking of buying on Monday and selling on Friday. Henningson arranged to open a U.S. cash account, under the terms of which the purchase price of shares must be paid in full within five days of the purchase, and Culley made his first purchase of 10,000 shares of Dome for U.S. $198,000. Subsequent purchases and sales of Dome shares are set out in Exhibit 2 which is reproduced herewith:

SCHEDULE II

IMP-PAC LUMBER LTD./

IMPERIAL STABLES (1981) LTD.

Purchase and sale of Dome Petroleum

shares 1981/1982

	# of Shares	$ U.S. Value	$ Cdn. Value	# of
	purchase	purchase	purchase	Shares
Date	(Sale)	(Sale)	(Sale)	Held
21/7/81	10,000	198,201	243,787	10,000
4/8/81	10,000	192,750	237,083	20,000
5/8/81	10,000	184,725	227,212	30,000
6/8/81	5,000	88,875	109,316	35,000
7/8/81	5,000	88,875	109,316	40,000
31/8/81	10,000	154,000	189,420	50,000
3/9/81	(10,000)	(159,567)	(196,267)	40,000
22/9/81	10,000	151,691	186,580	50,000
24/9/81	10,000	131,516	161,765	60,000
21/1/82	6,800	70,743	89,490	66,800
3/6/82	(10,000)	n/a	(68,764)	56,800
4/6/82	(10,000)	n/a	(70,005)	46,800
30/6/82	(20,000)	n/a	(113,260)	26,800
8/7/82	(20,000)	n/a	(113,260)	6,800
9/8/82	(6,800)	n/a	(31,118)	—
	Loss		($961,295)

Because the dates shown on Exhibit 2 are the settlement dates for the payment of shares the actual purchases occurred about a week earlier. The defendant's expert, Mr. George E. Robson, the senior member and vice- president of the corporate finance department of Dominion Securities Inc., prepared a table indicating this and other matters, for the period from July 14 to August 13, 1981 in the course of which Culley had acquired 40,000 shares of Dome for U.S. $750,000. That table is reproduced herewith from Exhibit 10:

Although the above exhibits speak for themselves they indicate, to me at least, a significant change in Culley's approach to the market in 1981. He bought a substantial block of shares and waited for about two weeks. During this period the shares remained more or less at the same price. Culley then, over a period of four consecutive days, while the shares slipped marginally in price, bought heavily into the market and held.

During a four-day period about three weeks later Culley did get in and out of the market at a small profit if one considers the transactions between August 31 and September 3, 1981 in isolation. Following those two transactions there was another wait for about three weeks when Culley again bought heavily over the three-day period from September 22 to 24, between which dates the price of the Dome shares took its quickest drop in value since Culley started to buy. By then Culley had acquired 60,000 shares of Dome at a cost of more than U.S. $1,000,000 over a period of just two months and, on paper at least, had lost about U.S. $250,000.

For reasons which are not clear Culley closed out his cash account with his brokers on October 30, 1981 and changed it to a margin account. By this means he would be able to acquire more shares without the necessity of paying cash for them. Under the margin account arrangement the brokerage firm would provide loans to the purchaser of up to 50 per cent of the market value of shares held. Accordingly, when Culley opened his margin account on October 30, 1981, he could have obtained financing from the brokerage firm with which he was dealing sufficient to purchase another 60,000 shares of Dome.

In fact Culley purchased no more Dome shares for four months when, for some unexplained reason, he made his final purchase of 6,800 shares at which time the shares were listed at about one half of their listed price when Culley first started buying them in July of 1981.

Notwithstanding this dramatic drop in the value of his share holdings Culley held on for a further six months during which time the shares took a further reduction in value from C. $13 to C. $7. At that point, in June of 1982, Culley decided to change his investment strategy. Rather than continue to hold the Dome shares he decided to sell his complete portfolio and, in order to recoup some of his losses, he decided to enter the options market in Dome shares.

In furtherance to this strategy he had his 66,800 Dome shares transferred to new brokers, Rademaker MacDougal and Company who, on Culley's instructions between June 3 and August 9, 1982, sold all of them at prices which steadily dropped from a high of C. $7 to a low of about C. $4.50 resulting in a loss to Culley on its total portfolio of Dome shares of almost C. $1,000,000.

Culley claimed to have been naive about the stock market. I suspect perhaps he was not quite as naive as he claimed to be but I have no doubt that at the time he decided to go into the options market he had no idea about the principles which governed it. His new brokers, upon whose advice he relied completely, set up a complicated plan in the options market called a "straddle" under the terms of which Culley could make money if the price of the Dome shares went up or down within certain limitations. At this time Culley was most anxious if not desperate to try to recover some of his losses. He was simply gambling or playing the market for the very short term with no thought of ever holding any stock except for the brief moment required under the term of the "straddle" to make a profit. Once again Culley was unsuccessful. As I understood the evidence he lost a further $45,000 trading in options.

Throughout this recitation of the events I have frequently rounded off figures relating to the cost and sale prices of shares, the number of transactions and the times during which shares were held because it was not necessary to be accurate to indicate, in general, what was happening. To be specific and accurate however on the losses sustained by Culley, I understand them to be $934,241 on account of the loss in value of the Dome shares and $45,962 on account of the losses sustained in trading on options.

Counsel referred me to many cases as well as to a lengthy article by John W. Durnford at page 837 of the Canadian Tax Journal, 35, (1987) entitled “Profits on the Sale of Shares: Capital Gains or Business Income" all of which I have read and from which I have concluded that the most significant principles to be applied in cases such as these are the following:

1. No single set of criteria can be laid down for all cases in order to determine whether a profit or loss arising out of a single or set of transactions should be characterized as being on capital account or current account or trading for income tax purposes. Each case must stand on its own and be decided on its own particular circumstances.

2. While there are a number of factors which can be considered in order to assist the Court in making its decision, such as the number of transactions, the type of property dealt in, the length of time the property is held, the income if any from the property, the taxpayer's involvement in the business associated with the property, the time spent by the taxpayer studying the market and the property acquired, etc., the most important criteria is the motive or intention of the taxpayer at the time of the acquisition of the asset which intention is to be determined most reliably from his course of conduct rather than exclusively from what he says his motive was.

The cases are well summarized in the Canadian Tax Journal article referred to and in several of the cases cited by counsel, particularly by Collier, J. in Bossin v. R., [1976] C.T.C. 358; 76 D.T.C. 6196. As noted by counsel each case turns on its own facts so that little purpose would be served in this decision by repeating what others have already done. Some of the cases cited bear some similarity to the circumstances in this one particularly the Bossin and Tamas v. R., [1981] C.T.C. 220; 81 D.T.C. 5150, both of which are distinguishable from the present case (the former by reason of the type of financing and the latter by reason of the time and effort spent by the taxpayer in his trading activities). In this case the plaintiff, whose actions are those of Culley, claims a business as opposed to a capital loss on the basis that Culley was a trader or dealer in Dome shares or alternatively that his dealing in the shares and options for shares constituted a concern in the nature of trade which he was conducting.

In my view Culley was not a trader or dealer in Dome Petroleum shares in the acquisition and sale of them during the period from July 21, 1981 to August 9, 1982, nor did his dealings in those shares constitute a concern in the nature of trade.

Prior to the time Culley commenced his acquisition of the Dome shares he had a record of getting in and out of the market relatively quickly. He appeared content to take a relatively small gain or small loss in relation to frequently large amounts invested. He himself described his investment strategy as in on Monday, out on Friday. It was this strategy that allowed him and Montgomery on some occasions to buy and sell stock without having to put up any money.

Culley says that all of the stocks which he and Montgomery purchased were purchased for the short-term profit or, as it sometimes transpired, loss. Prior to Culley’s dealing in Dome there was no suggestion that any stock would be held as an investment whether the price rose or fell. The stock was all bought for the short term or for what Robson calls, the “quick flip”. Indeed just the month before Culley went into the market on his own account he and Montgomery had "flipped" 10,000 shares of Dome over an eight-day period in which they lost about $1,000 on an investment of U.S. $175,000.

When Culley decided to go into the market without Montgomery there was a change in his investment strategy. Although he says he had in mind the shortterm Monday to Friday dealings his conduct does not bear that out. As Robson says the trader or dealer is characterized by buy/sell, buy/sell and not by buy/ buy/buy which is what Culley did, apart from one aberration of a buy and sell around the end of August 1981. In fact had Culley been acting like a trader or dealer and carefully watching the market for the quick dollar, which is all he said he wanted from his Dome investment, he could have gotten out of the market with a small quick profit on several of the ten days following his first purchase on July 14, 1981. Instead he chose, following the ten-day period, to quadruple his holdings in Dome.

Robson's chart, reproduced earlier in this decision, shows clearly that Culley could have, during the month following his first purchase of Dome shares, gotten out of the market at any time with a small loss and, on several occasions, a small profit. The fact that Culley chose, not only to stay in but, to substantially increase his holdings indicates to me that he was "taking a position” in Dome shares, that he was acquiring an investment, that he was buying to hold rather than to sell.

My view in this respect is reinforced by the fact that he increased his holdings from 40,000 shares to 60,000 shares in late September 1981 even though the shares had dropped fairly significantly in value. Had Culley maintained the investment strategy which he and Montgomery had maintained of getting in and out of the market quickly he would have sold the Dome shares by the end of August or at least by the end of September. Instead Culley decided again and again, contrary to his expressed intention and his previous practice, to buy more of the shares.

Robson describes the practice of lowering the average cost of a share by buying as the price goes down as "averaging down" and the act of an investor rather than a trader or dealer. A trader or dealer, says Robson, would sell quickly to cut his losses. He also described Culley's action of holding stock for about a year while it lost three quarters of its value as “fighting the tape" and once again said that this is not the act of a trader or dealer.

In my view Robson correctly described Culley's action as that of an investor who acquired a position in Dome and held it for a substantial period of time. Culley had changed his strategy from that of buying solely for the purpose of selling to that of buying to hold as an investment and to sell sometime in the future when the price became attractive enough.

Furthermore, with respect to Culley's claim to be a dealer or trader in the shares, he had practically none of the characteristics usually shown by them. He had no specialized knowledge of the market or the shares he acquired and, apart from having an interest in the price of the Dome shares, he made no effort to study things which might affect their price, particularly in the short term. Apart from calling his broker occasionally Culley spent little time trading and in fact, during the period he acquired his Dome shares, he was out of the province for substantial periods of time pursuing his first interest which was in establishing a race horse breeding business.

Nor can Culley characterize his acquisition of the Dome shares as other than an investment under the ancillary test for an investment as opposed to inventory. All the transactions were in a single stock which was acquired, held for a substantial period of time and then sold. This was not by any means a “flip” or a quick in and out of the market. Payment for the stock was made on a cash basis. There was nothing unusual about the financing which limited the time during which the shares could be held or fixed the date on which they had to be sold.

Culley was under no pressure from lenders or banks to repay any loans. He had just netted $4,000,000 on the sale of some business assets and could afford the loss. The fact that there was no income from the shares by way of dividends is of no significance for no doubt Culley was expecting, when he eventually sold the shares, to sell them at a profit.

Finally there is Culley's characterization of his acquisition of the shares to a Ms. Joanne Ralla, an officer from Revenue Canada. She said, and Culley did not deny it, that Culley told her specifically he had decided to build a portfolio, that he had sold off many of the assets in his lumber company, that he had a large amount of cash and wanted to start building up. In this connection there was no talk of in by Monday and out by Friday nor any other suggestion that Culley was buying for the short term.

The only evidence which supports the plaintiff's contention that the Dome stock was purchased for a quick sale is the evidence to that effect given by Culley in Court. As opposed to that evidence is the evidence of the actual purchase and sale of the shares, their financing, the time held, the times they were purchased and the prices paid as well as Culley's statement to the Revenue Canada officer. The evidence that the shares were purchased as an investment and not as inventory is overwhelming.

The defendant has refused to allow the loss incurred by the plaintiff in its trading in options in Dome as a deduction on the grounds that the trading in options must be treated in the same way as it treated Culley's dealing in the Dome shares. I can see no merit at all to that as a reason.

The option straddle arrangement put in place by Rademaker MacDougal and Company did not have as its purpose the acquisition of shares, it was rather the action of trading and dealing in options for the purchase and sale of shares carried on by the brokerage firm as the agent of the plaintiff. The criteria required in order to characterize these transactions as trading and dealing in the market as opposed to purchasing shares for an investment were supplied by the brokerage firm. Beyond the understanding that the brokerage firm would act to recoup some of Culley's losses by some sort of activity in the market Culley had no real understanding of what they were doing. I accept the submission of counsel for the plaintiff that this activity could not be considered as acquiring investments and that the losses which arose from it must be considered losses on current account.

It is only fair to Mr. Culley that I should state for the record I found him to be a perfectly honest and forthright witness and I make this observation notwithstanding my refusal to accept what he says was his motive or intention in acquiring the Dome shares. I have no doubt that there was in Mr. Culley’s mind at the time he acquired the Dome shares the possibility that he would sell them quickly if the price should rise to an acceptable level but in my view this was only one consideration among others. I do not find it at all unusual that, with the passage of time, Mr. Culley has come to believe, and genuinely believes, that this was his sole motivation in acquiring the shares. The human mind has a habit of recalling particularly well those things which are favourable and erasing from its memory tapes those which are not.

I put more or less into the same category Mr. Culley's professed naivety about matters relating to the stock market. I have no doubt that was the position with respect to his option trading straddle but I am equally certain that Mr. Culley understands perfectly well the significance of building up a stock portfolio.

The plaintiff's appeal to be allowed as a deduction against his taxable income the full amount of the losses arising out of its dealings in Dome Petroleum shares totalling $934,241 is dismissed with costs.

The plaintiff's appeal to be allowed as a deduction against its taxable income the full amount of the losses arising out of its dealings in the options of Dome Petroleum shares totalling $45,962 is allowed with no order as to costs.

Pursuant to paragraph 337(2)(b) of the Federal Court Rules counsel for the defendant is directed to prepare a draft of the formal judgment, which should also include the matters raised in paragraph 8 of the statement of claim and paragraph 5 of the defence, and submit the same to counsel for the plaintiff for approval as to form and then to me for approval and, if approved, for entry.

Appeal allowed in part.