Watts Estate v. The Queen, 84 DTC 6564, [1984] CTC 653 (FCTD)

Rouleau, J:—The issue is whether or not the profit realized from the sale of shares held in Hearne Coppermine Explorations Limited, by all three plaintiffs, was a capital gain and therefore not subject to tax under the provisions of the Income Tax Act. The reassessment was for the taxation year 1968.

All three actions were heard together on common evidence and are brought against the Crown pursuant to sections 172 and 175 of the Income Tax Act.

The plaintiffs: Murray Watts was a mining engineer, geologist as well as a prospector; Frederick W Henderson was a registered representative of various investment dealers in the city of Toronto and at the relevant time was a shareholder of Playfair & Company Ltd Investment Dealers; William G Leliever was a prospector. All were Ontario residents and shall hereinafter be referred to as Watts, Henderson and Leliever.

Because of the death of Mr Watts, following the trial, the style of cause in Action No T-38-78 should be amended to show the plaintiff as the Estate of Murray Watts.

Mr Watts had a very distinguished background and career in exploration and prospecting and his reputation in the industry was widespread. He had explored the Coppermine River area of the Northwest Territories as early as 1964 and staked claims in 1965. He then founded a company known as PCE Exploration Ltd to which he transferred his claims. He appreciated fully the difficulty and costs of exploration in the area: transportation problems, weather conditions, excessive precipitation, as well as the short season which would limit development. He had concluded that PCE would have to be a long-term project. As others became familiar with the Coppermine River area, prospects for development increased as he contemplated joint ventures with other mining projects.

During 1967 Leliever had staked claims in the Coppermine River area and had invited Henderson along with others to visit the site. Following this visit, Henderson contacted Jacob Austin, a Vancouver lawyer, whom he knew to be knowledgeable in the field of natural resources and who was heavily involved in mine company structuring and financing. He discussed the potential of a major mining development in the Coppermine River area. Watts, a geologist and mining engineer, was known to Austin as well as Henderson. The first meeting arranged by Mr Austin included the three plaintiffs; their purpose was to form a group to finance the acquisition and development of mining claims in the area.

In July, 1967 Mr Austin caused to be incorporated Hearne Coppermine Explorations Ltd (hereinafter called Hearne). During the same month, the plaintiffs, together with seven other western individuals, subscribed for a total of 400,000 shares of Hearne at 10¢ per share; each holding 40,000. At that time Hearne was a private company. Subsequently, the plaintiffs participated with others in subscribing for an additional 500,000 shares at $1. The total funds raised while Hearne was still a private company amounted to $540,000. With the funds, it acquired 3,000 mineral claims in the Coppermine area from Leliever for a consideration of $228,000 and additional stock.

A pooling agreement was entered into by all ten shareholders regulating the disposition of any of their shares; any sale required approval of seven of the ten initial subscribers. It also provided for the sale of their shares thirty days after any public offering.

The claims were then submitted to Chapman, Wood and Griswold Ltd Consulting Geologists for evaluation. As a result of their report, Hearne was to embark upon an exploration project calling for expenditures of $841,020. In order to accomplish this, it was then determined to make a public offering of 400,000 shares at $2.50 per share to realize $960,000.

The preliminary offering of treasury shares was affected by way of a prospectus dated May 3, 1968; the requisite funds were raised in a matter of hours, in fact the issue was oversubscribed. The prospectus also provided for the sale, by way of a secondary offering, of 250,000 of the 400,000 shares held in the pool agreement by the ten original subscribers.

Since the early 1960s Henderson, through Playfair & Company Ltd, had been acting for a New York Institutional investor known as Value Line Special Situations Fund; it was a great source of capital for junior companies. Through him they had acquired stock in PCE in March of 1967. Henderson testified that in June of 1968 he received an unsolicited offer to purchase 200,000 of the 250,000 shares of Hearne from the secondary offering, at $3.50 a share. This offer was below the market price, which was at that time between $4.25 and $4.50 per share. Within four to five hours, by telephone, the pooling group agreed to this sale. As a result, each of the ten original investors sold 20,000 shares, receiving $70,000. Taking into account their cost of $3,050, they realized a net gain of $66,950 the amount in dispute.

Counsel for Henderson contends that his client was dreaming of becoming the founder of a major mine in the Northwest Territories. He intended this to be a long-term investment, a long-term venture in the mining industry; that he was not a mining-stock promoter and the nature and quantity of the purchases and sales did not indicate a share trading venture. He submits that throughout the period it was not Henderson’s intention to sell any of the shares; in fact, he had no choice because control of the pooling agreement rested with the western group. His desire was to acquire more shares and broaden his holding in the company. The offer to purchase from Value Line was unsolicited and took him by surprise. He further submits that it could not be a venture if one considers that the stock was selling for $4.25 and they disposed of it for $3.50 a share. Henderson testified that had Value Line purchased on the open market it would have increased the price because of the activity, and consequently the group would have had an opportunity for a greater gain. There is no evidence before the Court that the pooling group had decided to sell shares to Value Line prior to the offer.

Mr. Watts, a senior gentleman aged 73, was president and a salaried employee of his own mining company operating in the Coppermine River area; he was among the first to explore in 1964 and returned in 1965 and 1966. He testified that, though he was involved for most of his lifetime in this business, he had nothing to do with the operations of Hearne, the drafting of the prospectus, nor the actual sale of stock. Over his fifty-year career as a prospector and geologist, he had in fact owned shares in two or three other companies and there was no suggestion from the evidence that he was a share trader or even dabbled in stocks. His evidence was that, as major discoveries were made in the area, shares became more valuable. He also gave evidence that he intended to treat this as a long-term investment.

Counsel for Watts argues that the test is subjective in determining the intention of the taxpayer; clearly, he was not engaged in the business of trading in securities. Though this was an isolated incident, it does not mean that it could not be in the nature of trade, but the evidence was clear that his client did not intend to trade in shares. A problem of presumption arises because mining is a speculative business; but, the jurisprudence suggests that this should not affect the objective test. It was prudent business to sell.

Counsel for Leliever argues that a transaction involving the acquisition of capital should not always be treated as an adventure in the nature of trade. That there is no evidence that at the moment of purchase the possibility of reselling was the motivation. He had just received $228,000 in cash and he was obviously in a liquid position. That he had no choice but to subscribe to the pooling agreement; as a young prospector, acquiring shares at a cost of $4,000 provided him with an opportunity to associate with very important and significant people in the mining field.

The Minister of National Revenue, in summarizing the evidence, points to Henderson as a stock salesman looking for opportunities for clients, among them Value Line. He arranges to meet Austin, a well-known figure in mining circles whom he had to suspect could put together a blue ribbon panel of directors. Both Henderson and Watts agreed that this whole matter was highly speculative in nature. The real capital was raised by issuance of 500,000 shares at $1; Henderson disposed of approximately 175,000 of these shares among friends and relatives, he acquired 15,000 for himself, but financed the purchase. All these transactions were accomplished within ten days of the incorporation. The pooling agreement, dated August 1, 1967, binds the plaintiffs not to sell stock during the first thirty days of the public offering. It is obvious that from the outset a public offering was contemplated. Watts testified that there was a copper mine fever in Canada in mid-1967. He submits that Leliever and Henderson, testifying that the secondary offering was to prevent the market from getting out of hand, seems inconsistent. He points to Henderson’s weak explanation for the secondary offering: that it was permitted under the Securities Act; if an additional demand for shares occurred, they would be available; it would save the time and cost of a new prospectus.

He argues that there is no doubt that Value Line was interested in the area as early as April, 1967 when it took a private placement of shares in PCE arranged by Henderson. He had provided Value Line with a preliminary prospectus of Hearne before it went public. Henderson was the most active party and could related to Value Line, PCE and Hearne. It was upon his initiative that the company was incorporated. He was a seller of securities and traded regularly. He constantly kept Value Line informed. It was he who received the offer and urged the founding group to dispose of their shares.

When dealing with Watts, the Crown submits that his only explanation was that it was good business practice to dispose of the shares; that he was going along with the group; that his major preoccupation throughout this time was PCE, his own company.

When dealing with Leliever, the Minister argues that it is inconceivable for him to suggest that he was not aware of the pooling agreement, the original prospectus or the secondary offering of shares.

When involved in such matters, the taxpayer’s intent is the question to be resolved; the vital question that I have to answer is whether the taxpayer had any intention to dispose of the shares before the unsolicited offer from Value Line; all plaintiffs submit there is no evidence to the contrary.

In reviewing the authorities submitted, the standard in what constitutes an adventure in the nature of a trade is fully discussed in the case of MNR v James A Taylor, [1956-60] Ex CR 3; [1956] CTC 189; 56 DTC 1125. The President of the Court in delivering his judgment at p 15 refers to the Californian Copper Syndicate Limited v Harris (1904), 5 TC 159, where he finds that the objective test which the Lord Justice Clerk laid down for determining whether the gain from a transaction was a capital one or income subject to tax, made this famous statement:

. . . Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

In referring to The Balgownie Land Trust, Ltd v CIR (1929), 14 TC 684, at 21 he quotes Lord President Clyde as saying:

. . . A single plunge may be enough provided it is shown to the satisfaction of the Court that the plunge is made in the waters of trade; . . .

The President, Thorson, as he then was, at 24 states as follows when dealing with the tests:

The first of these is that the singleness or isolation of a transaction cannot be a test of whether it was an adventure in the nature of trade . . .

And he goes on at 27 as follows:

Consequently, the respondent in the present case cannot escape liability merely by showing that his transaction was a single or isolated one, that it was not necessary to set up any organization or perform any operation on its subject matter to carry it into effect, that it was different from and unconnected with his ordinary activities and he had never entered into such a transaction before or since and that he purchased the lead without any intention of making a profit on its sale to the Company.

In other words, Thorson, P concludes the following:

First, the single mindedness or isolation of a transaction cannot be a test of whether it was an adventure in the nature of trade but it might be a very important factor. It is the nature of the transaction not its singleness or isolation that is to be determined.

Second, it is not essential to have a transaction being an adventure in the nature of trade that an organization has to be set up to carry it into effect.

Third, the fact that a transaction is totally different in nature from any of the other activities of the taxpayer and that he has never entered upon a transaction of this kind before or since does not take it out of the category of being an adventure in the nature of trade.

Fourth, the transaction may be an adventure in the nature of trade, although the person entering upon it did so without any intention to sell its subject matter at a profit.

Now the more positive guides:

Fifth, whether a particular transaction is an adventure in the nature of trade depends on its character and surrounding circumstances and no single criterion can be formulated.

Sixth, if the transaction is of the same kind and carried on in the same way as a transaction of an ordinary trader or dealer in property of the same kind as the subject matter of the transaction, it may fairly be called an adventure in the nature of trade.

Seventh, the nature and guarantee of the subject matter may be such as to exclude the possibility that its sale was the realization of an investment or otherwise of a capital nature or that it could have disposed of otherwise than as a trade transaction.

Eighth, that there are cases “where the commodity itself stamps the transaction as a trading venture”.

It is plain, as Thorson, P pointed out in the Taylor case, (supra), that the respondent had no considerations of a capital nature in mind. The nature and quantity of the subject matter were such as to exclude the possibility that it was other than a transaction of a trading nature. The respondent could not do anything with the lead except sell it and he bought it solely for the purpose of selling it to the company. He did exactly what his company would have done with the lead had it been permitted to import it.

In transacting with shares, a distinction is made in the Irrigation Industries Limited v MNR, [1962] SCR 346; [1962] CTC 215; 62 DTC 1131. In dealing with the subjective intention of the taxpayer, at 351 it is stated:

I cannot agree that the question as to whether or not an isolated transaction in securities is to constitute an adventure in the nature of trade can be determined solely upon that basis. In my opinion, a person who puts money into a business enterprise by the purchase of the shares of a company on an isolated occasion, and not as a part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at that time, he did not intend to hold the shares indefinitely, but intended, if possible, to sell them at a profit as soon as he reasonably could.

In distinguishing the Irrigation Industries case, (supra), it must be pointed out that the parties had done nothing to enhance the value of the shares. They had simply bought them, held them and sold them at a profit. At 355 Martland, J wrote:

The only test which was applied in the present case was whether the appellant entered into the transaction with the intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so doing. Is that a sufficient test for determining whether or not this transaction constitutes an adventure in the nature of trade? I do not think that, standing alone, it is sufficient.

In the case of MNR v Henry J Freud, [1969] SCR 75; [1968] CTC 438; 68 DTC 5279, it is clear that while the acquisition of shares may be an investment, it may also be a trading operation, depending on the circumstances.

In the case of Roy M Power v The Queen, [1975] CTC 580; 75 DTC 5388, Justice Addy refers to Noel, J in Racine et al v MNR, [1965] CTC 150; 65 DTC 5098 and quotes:

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

Justice Addy suggests that direct evidence of intention may come from a statement by that person which is subject to cross-examination. All issues must be determined by careful consideration of all the relative evidence, both direct and circumstantial. As Justice Addy puts it, one cannot be precluded from establishing that in a particular transaction, there was no intention to speculate; any more than in a case, such as this one, when a person has never previously been involved in speculating in shares. One is not precluded from finding that on a very first venture in the sphere, he did not in fact have the intention of reselling at a profit when he originally purchased the shares. Justice Addy wrote that one has to look at the balance of probabilities; was the selling of the shares the motivating factor in the transaction.

Was the primary intention, at the time of the purchase of the shares, to retain or to sell? What particular circumstances arose to cause them to sell? To suggest to me that they intended this as a long-term investment is not sufficient and I must examine the objective facts.

All three plaintiffs were fully aware of the highly speculative nature of this adventure. All three were familiar with Mr Austin and his reputation in the mining field, particularly his ability to structure and finance such ventures. Funds were required to enter into the preliminary exploration stages, but it is obsious that the amount intended to be raised by the public offering would barely meet this requirement. According to the balance sheet and the pro forma statement filed with the prospectus, both indicate that the company would remain in a considerable deficit position after the sale of the preliminary offering. The selling of shares by way of a secondary offering did not in any way enhance the liquid assets of the company or relieve it of its debt, it only served to generate profit to the ten original subscribing shareholders.

Henderson had been dealing with Value Line for six or seven years, he provided them with the draft prospectus before the issue went public. There was no direct evidence that he knew Value Line wished to participate, but all circumstances point to some knowledge on his part. I do not accept the evidence that the offer came as a surprise. How could they, within hours of the Value Line offer, obtain the consent of seven of the ten that made up the pooling agreement, an offer that was conveniently submitted thirty days after the public offering? Watts and Leliever were aware that the real exploration and development had to be long-term, they knew of the existence of a copper mine fever in Canada and were, from the outset, conscious of Henderson’s ability to interest Value Line in speculative stocks; this was an opportunity well planned and very professionally executed.

There is no doubt that it was good business to sell, but on the balance of probabilities, I have no difficulty in finding that it was their intention to do so from the beginning. The transaction was highly speculative; though isolated, it was truly a venture in the nature of trade.

The actions of Watts, Leliever and Henderson are hereby dismissed with costs.

It was agreed by counsel at the outset that the cost to Mr Henderson of disposing of his shares was fixed at $7,950 and that the assessment should be reduced accordingly.