Salada Foods Ltd. v. The Queen, 74 DTC 6171, [1974] CTC 201 (FCTD)

Urie, J:—The plaintiff appeals from a notice of reassessment dated December 31, 1971 made by the Minister of National Revenue, wherein there was included in the plaintiff’s taxable income for its 1968 taxation year the sum of $185,312 derived from the purchase and sale of foreign exchange, which it had not included in its tax return for that year. A notice of objection filed by the plaintiff was rejected by the Minister and the assessment was confirmed.

The plaintiff (hereinafter sometimes referred to as “Salada”) was incorporated under the laws of Canada and at all material times carried on, directly and through subsidiaries, business as a manufacturer and distributor of foods and food products. Throughout its 1967 and 1968 fiscal years (each of which ended on September 30) it had a number of wholly owned subsidiaries in the United Kingdom (hereinafter called the “UK subsidiaries”) the outstanding shares of all of which, with the exception of Salada Holdings Limited, were owned by the latter company. All of the common shares of Salada Holdings Limited were owned by the plaintiff.

The defendant, during the cross-examination of Robert H Sewards, the plaintiff’s Vice-president, Finance, the only witness called by either party, produced the following statement filed as Exhibit D-2:

Note:

(1) The exchange loss on the Long Term Note Receivable (eg 55,000£) In the amount of 8,874 was recorded in the books of Salada Foods Ltd in 1968.

(2) The exchange loss on the current portion which is not covered by the Sterling contract was recorded in the books of the UK companies.

The inter-company accounts referred to in the statement were said to represent cash advances and accumulated management fees for services performed by the plaintiff, the total of which for each of the two years in question is described as “Current financing for day to day operations” and was deducted from the aggregate of the other items to obtain the so-called “net long-term investment” by the plaintiff in its UK subsidiaries as at the end of its fiscal years 1967 and 1968. Of these sums the evidence indicates that only the loans to the Salada Holdings Limited, represented in the statement by the heading ‘‘Note Receivable”, and the “cost of shares” represent money actually disbursed by the plaintiff. The “post acquisition profits” represent the accumulated, consolidated, undistributed net profits earned by the UK subsidiaries, none of which were distributed by way of dividends or otherwise to the parent company, the plaintiff, during the years in question.

Mr Sewards testified that during the early part of the plaintiff’s 1966 fiscal year, its officers feared that the pound sterling would be devalued with the result that the plaintiff’s investment in its UK subsidiaries as disclosed in Exhibit D-2 would be depreciated in terms of Canadian dollars and decided that steps should be taken to counteract the effects of such an eventuality. Accordingly, on November 8, 1966, Salada entered into a “forward sale contract” with the Canadian Imperial Bank of Commerce for the sale by Salada and the purchase by that bank of £500,000 at $3 1/16 per pound, delivery to be made, at the plaintiff’s option, at any date between April 19 and May 19, 1967. The purchase and sale was apparently cancelled on May 15, 1967 when the expected devaluation of the pound did not occur, at a cost to the plaintiff of some $11,560.

Apparently an earlier transaction of a similar nature also entailed a loss to the plaintiff of approximately $3,000 in September of 1966. Both of these losses were deducted by the plaintiff and allowed by the Minister in the calculation of the plaintiff’s taxable income in the fiscal years in which they occurred, although their inclusion therein was said to have been an error on the part of the person preparing the plaintiff’s tax returns.

On August 29, 1967 another forward sale contract was entered into by the plaintiff with the same bank for the sale by Salada and the purchase by the bank of the sum of £500,000 at a price of $2.99 5/16 per pound for an aggregate price of $1,496,562.50, delivery to be made, at Salada’s option, at any date between January 29 and February 29, 1968. On November 18, 1967 the pound was devalued, the rate of exchange dropped and the plaintiff, on February 12, 1968, was able to purchase £500,000 at $2.6272 for an aggregate price of $1,311,250.50, which it immediately delivered under the forward sale contract to the bank, thus resulting in a gain to the plaintiff of $185,312 on the transaction. It is this sum that was included in the plaintiff’s 1968 taxable income by the Minister’s reassessment which is the subject matter of this appeal.

It is the plaintiff’s contention that the forward sale contract was entered into for the sole purpose of protecting its investment in the UK subsidiaries and if Salada realized a gain, which it does not admit, such gain was offset by the loss in its investment as a result of the pound devaluation. The gain, therefore, was on capital account and did not result from either a transaction entered into by Salada in the course of or for the purpose of its trading operations or an adventure in the nature of trade.

Counsel for the plaintiff urged upon me that I must look at the whole of the transaction to see whether in its totality it was one in which the plaintiff derived a gain which was income in nature or capital in nature. In his submission what the plaintiff was doing was insuring against a possible reduction in value of capital assets, namely the UK subsidiaries, arising out of devaluation of the pound. lt made no gain because the profit made from the forward sale contract was offset by the loss in the value of the capital asset. In this respect he distinguished other cases where gains made in the purchase and sale of foreign exchange have been held to be income in the hands of the recipient, because in all of those cases an analysis of the transactions underlying them indicated each had, as was said by Lord Greene, MR in Imperial Tobacco Co (of Great Britain and Ireland) Ltd v C!R, [1943] All ER 119 at 121, “an income character impressed upon it from the very first”.

This observation, he submitted, was also applicable to the transactions at issue in Atlantic Sugar Refineries Ltd v MNR, [1949] SCR 706; [1949] CTC 196; 4 DTC 602; Tip Top Tailors Ltd v MNR, [1957] CTC 309; 57 DTC 1232; 57 OTC 123; Eli Lilly and Company (Canada) Ltd v MNR, [1955] CTC 198; 55 DTC 1139, in each of which the underlying purpose of the acquisition of foreign currency was for the foreign exchange settlement of trade debts and from which, incidentally, profits accrued to the payor from fluctuations in the price of foreign exchange. In each case, it was argued, the transactions were impressed from the beginning with an income character.

The plaintiff contended that in the case at bar those considerations did not prevail and likened the purchase and sale of the English pounds for future delivery to an insurance policy to protect the plaintiff from an eventuality which did occur resulting in the depreciation in value of capital assets owned by it, in the same way that proceeds of a fire insurance policy protected an insured from the depreciating effect of a fire on its capital assets. There was, in his view, no real gain, because it was offset by the loss in value of the asset or, if there was a gain, it related to a capital asset and was not income.

On the other hand, while conceding that the transaction was not one in the ordinary course of the plaintiff’s business or trade, counsel for the defendant argued that it was an adventure in the nature of trade within the meaning of paragraph 139(1)(e) of the Income Tax Act and, therefore, the profit arising therefrom was taxable income in the plaintiff’s hands by virtue of sections 3 and 4 of that Act. He pointed out that there was no realized loss shown on the plaintiff’s books in that, for its corporate purposes, it took the gain arising from the forward sale contract on the English pounds into its earnings for its 1968 fiscal year, as disclosed in its statement of earnings for that year, without a corresponding reduction in the value of its invest- ment in the UK subsidiaries on the asset side of its balance sheet. It was, he submitted ,a notional loss only and the purpose for which the transaction was entered into was irrelevant. The sections of the Act above referred to, as they then stood, read as follows:

3. The Income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income from the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, Income for a taxation year from a business or property is the profit therefrom for the year.

139. (1) In this Act,

(e) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment;

The main authority upon which the defendant relied is MNR v James A Taylor, [1956] CTC 189; 56 DTC 1125, a decision of Thorson, P. In that case the learned President carefully reviewed the leading cases dealing with the meaning of the phrase “adventure or concern in the nature of trade” and formulated from them certain general propositions to guide the Court in dealing with a particular case. These are accurately summarized in the head-note to the CTC report reading in part as follows:

On the negative side he has this to say:

(i) The singleness or isolation of a transaction cannot be a test of whether it was an adventure in the nature of trade . . . It is the nature of the transaction, not its singleness or isolation that Is to be determined”.

(il) It is not “essential to a transaction being an adventure in the nature of trade that an organization be set up to carry it into effect”.

(lil) “. . . 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 that kind before or since does not, of itself, take it out of the category of being an adventure in the nature of trade.”

(iv) “The intention to sell the purchased property at a profit Is not of itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one. The considerations prompting the transaction may be of such a business nature as to Invest it with the character of an adventure in the nature of trade even without any intention of making a profit on the sale of the purchased commodity.”

On the positive side the Court outlines some specific guides:

(i) “. . . if a person deals with the commodity purchased by him In the same way as a dealer in it would ordinarily do such a dealing is a trading adventure.”

(ii) The nature and quantity of the subject matter of the transaction “may exclude the possibility that Its sale was the realization of an Investment or otherwise of a capital nature or that it could have been disposed of otherwise than as a trade transaction.”

In propounding the guide lines he recognized at page 210 [1136-7]:

I am also of the view that It is not possible to determine the limits of the ambit of the term or lay down any single criterion for deciding whether a particular transaction was an adventure of trade for the answer in each case must depend on the facts and surrounding circumstances of the case.

In discussing the applicable principles of law and, in particular, that referred to above as positive test number (ii), it should perhaps be observed that in the 1967 and 1968 statements the value in sterling of the plaintiff's investment in its UK subsidiaries was approximately £532,000 while the forward sale contract was for only £500,000. Moreover, of the net long-term investments in each of the years 1967 and 1968 as disclosed in Exhibit D-2 the sums of $406,936 in 1967 and $487,189 in 1968 represented undistributed profits of the UK subsidiaries, which could only have been received by Salada in the event that the directors of those subsidiaries duly authorized payments thereof by way of dividends or some other type of distribution and, in such event, presumably they would have been taxable in Salada’s hands. There was, of course, no obligation on the directors to make any such distributions, even if they could have done so in view of the strict foreign exchange control regulations then in existence with the United Kingdom, of which I think I am entitled to take judicial notice. Salada, then, unless it sold the shares of the subsidiaries, in which event the undistributed income would be reflected in the sale price of the shares, might never have been able to receive any part thereof and, if it did, it might well have been a substantially lower amount than that shown on the books of the UK subsidiaries after payment of tax thereon.

To term those sums, then, as part of the investment of the plaintiff in its UK subsidiaries ignores the fact that the latter are separate, legal, foreign entities and their undistributed earnings, in my view, can in no way be termed part of the plaintiff’s investment in them. As a matter of fact, their presence in the statement of the UK subsidiaries undoubtedly added substantially to the value of the shares of those companies. That value was acknowledged by Mr Sewards to be something substantially different than the value thereof as shown in Salada’s statements in which the shares were carried at their historic cost. The only way that their actual value could have been determined at the time of the completion of the forward sale contract would have been by a sale or by an appraisal of their value by competent appraisers using known techniques for so doing. No such appraisal was made. Bearing in mind all of these facts then, it seems to me that there is little or no relationship between the gain received by the plaintiff on its forward sale contract and its actual investment loss occurring as a result of the devaluation of the pound. To that extent then, in my view, the evidence of the witness and the arguments advanced by counsel for the plaintiff in support of the propositions that the gain was offset by the loss in investment and was attributable to capital account and not income tend to be specious and cannot be supported by other evidence nor withstand close scrutiny as to the result achieved by the transaction in question.

In arranging the forward sale contract the plaintiff acted in exactly the same fashion as a dealer or speculator in currencies would act. There was never any intention on the part of Salada that the transaction be in any way an investment in its normal sense and, in fact, it was acknowledged by the plaintiff to be wholly speculative. The whole success of the enterprise depended on purchasing the £500,000 at a lower price than that at which it had contracted to deliver them six months before and the necessity for so doing in turn arose, not because the plaintiff knew the pound was to be devalued, but because it speculated that it would. It was not investing idle capital funds nor was it disposing of a capital asset. What was done was done because Salada was confronted with an abnormal situation from which it hoped to gain an advantage, no matter what the motivating factor was for desiring such an advantage.

It was only one of three such transactions in which the plaintiff had entered for the purported purpose of protecting its investments although it had, in fact, entered in an unspecified number of “swap contracts’’ as a means of financing current operations in North America. These were for a different purpose than the forward sale contract involved in this appeal but indicated the familiarity of the plaintiff’s officers with dealing in currency futures and to some extent that such dealing was part of the earnings practices of the plaintiff. The method by which this was accomplished was set forth in Exhibit D-8 to these proceedings. Profits and losses resulting from these swaps were included in calculating Salada’s taxable income.

The intention of the plaintiff in entering the transaction is, of course, of some evidentiary value although Thorson, P at pages 211-12 [1137] of the judgment in the Taylor (supra) case notes that:

The intention to sell the purchased property at a profit is not of Itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one.

No evidence that any of the transactions, including the forward sale contract of August 29, 1967, were authorized by resolutions of the board of directors of the plaintiff was adduced and it is, therefore, difficult to ascertain the intention of the company as distinct from that of its officers in entering into the contract. But there is no doubt whatsoever that from beginning to end the intention of the officers of the company was simply to buy and resell currency at a profit and in the absence of evidence of the company’s intention to the contrary, the intention of its officers must be synonomous with that of the company.

Applying the two positive tests propounded by Thorson, P in the Taylor case to the facts in evidence to which I have earlier made reference, and drawing what I consider to be the proper inferences therefrom, I have reached the conclusion that the purchase and sale of the £500,000 sterling pursuant to the forward sale contract dated August 29, 1967 was a purely speculative transaction and was entered into with the intention and hope that a profit would accrue. It was, therefore, an adventure in the nature of trade.

That being the case, does the fact that the plaintiff has stated that the purpose of the transaction was to protect and preserve one of its capital assets, namely its investment in its UK subsidiaries, affect in any way this determination? In my opinion, the short answer is that it does not. The Lord Chancellor in the venerable case of Mersey Docks and Harbour Board v Lucas (1883-90), 2 TC 25 (HL) at 31, is authority for the proposition that

The mode of the application makes no difference whatever to the question of what Is “profit” and what is “gain”.

At page 33 Lord Blackburn expressed the same proposition in another way.

There is no ground whatever for saying it, that I can see; there is nothing in the nature of things, there is nothing in the words of the Act, to say that when an income has been actually earned, when an actual profit upon which the tax Is put has been earned and received by any person or corporation, Her Majesty’s right to be paid the tax out of it In the least degree depends upon what they are to do with it afterwards, unless there is an express enactment, which i think there Is in some cases, that they are to apply it to charities and other purposes. If the amount thus received is to be applied at their pleasure, they must pay tax. If it is to be paid over to the shareholders or to creditors, or to anybody else, the Queen is still to have her tax.

While the factual situation in the case at bar is certainly not analogous to the Mersey Docks case, the principle is, in my view, wholly applicable here. It has been followed in the Exchequer Court in MNR v Constant, [1958] Ex CR 246; [1958] CTC 175; 58 DTC 1100, and in MNR v Saskatchewan Co-operative Wheat Producers Ltd, [1928-34] CTC 47 at 54; 1 DTC 159, and by the Supreme Court of Canada in Woodward's Pension Society v MNR, [1962] SCR 224 at 228; [1962] CTC 11 at 15; 62 DTC 1002 at 1004. Having found that the income was from an adventure in the nature of trade on the above authorities, it is immaterial what the motive was that brought the profit into existence and how it was applied thereafter.

The plaintiff’s argument that because the intention to make a profit was for the purpose of protecting and preserving its investment, therefore, must fail. Accordingly, l am of the opinion that the profit in question was properly taken into account in computing the plaintiff’s income for tax purposes and its appeal, therefore, will be dismissed with costs.