Stanley Drug Products Ltd. v. MNR, 90 DTC 1664, [1990] 2 CTC 2646 (TCC)

Rowe, T.C.J. [Orally]:—The appellant appeals from a reassessment of income tax with respect to its 1984 taxation year. The appellant concedes the following assumptions are correct as set out in paragraph 2(a) to (h) inclusive of the respondent's reply to notice of appeal, except for characterizations of profit.

The admitted portion therefore reads as follows: the appellant purchased the first SRTC promissory note (the first note) on February 14, 1984 from Telescan Research Inc. (Telescan) for $400,000. The note had a face amount of $400,000. (b) Telescan designated the full face amount of the first note under subsection 194(4) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), (c) the first note was redeemed by Telescan on February 15, 1984 for proceeds of $220,000. (d) the appellant's cost of the first note is deemed by paragraph 127.3(a) of the Income Tax Act to be $200,000. (e) on October 31, 1984 the appellant purchased the second SRTC promissory note from RND Capital Corporation (RND) for $400,000. The note had a face amount of $400,000. (f) RND designated the full face amount of the second note under subsection 194(4) of the Act. (g) the second note was redeemed by RND on October 31, 1984 for proceeds of $248,000. (h) the appellant's cost of the second note is deemed by paragraph 127.3(a) of the Act to be $200,000.

In addition, counsel filed as Exhibit A-1 an agreed statement of facts. Then Mr. Leslie Strike, Deputy Chairman of the appellant, testified the appellant is a pharmaceutical manufacturer and at all times relevant to this appeal he served as its president.

Prior to the transactions previously described the appellant had not previously been engaged in the buying or selling of promissory notes. He agreed the purchase of the notes was to obtain relief from income tax, and the appellant never contemplated holding onto the notes. He testified he thought the appropriate election under subsection 39(4) of the Income Tax Act had been filed in June 1984 but later discovered that not to be correct.

As a result, the appellant's accountants, by a letter dated December 31, 1986 sent to Revenue Canada the prescribed forms 1123, for the appellant's 1984 and 1985 taxation years for purposes of making an election under subsection 39(4) of the Income Tax Act.

Revenue Canada placed the letter of December 31, 1986 and the prescribed forms attached thereto in the appellant's return of income for its 1984 taxation year prior to reassessment. When the reassessment issued it included into income profit from the resale of the promissory notes and declined to accept the subsection 39(4) election on the basis it was not included in the return of income for that year.

Two issues then arise. First, can the December 31, 1986 letter to Revenue Canada with the proper forms required by subsection 39(4) of the Act be regarded as having been properly part of the 1984 return? If the answer is affirmative then the election to treat the disposition of the Canadian securities as a capital transaction will end the matter. If the answer is negative, the second issue then is whether the appellant was correct in reporting the transactions as a capital receipt, or whether the respondent is correct in the reassessment as income.

Subsection 39(4) of the Income Tax Act reads as follows:

39.(4) Except as provided in subsection (5), where a Canadian security has been disposed of by a taxpayer in a taxation year and the taxpayer so elects in prescribed form in his return of income under this Part for that year,

(a) every Canadian security owned by him in that year or any subsequent taxation year shall be deemed to have been a capital property owned by him in those years; and

(b) every disposition by the taxpayer of any such Canadian security shall be deemed to be a disposition by him of a capital property.

Counsel for the appellant argued the respondent had admitted the forms were placed in the appellant's return of income for its 1984 taxation year prior to reassessment. Counsel then went on to submit there are three groups of elections under the Income Tax Act. The first group, an example of which may be found at subsection 48(1), requires an election to be filed in “prescribed manner and within prescribed time".

Another example is to be found in subsection 70(2) where a taxpayer's legal representative has one year from date of the taxpayer's death, or within 90 days after the filing of any notice of assessment to make a particular election.

Further, subsection 78(1) requires a taxpayer to file an agreement “in prescribed form on or before the day on or before which the taxpayer is required by section 150 to file his return of income." This language is also used in subsection 110.4(2) as it relates to averaging.

The second group of elections, according to appellant's counsel, specifically states that certain elections must not only be in prescribed form, but must also be filed with his return for the year. An example of this wording may be found in subsection 37(1) of the Act.

The third group of elections require a taxpayer to make an election in his return of income. Apart from subsection 39(4) that language may also be found in subsection 21(1).

Counsel pointed out that a later filing of an election had been upheld by the Tax Court of Canada in the case of Fishery/. M.N.R., [1988] 1 C.T.C. 2054; 88 D.T.C. 1027. The taxpayer in that case was an individual as opposed to a corporation, and the Minister had taken the position that an election under subsection 26(7) of the Income Tax Application Rules, 1971 (the "ITAR") was not filed in time.

At page 2055 (D.T.C. 1028) of his judgment, the Honourable Judge Bonner stated :

Counsel argued further that an interpretation of the requirements of ITAR 26(7) in the manner urged by the appellant would permit a taxpayer to indefinitely postpone the making of an election under that provision. Plainly it would, at least until April 30th of the year following the first year in which, (a) tax is payable by the appellant, and (b) there is a disposition of property owned by him on December 31, 1971. What counsel failed to explain, however, is why such an interpretation was unintended by Parliament and contrary to the rationale of ITAR 26(7). He did suggest that such an interpretation would impose a “strict requirement with potentially serious consequences” on certain taxpayers but not on others on the basis of the existence or non-existence of taxability, a condition which he described as foreign to the scheme of the election provision. I can see no force in this argument. There is nothing inherently illogical in permitting the deferral of an election until the time when the making of the election will, of necessity, have a practical consequence in the fixation of tax liability.

In the case of Trynor v. M.N.R., [1988] 1 C.T.C. 2425; 88 D.T.C. 1294, the Honourable Judge Kempo of the Tax Court of Canada followed the decision in Fisher and at page 2427 (D.T.C. 1296) of her judgment stated:

Counsel for the appellants submitted that the Fisher case was authority for the proposition that where the Income Tax Act (the "Act") itself did not set a deadline for the filing of a return because no tax was payable, no such deadline had been imposed by the wording of ITAR 26(7), I agree.

However, as counsel for the respondent pointed out, corporations are treated different than individuals. Under subsection 150(1) of the Act a corporation must file a return of income whether or not any tax is payable.

The cases of Fisher and Trynor turned on the fact that individuals did not have an obligation to file a return in the event tax was not payable. The appellant had an obligation to file a return for its 1984 taxation year and did so.

However, the prescribed form 1123, was not filed with the return, nor was it then in the return. It is, I think, obvious the section was not intended by Parliament to permit elections after the taxpayer had a year or several years to see how his Canadian securities had performed.

The provision is obviously intended to cause taxpayers to make an election at the time of filing as the Minister could expect to open up the envelope and find the return and the election in the proper form in the return.

At page 87 of Dreidger, Construction of Statutes, 2nd Edition, Toronto, Butterworths, 1983, the author states: "Today there is only one principle or approach, namely the words of an Act are to be read in their entire context and in their grammatical and ordinary sense, harmoniously with the scheme of the Act, the object of the Act, and the intentions of Parliament."

Despite numerous pot-shots being taken at the draftpersons responsible for various portions of the Income Tax Act it usually states exactly what it means, no more and no less.

The choice of a word or phrase is often significant, as is the absence of that word or phrase compared to other sections of the Act which carry out the same basic procedure for the same overriding purpose. It is correct the corporation must file a tax return regardless of whether any tax is payable. If it does not, then unlike an individual who has no tax payable the corporation will be subject to the consequences of failing to file as required by subsection 150(1) of the Act.

But the filing of a return for a taxation year is done after the physical passage of the year itself, and in the case of a corporation, up to six months after the end of the taxation year. As a result, the tax return is always a snapshot of a taxpayer's affairs at a point in time determined to be at the end of the taxation year for him, her or it as the case may be.

On a strict wording of subsection 39(4) if the return arrived in one envelope and the form T123 in another, with reference to the return itself, replete with apology for the omission, then that T123 would not have been in the return of income upon arrival at the taxation office. What if it arrived two days after the deadline for filing the return?

Perhaps a larger question is what is a return? We know it must be in the prescribed form for the particular taxation year. However, as Judge Kempo noted in Trynor at page 2428 (D.T.C. 1297), and I quote directly from her judgment:

The use of the word "shall" in a Regulation is not necessarily conclusive as to whether the provision was mandatory or directory. In my opinion consideration must be given to the nature of the provision and whether it is substantive or procedural. If procedural, regard must be had as to whether a failure to adhere thereto would cause surprise, uncertainty or prejudice to the Minister. The information and decision to use V-Day values as per form 12076 required a mere statement of intent. Here this decision was made and had been clearly communicated. No surprise, confusion or prejudice to the respondent had been alleged or argued. I agree with appellants' counsel that to hold otherwise would have the result of mandating form above substance.

However, in the case at bar, if the subsection 39(4) election is to be declared valid the Minister would be bound by it and unable to reassess the transaction as being income to the appellant. The mere fact the Minister placed the 1123s into the appellant's return should not be held against him since it is clear from the letter dated March 4, 1987 to the appellant that Revenue Canada continued to be of the opinion the election must be made at the time the return was filed.

However, the wording of subsection 39(4) does not state the form must be in the return on or before the day which the taxpayer is required by section 150 to file a return of income. As such, it could be seen to leave open the potential for late filing, which apart from attracting penalties, could still be a taxation year-end snapshot of the affairs of the taxpayer.

The transactions now in issue were reported by the appellant as capital and were not reassessed for the 1984 taxation year until May 4, 1987. It is clear from the correspondence attached as Exhibits A and B to Exhibit A-1 that the submission of the T123s and their physical placement in the 1984 tax return of the appellant was done on a without prejudice basis.

Had the Minister refused at all to accept the T123 form in the letter then the issue would not have been litigable in its present format. But the physical placement of the form in the return did not constitute filing in the return for the 1984 taxation year.

I find the purported election under subsection 39(4) on December 31, 1986 to be invalid and not in accordance with the plain ordinary meaning of the section, the object of the section and of the Act itself pertaining to elections and the filing of same. The meaning of in the return must mean it must be included in the return at time of filing, or at least prior to the expiration of the filing deadline.

Having so held, it means I must turn to the second issue, stated again, were the SRTC transactions capital or income? After submissions were concluded counsel for the respondent, with the consent of appellant's counsel, brought to my attention the case of Smith, R.H. v. M.N.R., [1989] 2 C.T.C. 2069; 89 D.T.C. 331, a decision of the Honourable Judge Teskey of the Tax Court of Canada.

From reading the decision it is apparent Judge Teskey did not have the advantage of having put before him the line of English cases cited by counsel for the appellant in his brief before me.

Prior to 1984 the appellant had not invested or traded in promissory notes. Since it was not its usual business to invest in notes or SRTC notes, was the investment an adventure in the nature of trade?

In 1984 the SRTC scheme was a relatively new ballgame, and was brought to the appellant's attention by its accountants. The risk was practically eliminated due to the structure of the transaction and the return was immediate, in effect a daylight transaction that was able to produce a profit to the appellant because of the very nature of the SRTC tax credits. The transactions were not in any way sham transactions, nor did the Crown allege artificiality.

The English case of Bishop v. Finsbury Securities Ltd., [1966] 3 All E.R. 105, before the House of Lords is extremely helpful. Finsbury Securities was clearly a trader in shares and securities. It entered into a scheme and incurred losses which it claimed to be deductible by virtue of having occurred in the course of the trade of dealing with shares.

At page 109 Lord Morris of Borth-y-Gest, speaking for the Court, stated:

My lords, the various arrangements are not to be regarded as sham transactions. They were as real as they were elaborate; but I cannot think that there is room for doubt that they were no more than devices which were planned and contrived to effect the avowed purpose of tax avoidance. The company used their organization and their resources so that shareholders in Warsaw and in other companies involved should not wholly be deprived of money that had to be paid in tax. The scheme was one whereby the Revenue would be denied certain sums of money. Such sums could be made to find their way to the pockets of the shareholders in the various companies less such proportion as was the payment for the skillful services rendered. That was the reality of the matter.

At page 112 of the judgment he went on to say;

A consideration of the transactions now under review leads me to the opinion that they were in no way characteristic of, nor did they possess, the ordinary features of the trade of share dealing. The various shares which were acquired ought not to be regarded as having become part of the stock-in-trade of the company. They were not acquired for the purpose of dealing with them. In no ordinary sense were they current assets. For the purposes of carrying out the scheme which was devised the shares were to be and had to be retained. The arguments before your lordships depended mainly on the submission by the Crown that the shares were required for a period of five years as part of the capital structure of the company from which an income could be earned and, on the other hand, on the submission of the company that they were acquired as part of their stock-in-trade.

In my opinion neither argument is correct. For the reasons which I have already given this transaction on its particular facts was not, within the definition of s. 526, “an adventure or concern in the nature of trade” at all. It was a wholly artificial device remote from trade to secure a tax advantage.

This reasoning was followed by the House of Lords in the case of FA & AB Ltd. v. Lupton, Inspector of Taxes, [1971] 3 All E.R. 948. The transactions between the appellant and RND and Telescan with whom it dealt on the notes was structured so as to be in each case a closed circuit transaction. There was no possibility of trade in the ordinary sense of the word involving any wider market.

Also, it had little of the indicia of an adventure in the nature of trade other than potential for profit. Merely because an investment is peculiar, has practically no risk and instantly creates a profit does not automatically turn it into an adventure in the nature of trade, or otherwise, barring the application of a particular statute, turn that profit into income.

Of course an SRTC transaction had none of the essential characteristics of an investment in the ordinary sense. The entire SRTC program was far from being ordinary, but the appellant, by virtue of its two transactions in 1984, in the manner in which they occurred, was not trading in SRTC notes.

Neither can it be deemed to have undertaken an adventure in the nature of trade. Advantage was taken of a lawful mechanism permitted by the Act and presumably in accordance with the intent of Parliament.

The respondent is directed to reassess the appellant for its 1984 taxation year by treating the profit from the SRTC promissory notes as a capital receipt. The appellant is entitled to costs on a party-to-party basis.

Appeal allowed.