Sullivan Estate v. The Queen, 90 DTC 6191, [1990] 1 CTC 170 (FCTD)

Joyal, J.: —This is an appeal from a notice of reassessment issued by Revenue Canada and relating to the 1981 taxation year. At all material times, Mr. Stewart and the late Mr. Sullivan were president and vice-president respectively of Pacific Copper Mines Ltd. Each entered into an option agreement to buy certain shares in the company and the Court is asked to determine if a loss which subsequently resulted from the transaction constitutes a loss on capital or on income account.

For purposes of the trial, the parties agreed to have both actions tried on common evidence. The unfortunate demise of the late John F. Sullivan, however, limited the personal viva voce evidence of the plaintiffs to that of Mr. Stewart. I should therefore set out the evidence as for the case of Mr. Stewa. t. The conclusions, however, are to apply to and bind both of them.

The Facts

Among Pacific Copper Mines Ltd. (Pacific Copper) assets in 1979 was a holding of some 3 /2 million shares in an Australian company bearing the same name. It became generally known in that year that there would be an opportunity to dispose of all or part of these shares and generate capital funds for Pacific Copper.

In expectation of this, and in the probability that Pacific Copper shares would thereby increase in value, the plaintiff Mr. Stewart was granted an option on January 2, 1980, to acquire 100,000 shares of Pacific Copper at a price of $2.20 per share. On September 3, 1980, Pacific Copper sold 56 per cent of its Australian company holdings for a price in excess of $11 million.

On October 24, 1980, when the market value of the company shares had climbed to $4.40, the plaintiff exercised his option. The transaction being governed by section 7 of the Income Tax Act, he was deemed to have received a taxable benefit in that year of $215,000. The plaintiff, however, expected the price to increase. He did not dispose of his shares at that time. It was a year later, in September 1981, that he sold the shares at a price of $2.78 per share and incurred a loss of $157,000. In his tax return for that year, he ascribed this as a loss on income account on the grounds that his purchase and sale of the company shares was an adventure in the nature of trade.

Revenue Canada objected to this. It took the position that the 1981 loss was not an income loss from a business or property within the meaning of paragraph 3(d) and subsection 9(2) of the Income Tax Act. The transaction constituted a loss on account of capital and disallowed the loss deduction.

Plaintiffs Position

As evidence of his intention to make his share transaction an adventure in the nature of trade, the plaintiff stresses the fact that the transaction he originally entered into was highly leveraged. The option price of $2.20 per share represented an outlay of $220,000 of which ten per cent or $22,000 was payable forthwith and the balance of $198,000 was by way of promissory note bearing an interest rate of prime plus one per cent and repayable in five consecutive annual instalments of $39,600 each, commencing October 24, 1981. It would have been inconceivable for any person in the plaintiff's position to put himself out to such an extent and risk loosing a substantial part of his net worth if the market took a downturn.

Furthermore, according to the plaintiff, the whole purpose behind the option scheme and his exercise of it was to capitalize, if I may use that expression, on the projected sale of Pacific Copper shareholdings in the Australian company, on the consequent infusion of capital in the company's accounts and on the expected surge in the market value of the company's shares. In other words, the transaction was to be a one-shot deal, conditioned by one single capital transaction by Pacific Copper and indicating an intention on the part of the plaintiff to enter into a short-term in-and-out adventure. The plaintiff's decision to hold on to the shares was in the expectation that share prices which reached $4.40 on September 30, 1980, would continue to rise and therefore bring him a larger profit. The fact that share prices in fact returned to their more historical levels and that he finally disposed of them in September 1981 to his own investment company at the price of $2.78, is in no way indicative, according to the plaintiff, of any change in his original intention.

In the circumstances of the cause, argues the plaintiff, the loss of $157,000 suffered in the taxation year 1981 should be treated as an income loss and the reassessment vacated accordingly.

Crown's Position

The Crown argues that the 1981 loss was not a loss on income account. The plaintiff's purchase of his company's shares when he exercised his option was for investment purposes. It was not part of a business being conducted in buying and selling shares nor could that single transaction, isolated from other similar ones, take on a separate and distinct flavour.

The Crown also argues that even if it should be assumed that the transaction was on account of income, no trading loss was suffered by the plaintiff. As the evidence discloses, the plaintiff bought the optioned shares at $2.20 per share. He later transferred them to his investment company at $2.78 per share, representing a profit on that transaction of $.58 per share or $58,000.

The Law

Much has been said in legal lore about what constitutes a capital transaction on the one hand and an income transaction on the other. Various tests have been propounded from time to time giving grist to academic mills and suffusing case books with a conglomerate of judicial pronouncements. I do not suggest that an accumulation of commentaries on the issue is of no particular consequence; on the contrary, judicial pronouncements serve as essential guides to any judge so that a proper analysis of the facts may be made and the proper questions which have to be explored in any given case are properly canvassed. No matter the profundity or banality of such pronouncements, however, they must of necessity be measured or interpreted in the context of all the particular circumstances of each case.

In M.N.R. v. Taylor, [1956] C.T.C. 189; 56 D.T.C. 1125, President Thorson of the Exchequer Court suggests, with ample justification, that the singleness or isolation of a transaction cannot be a test as to whether it was an adventure in the nature of trade. The very word "adventure", he says, implies a single or isolated transaction and it is erroneous to set up its singleness or isolation as an indication that it was not an adventure in the nature of trade.

In Tara Exploration and Development Co. Ltd v. M.N.R., [1970] C.T.C. 557; 72 D.T.C. 6370, President Jackett of the same Court held that the profit realized on the purchase and sale of shares of companies associated with the taxpayer was from an adventure in the nature of trade.

In Sydney Bossin v. The Queen, [1976] C.T.C. 358; 76 D.T.C. 6196, Collier, J. of the Federal Court was dealing with a taxpayer who rarely dabbled in the stock market. When he finally did so by participating in a syndicate and suffered a $14,000 loss, he claimed that it constituted a business loss deductible from income otherwise earned. After reviewing at length the particular facts of the case, Collier, J. found that the taxpayer was involved in a business venture and that his loss was on an income account.

In The Estate of Murray Watts et al. v. The Queen, [1984] C.T.C. 653; 84 D.T.C. 6564, Rouleau, J. quotes at length the guides proposed by President Thorson in the Taylor case, supra, as follows at page 657 (D.T.C. 6568):

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 a 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 been disposed of otherwise than as a trade transaction.

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

There is also another line of cases. In Paul F. McDonald v. M.N.R. a Tax Review Board decision reported at [1979] C.T.C. 3000; 79 D.T.C. 814, Member Taylor held that losses suffered by the taxpayer following his acquisition of shares from other investors in a stock brokerage firm constituted a capital loss, the taxpayer having acquired the shares as an investment and not for trading purposes.

The same finding was made in George Sher v. The Queen, [1980] C.T.C. 168; 80 D.T.C. 6095, where a loss by a broker on the sale of shares in the brokerage house for which he worked was held to be a capital loss.

Findings

The position of the plaintiff is undoubtedly framed in an ironic picture. Having exercised his option in 1980 and, pursuant to section 7 of the Income Tax Act, having been assessed income taxes on the profit deemed to have been realized on the date of the exercise of the option, he sees no reason why a subsequent loss should be held to be capital in nature. If out of the same kind of transaction, a profit is deemed to be income, a subsequent loss should be similarly treated.

I am reminded in this respect of the comment made by Collier, J. in the Bossin case, supra, at page 371 (D.T.C. 6205) that if the transaction entered into by the taxpayer had resulted in a profit instead of a loss, the Crown would have doubtless assessed the profit as income. This would, of course, suggest that Crown policy is to treat all profits on income account and all losses on capital account. One must remember, of course, that the taxpayer is also dancing the same tango when he wants all profits to be treated on capital account and all losses to be treated on income account. I can only conclude that many are the astute, beguiling or shrewd observations which may be made when dealing with such an esoteric institution as the income tax system.

I may, nevertheless, be permitted to repeat an observation I have made in other cases dealing with a taxpayer's intention, the favourable determination of such intention being basic to the plaintiff's case. Statements or affirmations by a taxpayer of an intention is always evidence in the case. The weight to be given to such assertions however will be in more or less direct proportion to more objective evidence which is either more consistent with the stated intention or more inconsistent with it. When taken together, these two components, one way or the other, may together make for persuasive if not always conclusive evidence.

It is true that on the facts before me, the terms of the option granted to the plaintiff by his company suggest a highly leveraged or risk position leading to the inference that the plaintiff was in for the short haul, that the exercise of the option at the option price was with a view to disposing of the shares in a rising market which the plaintiff anticipated.

I note, however, that on the plaintiff's exercise of his option on October 24, 1980, the share values had already experienced a rise in price to $4.50, twice the level of the option price, I must conclude that the exercise of the option at that time considerably reduced the risk to which the plaintiff referred.

I should also note that according to the company's annual report for the year ending June 30, 1981, a dividend of $1 per share was declared and paid. The evidence is that the plaintiff received that dividend on his 100,000 shares in the taxation year 1981 and he would necessarily have had to be a shareholder of record at that time. The evidence discloses that the dividend was declared on December 5, 1980, and payable on February 11, 1981, to shareholders of record as at December 19, 1980. The plaintiff knew, however, some weeks before he exercised his option, namely on August 18, 1980, when the Board of Directors of the company approved of the sale of the company's shares in the Australian company, that approximately 50 per cent of the proceeds received would be paid to shareholders by way of a dividend. No dividend having been actually declared as of the option date, October 24, 1980, it would have been an incentive to the plaintiff to hang on to his shares for that purpose. It would also have been a disincentive to dispose of any of his shares prior to the record date and reduce his exposure.

I further note that in the course of the years 1978-1980, the plaintiff did engage in stock market transactions, treated them as investments and reported them as profits and losses of a capital nature for tax purposes. Although I fully appreciate that this approach by the plaintiff in that respect is not determinative of the approach he might have otherwise taken with respect to the optioned shares, it does indicate a pattern of stock transactions which did not in fact invite the kind of scrutiny which would make him fall into the trader fold and which would give greater credence to the trading nature with respect to his optioned shares.

It might, of course, be suggested that the plaintiff's 1978-1980 stock transactions represented individual capital outlays or risks somewhat more moderate than the $220,000 purchase of his optioned shares. Such would make tenable the plaintiff's intention of making of it a strictly trading proposition. Yet if the element of risk or high exposure is indicative of a taxpayer's intention in that regard, the plaintiff's risk or exposure had been practically eliminated when he exercised his option on October 24, 1980, made his down payment and issued his promissory note for the balance.

The plaintiff stated that he held on to his shares until September 8, 1981, as he expected that their market value would continue to rise and produce a higher profit. It is also in evidence that on that date, he did not sell his shares on the open market but assigned them to his own investment company, Maritime Investment Ltd. at $2.78 per share. In my view, this action by the taxpayer, although not necessarily in conflict with his intention of getting in and out quickly, dilutes to some degree the evidentiary weight which could otherwise be given to his expressed intentions.

It would also seem to me that, in the light of the absence of risk when the plaintiff exercised his option, of the foreknowledge that a relatively high dividend would be declared and provide for him a greater total profit, the material and objective ingredients to isolate the transaction and give weight to an exceptional and singular purpose, are not convincing.

Conclusions

In making the foregoing findings, I am not unmindful of the pitfalls and dead ends encountered in the labyrinth of a taxing statute like the one before me. It is true that for purposes of section 7 of the Income Tax Act, the spread between option price and market price is deemed to be income or a benefit to the plaintiff and taxed as such in the year in which the option is exercised. It is also true that, as in this case, any subsequent loss is treated as of a capital nature. Observers might very well question the logic or purpose of treating the transaction as of an income nature at one end of it and as of a capital nature at the other. Yet such seem to be the effects of specialized as against more generalized provisions of the statute and no case law or precedent was suggested to me which would assist in resolving the inconsistency.

In fact, there might not be such a degree of inconsistency as is perceived. For example, had the company paid a substantial bonus to the plaintiff, instead of providing him with optioned shares, that bonus would obviously have been treated as income. If, in turn, the money from the bonus payment had been used by the plaintiff to buy company shares, any profit or loss subsequently enjoyed or endured would of course have been subject to no less a test as to its income or capital nature as has been the case before me.

I should not infer that the plaintiff's stated intentions are totally unfounded or completely contradicted by more objective facts. I am perfectly aware that in all purchases and sales of publicly traded shares, there is always a continuing and indeed evident intention of disposing of the shares at a profit. It would be incongruous to impose on a taxpayer in order to establish that a transaction was of an income nature to prove that the taxpayer's original intention in acquiring the shares was to dispose of them at a loss. Such, however, is not the case before me. I can only conclude that, on the particular set of facts before me, the plaintiff has not succeeded in rebutting the Crown's assumptions on which it based its reassessment.

I should accordingly dismiss the plaintiff's action and confirm the Crown's reassessment.

The Crown is entitled to its costs.

Appeal dismissed.