Neville B. O’sullivan v. Minister of National Revenue, [1988] 1 CTC 2433, 88 DTC 1329

Sarchuk, T.CJ.:—The appeals of Mr. O'Sullivan (O'Sullivan) are from reassessments to tax for his 1979, 1980 and 1981 taxation years. Several issues are raised by the appellant in his notice of appeal. The first arises out of the inclusion by the respondent in O'Sullivan's income of gains in the amounts of $4,844.42, $31,839.15 and $30,543.24 in those years respectively. The appellant pleaded that the gains were made by members of his family and ought not to have been so included. At the commencement of the trial counsel for the appellant advised the Court that this issue was being abandoned, conceding that the respondent's reassessments, made as they were on the basis that the gains were realized by the appellant on his own account, were correct.

The second issue relates to a gain in the amount of $1,002,957.73 resulting from the disposition in 1981 of certain shares in March Resources Ltd. (March Resources) of which only $746,733.19 was reported and which was, according to the respondent, income of the appellant. The appellant's position is that the proceeds from the sale of the March Resources Ltd. shares, in fact and in law, did not belong to him but rather belonged to Ingersoll Management Inc. (Ingersoll) and that to the extent he received such proceeds he held them on behalf of Ingersoll.

The third issue relates to a penalty imposed by the respondent in the amount of $30,107.33 on unreported income of $256,224.54 in the 1981 taxation year. Counsel agreed that the source of this unreported income was the March Resources transaction. Appellant's counsel advised the Court that in the event the March Resources profits were properly taxed as income of the appellant the imposition of penalty would not be disputed. If, on the other hand, the appellant were to be successful the respondent agreed that the penalty imposed should be vacated.

The facts giving rise to this reassessment can be briefly summarized. O'Sullivan is an investor and for many years has been associated with the stock market. Upon leaving university in the mid-1950’s he went to work on the floor of the Toronto Stock Exchange and then was employed for a period of time as a commission salesman. In 1965 he moved to Vancouver where he was first employed by a broker-dealer and then by West Coast Securities. In 1972 he left that business and until 1976 conducted a placer mining operation in the interior of British Columbia. Upon his return to Vancouver he incorporated Ingersoll, the shareholders of which were his wife as to 80 per cent and his four daughters as to five per cent each. Its business was to buy and sell securities. The appellant was a salaried employee of Ingersoll and at all material times directed its trading and investment operations. He was, in the words of his counsel, the sole managing and guiding spirit behind the company.

From 1976 to 1980 O'Sullivan did not invest in the stock market in his own name because there was a substantial judgment outstanding against him. In 1980 when this judgment was discharged he once again began to buy and sell shares and stock on his own account. His role with Ingersoll did not change and he continued to manage its affairs and make all of its investment decisions. Although O'Sullivan said that the line between his personal trading and that of Ingersoll was often blurred it is a fact that at all relevant times Ingersoll and the appellant maintained separate records and retained separate accountants. Ingersoll's financial statements and income tax returns were prepared by Topping, Eyton and Partners, a firm of chartered accountants. O'Sullivan relied on his bookkeeper, Stella Mitchell, to prepare his income tax return for taxation year 1982 while in 1981 his return was prepared by an "independent chartered accountant".

Mr. O'Sullivan stated that he has never been a promoter, a director or officer of any of the companies in which he bought and sold shares, nor has he ever been classified as an insider. His activities were confined to a study of the market and the recognition of situations which he believed were advantageous and then investing money in those situations. O'Sullivan rejected a suggestion that he alone or with others was "manipulating the stock market", preferring to describe his involvement in certain situations as "orchestrating the market". This phrase was used by him to characterize various steps taken to maintain an orderly market, an activity in which he had some expertise and which he conducted on behalf of clients.

The specific transactions which are at the heart of the issue occurred in the following manner. In August 1980 O'Sullivan was approached by Frank Matthews (Matthews), a stock promoter and business acquaintance with whom he had dealt previously. Matthews was the director and promoter of March Resources, a company whose shares were being traded on the market at that time at approximately $2 per share and for which he was "doing a financing” through Continental Carlisle and Canarim Securities. He asked the appellant to lend him $50,000 and to buy "some of the underwriting". O’Sullivan agreed to lend Matthews the money and committed himself to buy 60,000 of the 300,000 units being underwritten. As part of the arrangement O'Sullivan was to receive 100,000 shares of March Resources escrow stock from Matthews at no cost.

Although O'Sullivan's evidence was often vague and lacked detail the component elements of the agreement appear to have been transacted in the following manner:

(a) The personal loan of $50,000 to Matthews was made by O'Sullivan by way of a cheque drawn on the bank account of Ingersoll. In the books of Ingersoll the $50,000 advance was entered and treated as a debit to O'Sullivan's loan account. In due course Matthews repaid the $50,000 to O’Sullivan and according to the appellant this sum ultimately formed part of substantial cash advances made by him to Ingersoll during 1980 and 1981.

(b) The purchase of the 60,000 units of March Resources: O'Sullivan in his capacity as secretary/manager of Ingersoll, caused it to subscribe for 30,000 units. O'Sullivan personally subscribed for 10,000 units and a further 10,000 units were subscribed for by one Len Meltzer, a West Coast Securities salesman, either on his own behalf or on behalf of a client. The remaining 10,000 units appear to have been subscribed for by a friend of the appellant, a Mr. Goldsmith, but eventually came back into O'Sullivan's hands. He described this transaction in the following words:

Q. Yes, but you — you also made an arrangement with a Mr. Goldsmith. Isn't that correct?

A. Yes, maybe he bought 10.

Q. Mr. Van Iperen: He bought 10 didn't he?

A. Okay, yes.

Q. And, but sold them back to you?

A. He didn't have the money, I used his name as a name of convenience, and I took the liberty of the stock.

Q. Okay, so they ended up with you?

A. They ended up back with - I don't know whether it ended back with Ingersoll or me, but I do remember the particular trade you're referring to.

Q. Well, sir I suggest they ended up with you.

A. Well, as I say, Ingersoll or myself.

Q. No, I suggest you you they —

A. Then they could have ended up with myself.”

(c) The escrow shares: All 100,000 escrow shares were transferred by Matthews to O'Sullivan. A series of documents (Exhibit Ri) including the transfer document, letters from solicitors and a Vancouver Stock Exchange Escrow Agreement dated March 1981 confirm this transfer. None of the documents makes any reference whatsoever to Ingersoll nor is there any reference therein that the escrow shares were held in trust for Ingersoll. O’Sullivan conceded that there were no other documents in existence to support the assertion that the escrow shares belonged to Ingersoll. No claim has ever been made by Ingersoll against O'Sullivan in respect of these shares. The first release of escrow shares following the transfer to O’Sullivan occurred on or about March 31, 1981. The 15,000 shares received by him at that time were sold and the proceeds used to pay part of an existing personal tax liability. As other shares were released from escrow they too were sold by O’Sullivan on his own account.

Certain other facts should be referred to at this point. In May 1981 Ingersoll purchased 25,000 shares of March Resources for its own account. The shares appreciated in value momentarily, then fell rapidly causing a substantial loss to Ingersoll and as a result O'Sullivan advanced his own funds to Ingersoll as and when required. Ingersoll's financial statements disclose that as at March 31, 1980 the amount due and owing from Ingersoll to O’Sullivan was nil. On March 31, 1981 the amount due to him was $539,720 and by March 31, 1982 it had increased to $998,829. O’Sullivan said that the advances made by him in that two-year period consisted principally of the proceeds of disposition of the escrow shares in March Resources. At all times these advances were recorded in the books of Ingersoll as amounts due and owing to O'Sullivan and were described as a loan or loans from O'Sullivan.

As noted previously in 1980 the appellant began to trade on his own account. In his return of income for that taxation year he treated certain gains on the disposition of shares as being on capital account and was so assessed by the respondent. In his returns of income for taxation years 1981 and 1982 all gains and losses arising out of his trading activities were reported as being on income account. Included were the gains arising on the disposition of the March Resources escrow shares which are the subject of the reassessments. This change in the method of reporting gains on disposition was made on the advice of O'Sullivan's accountant.

The appellant's primary position is that the March Resources escrow shares and the proceeds of the disposition thereof belonged to Ingersoll and not to O'Sullivan. Counsel submitted that the reporting of these profits by O'Sullivan in his returns of income during the relevant taxation years is not determinative of the matter, citing as authority for this proposition the case of M.N.R. v. Société Coopérative Agricole de la Vallée d'Yamaska, [1957] C.T.C. 132; 57 D.T.C. 1078. In this decision of the Exchequer Court of Canada, Mr. Justice Fournier stated:

An irregular entry in the books or records, or in the financial statement, (which does not conform to the established facts) cannot, in my opinion, have the effect of changing non-taxable income into taxable income.

The Court was urged to accept O’Sullivan’s assertions that Ingersoll’s and his activities were treated as one and the same, and to find that the record keeping of both O’Sullivan and Ingersoll did not reflect the true circumstances. It was further submitted that other facts also supported an argument that the escrow shares and the proceeds of their disposition belonged to Ingersoll such as: virtually all of the proceeds were ultimately advanced to Ingersoll; the loan of $50,000 was effectively made by Ingersoll to Matthews and was ultimately repaid to Ingersoll and the bulk of the units of March Resources subscribed for were taken by Ingersoll.

Counsel argued that it was evident that the burden of the transaction was borne by Ingersoll. In such circumstances one had to view O'Sullivan as a trustee on behalf of Ingersoll and since he held the escrow shares in that capacity he was bound to account for them or the proceeds thereof to Ingersoll. Several decisions were cited in support of this argument including Regal (Hastings) Ltd. v. Gulliver and others, [1942] 1 All E.R. 378; Aberdeen Ry. Co. v. Blaikie Brothers (1854), 1 Macq. 461; and Canadian Aero Service Ltd. v. O'Malley et al., [1974] S.C.R. 592; 40 D.L.R. (3d) 371. Counsel submitted that the circumstances in the case at bar were demonstrative of a classic corporate opportunity case. He argued that if the opportunity belonged to the company and an employee such as the appellant spirited that opportunity unto himself, the profits should have been the company's and O'Sullivan's duty was to act accordingly. The fact that no action had been taken by Ingersoll against O’Sullivan could be disregarded because virtually all of the moneys received from the sale of the escrow shares had been advanced to Ingersoll in any event. To explain why those advances were treated as a loan from O'Sullivan counsel argued that it was open for the Court to find that it was done by Ingersoll's accountant "inferentially at least", without the taxpayer's instructions. Mr. Mitchell submitted:

"From start to finish I think that's got to be the understanding in this case, is that if Mr. O'Sullivan had known the nuances of what was going on, or could have appreciated the nuances of what was going [on] we would not be here . . . today.”

Notwithstanding counsel's valiant effort, it is virtually impossible to accept his description of Mr. O’Sullivan as an individual "who did not appreciate the nuance of the company versus him”. O’Sullivan impressed me as an astute and intelligent businessman. I am satisfied, given O’Sullivan’s experience and background, that he clearly understood the purpose and essential nature of a corporation and also understood the distinction between its business affairs and his own. Under his management Ingersoll, at all relevant times, retained separate accountants, kept separate books and records, actions not consistent with O'Sullivan's bald assertion that he and the company were all one and that when he “lost a million here and the company gained a million there" such gains and losses simply offset each other.

It is equally difficult to accept counsel's submission that Ingersoll took the financial burden of the March Resources transaction. Although O'Sullivan obtained the $50,000 he loaned to Matthews from Ingersoll, its financial records show that amount as a debit to the loan account of O ‘Sullivan. These records prepared by Ingersoll's accountants have not been demonstrated to be wrong nor has there been any evidence from the accountants to support the sought for inference that they acted in this instance without consulting or obtaining instructions from their client. O'Sullivan has never taken exception to the quality of service provided by this firm nor has he branded it incompetent as he did his personal accountants. There is no evidence that Ingersoll was privy to O'Sullivan's arrangement with Matthews other than O'Sullivan's evidence, which I do not accept. Furthermore Ingersoll did not accept all of the financial responsibility for the purchase of the March Resources units. It subscribed only for 30,000 units while the balance were taken by O'Sullivan and a third-party purchaser.

With respect to the advances made by O'Sullivan to Ingersoll the submission that the manner in which they were recorded by Ingersoll was an accounting error made without the knowledge of O'Sullivan cannot be accepted. There is a complete absence of direct evidence that such an error occurred, this in circumstances when such evidence was, on the face of it, readily available to the appellant to produce.

The appellant has also failed to demonstrate that the respondent was wrong in relying on his income tax returns to conclude that Ingersoll was neither entitled to the escrow shares nor entitled to the proceeds thereof. In his return for taxation year 1981 O’Sullivan reported business income of $677,676 arising out of the gains and losses incurred in trading in various securities. Included in this total there was a reported gain of some $738,000 on the disposition of March Resources escrow shares. I do not accept his assertion that this amount was improperly included in his income as a result of the unilateral action of an incompetent accountant. O'Sullivan signed this return showing a balance of taxes due of $392,393. It is totally inconceivable that he failed to notice that he was signing a return as a result of which he accepted a tax liability in that amount and not have raised the issue with his accountant.

Counsel for the respondent submitted that it was only when Ingersoll incurred substantial losses in subsequent years that an element of hindsight tax planning took place and an attempt was made to treat the gains as Ingersoll’s rather than the appellant's. This submission may have some substance for there is no evidence of any intention to consider the gains as Ingersoll's until a later time when it was apparent that Ingersoll had incurred these losses. In this context I also bear in mind O'Sullivan's evidence relating to a meeting he had in October 1982 with Mr. Vavasour, a Revenue Canada auditor who was charged with the responsibility of reviewing the appellant's personal income tax returns for the taxation years in issue. No mention was made by O'Sullivan during the course of the meeting that the March Resources profits had been improperly credited to his account or that they belonged to Ingersoll.

The principles of law relating to the fiduciary responsibility of an officer or a director to the corporation are not in dispute. Counsel for the appellant contended that as a senior officer of Ingersoll O’Sullivan stood in such a fiduciary relationship to Ingersoll and was precluded from obtaining for himself an opportunity which existed and which rightfully belonged to Ingersoll. The principles of law advanced are sound. However the evidence does not support the application of those principles in this case. There is no evidence to support a conclusion that the Matthews request for assistance was directed to Ingersoll. It is clear, on the other hand, that it was O'Sullivan's expertise and financial assistance that was being sought. On the facts it was O'Sullivan's opportunity, not Ingersoll's.

In Canadian Aero Service Ltd. v. O'Malley, supra, Laskin, J., as he then was, made the following comments at pages 606-7 (D.L.R. 382):

Descending from the generality, the fiduciary relationship goes at least this far: a director or a senior officer like O’Malley or Zarzycki is precluded from obtaining for himself, either secretly or without the approval of the company (which would have to be properly manifested upon full disclosure of the facts), any property or business advantage either belonging to the company or for which it has been negotiating; and especially is this so where the director or officer is a participant in the negotiations on behalf of the company.

An examination of the case law in this Court and in the Courts of other like jurisdictions on the fiduciary duties of directors and senior officers shows the pervasiveness of a strict ethic in this area of the law. In my opinion, this ethic disqualifies a director or senior officer from usurping for himself or diverting to another person or company with whom or with which he is associated a maturing business opportunity which his company is actively pursuing; he is also precluded from so acting even after his resignation where the resignation may fairly be said to have been prompted or influenced by a wish to acquire for himself the opportunity sought by the company, or where it was his position with the company rather than a fresh initiative that led him to the opportunity which he later acquired.”

[Emphasis added]

There is no evidence upon which I can reasonably find that it was O'Sullivan's position with Ingersoll which led him to the opportunity which he acquired.

I am satisfied that the respondent was not in error in relying on the returns signed by the appellant, the statements contained therein, and on the financial statements and returns of Ingersoll, all leading to the conclusion that the escrow shares belonged to the appellant No acceptable evidence was tendered from which it could reasonably be concluded that the transfer documents (Exhibit R-1) did not reflect the situation as it existed. I am unable to accept O'Sullivan's evidence without reservation. His assertions as to the improper recording of the various transactions in Ingersoll's books and as to the wrongful inclusion of the March Resources profits in his income tax returns was not at all convincing. His explanation of the rationale behind the transfer of the escrow shares by Matthews to O'Sullivan personally rather than to Ingersoll was lame and implausible.

In the alternative the appellant contends that if the gains from the disposition of the March Resources escrow shares are to be taxed in his hands, they should be treated as being on capital account. Counsel submitted that O’Sullivan could not be characterized as an insider or promoter, nor was he an officer or director of March Resources. That being the case, the general rule that a purchase of shares in a public company is a well-recognized method of making an investment should apply. As Martland, J. stated in Irrigation Industries Limited v. M.N.R., [1962] S.C.R. 346 at 352; [1962] C.T.C. 215 at 221:

Corporate shares are in a different position because they constitute something the purchase of which is, in itself, an investment. They are not, in themselves, articles of commerce, but represent an interest in a corporation which is itself created for the purpose of doing business. Their acquisition is a well recognized method of investing capital in a business enterprise.

On this issue evidence on behalf of the appellant was adduced from Mr. M.A. Cruz who was during the relevant period of time an Appeals Officer with Revenue Canada, Taxation, and had occasion to review the appellant's 1980 and 1981 income tax returns. In recommending the reassessment of the March Resources gains in taxation year 1981 Mr. Cruz acted for the following reasons:

The taxpayer received the shares from Francis Matthews, President of March Resources, as consideration for the taxpayer's activities in initiating the sale of some 60,000 shares at $2.28 per share sometime in August 1980. And also for lending $50,000.00 to Mr. Matthews.

Mr. Cruz stated that the appellant's conduct was similar to that of an underwriter in that he was one who participated in the promotion or underwriting of a particular issue of shares.

Counsel for the appellant submitted that the conclusions of the respondent were erroneous in fact and in law. The respondent had disregarded the fact that the appellant had reported all of his activities on income account and treated all transactions excluding therefrom only March Resources as being on capital account. Counsel contended that O'Sullivan was simply an investor who acquired some shares and at the appropriate times sold them. He argued that the respondent had committed a basic error in treating the proceeds from the disposition of the March Resources shares differently from all other stocks in which the appellant had traded during the course of that taxation year. In such circumstances no rationale existed to permit the respondent to treat the March Resources transaction in isolation as a disposition on income account.

The appellant’s alternative position must also be rejected. The manner in which the respondent assessed certain other transactions in the 1981 taxation year is only marginally relevant to my determination of the true nature of the March Resources transaction. There is no evidence before me as to the circumstances in which O'Sullivan came to buy shares of Northill Resources, Palliser Resources, Damascus, Rodeo Resources, Ventora Resources or any other shares listed in the schedule to his 1981 income tax return. There is no evidence of the assumptions upon which the Minister acted in reaching his conclusion in relation to the other transactions.

The question to be determined is whether the onus to establish the existence of facts or law showing an error in relation to the imposition of tax on the March Resources gain has been met. I have concluded that it has not and that the facts clearly support the reassessment. The March Resources transaction bears none of the hallmarks of an investment and is a classic example of an adventure in the nature of trade. The acquisition of 20,000 units by O’Sullivan personally, the sale of 10,000 units to Meltzer and his influence in directing Ingersoll to acquire another 30,000 units accounted for 20 per cent of the underwriting being promoted by Matthews. Additional funds were required by Matthews and were provided by way of a loan of $50,000 from O'Sullivan. The appellant played an active role in the underwriting of March Resources by arranging for the sale of 60,000 units and by assisting Matthews financially. In consideration for the loan and assistance O'Sullivan received the escrow shares from Matthews which he subsequently disposed of at a profit.

The background of the taxpayer is relevant in this context. On a number of occasions he has "orchestrated markets" for clients and was paid a fee for that service, on occasion, in shares of the company involved. Although his arrangement with Matthews in the March Resources underwriting does not fall into his definition of "orchestration" I am satisfied his involvement went well beyond the activities of an ordinary investor in the stock market.

The respondent's reassessments were correct and the appeals must be dismissed.

Appeal dismissed.