Frederick W Henderson, Murray Watts and William G Leliever v. Minister of National Revenue, [1977] CTC 2421, 77 DTC 297

Delmer E Taylor:—These are appeals from income tax reassessments for the taxation year 1968 in which the Minister of National Revenue increased the taxable income of each of the appellants by an amount of $66,950. The respondent relied, inter alia, upon sections 3, 4 and paragraph 139(1 )(e) of the Income Tax Act, RSC 1952, c 148 as amended. The appeals were heard on common evidence.

Facts

From March 1967 to March 1970, Frederick W Henderson (hereinafter referred to as “Henderson”) was, inter alia, a shareholder and director of Playfair and Co Ltd (hereinafter referred to as ‘‘Playfair’’), Toronto, Canada, a company engaged in the business of securities, underwriting and investment for clients. Mr Murray Watts (hereinafter referred to as “Watts”) was, inter alia, at all times material, a geologist, mining engineer and prospector. Mr William Leliever (hereinafter referred to as “Leliever”) was, inter alia, at all times material, a prospector. A private company under the laws of the Province of British Columbia, Hearne Coppermine Explorations Limited (hereinafter referred to as ‘the company” or “Hearne”) was incorporated on July 20, 1967, and the three appellants were among the ten founders (hereinafter referred to as the “associates”).

Each of the associates purchased 40,000 common shares of Hearne from treasury at 10¢ per share, raising thereby the original capital of the company—$40,000. These 400,000 shares (hereinafter referred to as “subscribers’ shares”) were subject to a pooling arrangement among the associates, which in general terms limited the right of any individual to sell such stock without the agreement of at least seven of the associates.

Leliever received 500,000 shares also from treasury and $228,500 (partially in cash and partially as a debt payable from the company) for transferring to Hearne a substantial number of his mining claims in the Coppermine River region of the North West Territories. Some 200,000 of Leliever’s shares were at a later date transferred by Leliever to five other associates for nominal consideration. From treasury also a further 250,000 shares were issued at 10¢ per share, for mining claims, to three of the associates, one of whom was Henderson. The above-noted total of 750,000 common shares were held as “escrow shares”.

In August 1967, 500,000 common shares were sold from treasury at $1 per share to “close friends, relatives and business colleagues” of the associates. These shares were also subject to the same restrictions regarding “pooling” that were accepted by the associates in the original subscribers’ share issue.

Hearne borrowed funds in excess of $500,000 which together with the proceeds of the private stock issues detailed above were expended for administration, exploration, purchase of mining claims and investment in the shares of a public mining company, PCE Limited (hereinafter referred to as “PCE”), which already owned and was developing mining claims in the general Coppermine River area. The president of PCE was Murray Watts, one of the appellants in this matter.

On March 29, 1968 Hearne became a public company and a prospectus dated May 3, 1968 was issued, which provided for the sale of 400,000 shares at $2.50 per share to commence May 28, 1968. These shares were all sold before June 6, 1968. The company in this public offering used the services of two investment dealers—Playfair & Co of Toronto, and Hemsworth, Turton & Co of Vancouver, a firm with which one of the other associates was involved.

On June 7, 1968 a block of 200,000 shares of the “subscribers’” stock was sold at the price of $3.50 per share to a New York investment firm, Value Line Special Situations Fund (hereinafter referred to as “Value Line”). This block of stock was made available by the surrendering for such a sale of 20,000 shares each from the ten associates. The net gain for each of the associates was an amount of $66,950, giving rise to the matter at issue in these appeals.

Contentions

From the respective notices of appeal for all three appellants, the following common ground was put forward:

It is an established principle of law that it is the intention of a taxpayer at the time he purchases a property that is the sole factor in determining whether a gain realized by him on the sale of the property is an income gain or a capital gain. If the intention of the taxpayer was to turn the property to account so as to realize a profit, the resultant gain would be an income gain. However, if the intention of the taxpayer was to hold the property as an investment, the resultant gain would be a capital gain. The intention of a taxpayer is determined by the surrounding facts and it is respectfully submitted that in the circumstances of the appellants’ purchases of 40,000 shares each in Hearne for cash while it was a private company, the facts support no position other than that the appellants purchased these shares as an investment.

The fact that a taxpayer sells an investment when offered a sufficiently high price does not lead to the conclusion that the taxpayer had any intention at the time he purchased the investment other than to hold it as an investment. This is true even if this offer was made to the taxpayer and accepted by him within a relatively short period of time after he purchased the investment.

The fact that a taxpayer has some special knowledge or professional skill does not mean that a property purchased by him which has some relationship to his special knowledge or professional skill cannot be held by him as an investment.

For the respondent, the issue was:

The appellants and their associates formulated and executed a plan whereby Hearne was incorporated, invested with capital and mining claims and Caused to engage in the business of exploring for minerals. The Associates formulated and executed as well a profit making scheme whereby each of the Associates was to be issued 40,000 shares of Hearne at 10 cents per share so as to enable each Associate to turn to account for profit at the first available opportunity the whole or such part of his 40,000 share block as might seem expedient. The Associates planned and intended to create a favourable opportunity for the disposition by them of Hearne shares shortly after the completion of the contemplated primary disposition to the public of treasury shares of Hearne under the first prospectus of Hearne. The profit realized by each appellant on the sale by him of 20,000 shares of Hearne to Value Line was thus realized in the course of carrying out or carrying on a scheme for profit making.

The profit realized by each appellant was a profit realized from a business: in the case of Henderson, as a securities agent and promoter of securities; in the case of Watts, as a mining engineer, geologist, prospector and promoter of mining securities; and in the case of Leliever, as a prospector and promoter of mining securities.

Evidence

As witnesses on their own behalf, the appellants introduced the following documents:

Exhibit A-1—Memorandum of agreement dated July 31, 1967 between

Hearne Coppermine Explorations Limited and the associates;

Exhibit A-2—Memorandum of agreement dated August 1, 1967 between

Hearne and Mervin E Davis and Fred W Henderson (two of the associates);

Exhibit A-3—Prospectus—Hearne Coppermine Explorations Limited

—dated May 3, 1968.

Through the appellants, counsel for the respondent identified and filed these documents:

Exhibit R-1—Letter with an attachment, from Prowsky, Lindzon &

Biback, Solicitors, to the Department of National Revenue dated May 14, 1973;

Exhibit R-2—Memorandum of agreement between Frederick W

Henderson and Hearne dated September 8, 1967;

Exhibit R-3—Photostatic copy of the share trading ledger sheet of

Henderson from the records of Playfair & Co, Stockbrokers;

Exhibit R-4—Photostatic copy of the share trading ledger sheet of

Watts from the records of Playfair & Co, Stockbrokers;

Exhibit R-5—Photostatic copy of the share trading ledger sheet of

Leliever from the records of Playfair & Co, Stockbrokers;

Exhibit R-6—Copy of a letter from a firm of Vancouver solicitors to

the British Columbia Securities Commission, dated June 6, 1968, stating that the primary distribution of the shares under the Hearne prospectus had been completed.

Argument

Counsel for Henderson made the point that his client’s situation was rather particular since he was not in the business of buying and selling securities, he had always treated the results of any of his security dealings as capital, he was not the kind of person to perpetrate any scheme as alleged by the respondent, and stated that such a scheme should not be attributed at all to the associates.

Counsel for Watts suggested also that his client’s position was slightly different than any of the other associates, given his background and mining experience. Watts was not interested in the business of trading in securities—he was not a trader, and the occasional buying and selling of shares should not be barred to him merely because he is a mining geologist.

For Leliever, counsel asserted his client was also in a unique situation in view of the fact that there had been only one transaction involving Leliever, his client’s intention had been to make an investment, and he had not participated in any common design for the purpose of profiting by the purchase or sale of the shares.

Counsel for the respondent noted for the Board the many questions which in his opinion remained unanswered; asserted the existence of a common design; and regarded the ordinary association of all three appellants with the mining industry in their regular working activity to be destructive, in itself, to their cases. Considerable importance was attached by counsel to two points—the pooling arrangement, and the fact that the 200,000 shares sold to Value Line came from the allocation shown in the prospectus as a “Secondary Offering”.

Findings

The Board turns to the “unanswered questions” detailed by counsel for the respondent only to reassert that it is the evidence provided and the questions answered with which the Board must deal, not the unknowns and probabilities.

Another assertion by the respondent—that each appellant is subject to income tax on the gain by virtue of his individual personal business background—also needs a response from the Board in view of the substantial relationship each one had to the industry. The presumption that all three appellants were acting as traders when buying and selling shares could be one arguably within logical parameters. However, such a badge as an individual “trader” should cast a shadow over a larger area than merely the transaction with which this hearing is concerned. Further, there is no evidence that sales of Hearne shares made by the appellants subsequent to this particular transaction with Value Line were considered either by the appellants or the respondent as trading. I am unable to view the evidence in such a light that I can distinguish beyond question this particular transaction involving the purchase of shares in Hearne and their subsequent sale to Value Line as trading while accepting that the personal transactions of the same appellants over many years, in many different companies, had not been so treated.

Turning to the major point at issue, it appears to me that a. substantial effort was made on behalf of the individual appellants in trying to distinguish the role of each one from that of the other two, and then again each one from the other seven associates, who are not represented at this hearing. The most concrete description provided of that from which everyone apparently wished to be far removed was given by counsel for Leliever—“a common design”. The Board is unable to discern as clearly as counsel for the appellants can do the fine distinctions which would indeed segregate any one or all three of the appellants from a common purpose, either among themselves or with the associates. I am completely satisfied that the three appellants together, without additional assistance, had the competence and the experience to put together a program, at least of the character if not perhaps the scope of that alleged by the respondent in this case. The inclusion as investors and directors of seven other persons having the reputations and abilities indicated for those in the Vancouver area could only serve to enhance the prospects for success. Whether actively or more passively, each supported, contributed to and was eventually benefited by the concerted action, deliberations and decisions taken by the management of Hearne. There was a “common design” certainly—and the appellants were willing and able participants; the only question involved is whether this common design was for the purpose of and limited to organizing and developing mining properties, or whether it was for organizing and perpetrating a profit-making scheme on behalf of the appellants, involving the purchase and sale of shares of capital stock in the company.

This “organized program” or “common design” had as its major ambition, according to the respondent, the transaction by which the associates sold to Value Line 200,000 shares of common stock at $3.50 per share for which the associates had paid into the company treasury 10¢ per share.

The evidence available shows that, starting from only an idea (leaving aside for the moment what that idea might have been or where it had originated), Hearne by early June 1968 had received from various sources in excess of $2,000,000: held almost 3,000 apparently valuable mining claims; had made a profit of nearly $200,000 through buying and selling the shares of PCE (to Value Line); retained PCE stock stated to be worth more than $1,000,000; and had broadened out its base of investors to encompass the public. Value Line was already a substantial investor in PCE, and plans for the 1968 exploration of the mining claims of Hearne were well advanced. The company had relatively little in the way of liabilities and had at least the proceeds of the public offering (about $1,000,000) available. At the time of the sale to Value Line from the private holdings of the associates, there was indeed good reason for optimism and satisfaction and it is against this background that the Board is required to view the actions and conduct of the associates.

It is not my reading of the legislative record that the only factor to be weighed in appeals of this nature is the avowed intention of the party at the time of purchase or acquisition of the property involved. In another matter (Arthur E Kruger, Elmer D Bassani and Pantel Holdings Ltd v MNR, [1977] CTC 2311; 77 DTC 208) I made the following observations at page 2321 [215]:

In my opinion, to determine a question of the kind posed at this hearing, particularly dealing with the purchase and sale of land and considered against the background just described, requires the following:

(a) an examination of the appellants’ personal and business circumstances at the time of acquisition, as such circumstances conflicted with, or complemented the probable fulfilment of their stated intention;

(b) a review of the efforts made and the progress demonstrated toward such stated intention as an objective;

(c) a critical consideration of the reasons advanced for the eventual abandonment or the frustration of the stated intention.

It appears to me that the circumstances where the purchase and sale of company shares is involved should be regarded as having at least some elements of similarity. In the instant case, the stated objective of the appellants’ investment was to organize and develop a mining company. Their personal and business experience and circumstances at the time of purchase of the 40,000 shares augured well for the fulfilment of that objective. Their efforts and progress subsequent to the investment demonstrated continued pursuit of that objective and, as indicated earlier, these efforts were substantial indeed.

With regard to the “eventual abandonment or frustration” (to the degree that the sale of 20,000 shares each could be so interpreted), the Board faces another kind of question. It cannot be said, and it has not been so put forward by the appellants, that their exclusive intention was to invest for the purpose of organizing and developing the mining company. They accepted, as counsel for the respondent asserted, that they hoped some day to realize a profit on their investment in the shares of Hearne. Indeed, the pooling arrangement indicates that some serious consideration was given to the prospect of sale. Counsel for Henderson gave the explanation for pooling as “this is a natural thing to do to protect the Company, not for the benefit of the shareholders”. The Board agrees that such an arrangement had the potential to afford certain stability to the company during its formative period, but it would be naïve to think that there was not also the potential for benefit to the shareholders in such restraint, in order to select a time considered most propitious for the release of subscribers’ stock to the general public. The pooling arrangement as such, in the opinion of the Board, although not determinative, is not supportive of the position of the appellants.

In a land transaction such as that in Kruger, Bassani et al (supra), a common and favourite entreaty is that the sale which eventually produced the gain in dispute was “unsolicited”—events completely beyond the initiation or action of the appellants promoting the abandonment or frustration. In the instant case, nothing has been brought to the attention of the Board which would support a conclusion that there was any interference or impediment in the stated intention—to Organize and develop a mining company and to hold common stock therein. Quite the contrary—the company stock for which the appellants had paid 10¢ per share had sold quickly to the public at $2.50 per share and was trading at more than $4, and there was no indication given to the Board that the expectation from the mining claims had diminished by June 1968. Sufficient funds had only been raised by the public sale to carry out the 1968 exploration and development program—the major operational financing requirements still lay ahead. However, the public was now aware, through the prospectus, that privately held subscribers’ shares were available and the demand for shares was high, since 400,000 shares from the primary offering under the prospectus had sold very quickly. Under these circumstances, the appellants cannot claim completion of their objective, nor can they claim the offer to sell their shares was unsolicited. Nothing could have indicated more explicitly their desires and intentions at the time of the prospectus than the phrase from the section dealing with the secondary offering “250,000 common shares will be sold . . .” (italics mine). It remained only for the associates to determine the market price and the time at which the sale would be made.

It appears to the Board that the respondent has relied rather heavily on the argument that some unusual design, involving Value Line, was the object of the entire exercise. The Board is unable to visualize such a situation from the given set of circumstances and, indeed, points Out explicitly that it does not attribute any ulterior motives to the associates. However, there is no question, in the opinion of the Board, that the prospect of selling the subscribers’ shares at a profit had always existed and had been considered, and that it was at a level of sufficient importance by the time Hearne was converted into a public company and the prospectus issued, that it warranted bringing direct and specific attention to that opportunity by listing the secondary offering. Had Value Line not become the purchaser, the opportunity was available to the associates to use the normal channels for sale, as indicated in the prospectus “through registered dealers”. Any gain realized in view of the deliberate effort to alert the public that such shares were available therefore cannot be termed as having arisen from an unanticipated or fortuitous event, thereby causing frustration or abandonment of any stated objective.

Decision

The Board is satisfied that the course of action followed by the appellants (as part of the associates forming Hearne) was such as to give the characteristics of a venture in the nature of trade to the purchase and sale of the company shares involved in these appeals. The gains realized were not on capital account and are subject to the imposition of income tax. The appeals are dismissed.

Appeals dismissed.