Brien a Hornby v. Minister of National Revenue, [1972] CTC 2539, 72 DTC 1476

The Chairman:—This is an appeal from a reassessment to income tax for the taxation year 1967, wherein the Minister disallowed the deduction of certain sums claimed as losses or expenses incurred by the taxpayer while trading in securities.

The appeal was heard at the City of Windsor in the Province of Ontario on September 21, 1971 my J O Weldon, Esquire, QC, then a member of the Tax Appeal Board as it was then constituted. The decision in this case was not delivered before Mr Weldon’s retirement from the Tax Review Board and the parties have consented that judgment be rendered by a present member on the basis of the transcript of the proceedings at the hearing before Mr Weldon at the time and place aforesaid.

The facts in the case are not in dispute and no evidence was called at the hearing, the proceedings having been limited to argument on the part of counsel for the respective parties. The following facts are taken from the notice of appeal and were agreed to by the respondent.

From the year 1953 until about December of 1963, the appellant was employed by Leslie Bongard & Co Ltd, a stock brokerage firm with offices in the City of Windsor, in the County of Essex, and elsewhere. He served as office manager and customer’s man during the time he was so employed and at the same time traded in securities on his own account. During this period he acquired a reputation for being a competent young man with a promising future in the stock brokerage business.

During the latter part of 1963 the appellant was approached by a representative of Waite, Reid and Company Limited (hereinafter called the “company”) and was offered a position with that company on certain terms, the basic one being that, if he accepted, he was to be manager of a branch office which the company wished to open in the City of Windsor.

The company was incorporated under the provisions of The Corporations Act of Ontario as a private company having an authorized capital of $500,000, dividend into 50,000 common shares with a par value of $1 each and 45,000 6% non-cumulative, non-voting preference shares having a par value of $10 dollars each. The company was also engaged in the stock brokerage business and was a member of the Toronto Stock Exchange as well as other stock exchanges across the country.

At the time of this offer, apparently, the rules of the Toronto Stock Exchange prohibited the company from paying an employee a commission in excess of 33%% of the commissions earned by the company upon business solicited by him unless he was a director of the company. In order to become a director, again in keeping with the rules of the Toronto Stock Exchange, he had to own holdings in the company to the extent of at least $5,000. He also had to be approved by the Stock Exchange prior to his election as a director.

It seems that, in addition, the company was anxious to have the appellant purchase trading assets in the capital stock of the company to the extent of $25,000 in order for him to become a. director. However, this was not a requirement of the Toronto Stock Exchange but rather, or so it appears from the pleadings, simply a company rule or wish. The evidence as shown in the pleadings also indicates that, if the appellant became a director of the company, he would be entitled to trade in securities listed on the exchange for one-fifth of the commission he would otherwise be obliged to pay. This latter privilege, of course, would result in greater earnings on his part should he engage in personal trading in securities listed on the Exchange.

In any event, the appellant did accept the offer to become the manager of the company’s Windsor office and subscribed for trading assets of capital stock in the company to the amount of $5,005 for which he received 5 common shares and 500 preference shares. His application to the Exchange was approved and he was subsequently elected a director of the company.

However, the appellant did not wish to purchase any shares in the company in excess of the number required to qualify him as a director in so far as the Toronto Stock Exchange was concerned, and he failed to accede to the requests by the company to purchase additional shares to the amount of $25,000 already referred to.

It seems that subsequently the rules of the Toronto Stock Exchange were amended and he was required to have book holdings of at least $10,000 instead of the $5,000 previously required, and the appellant complied with this new ruling by subscribing and paying for trading assets of capital stock in the company valued at $10,700.

It is not disputed that, by virtue of his directorship, his income during the course of his employment with the company was increased because he was able to participate in commissions beyond the percentage permitted to an ordinary employee of a company and also because of the lower rate of commission he was required to pay when he traded in securities on his own account.

Unfortunately, the company went into bankruptcy in the taxation year 1967 or 1968 and the appellant lost the $10,700 that he had as trading assets in the capital stock of the company. During the same year, he had shown a profit in his trading ventures on his own account of some $3,000 and in his income tax return attempted to write off against these profits his losses with the company in the amount of $10,700. It is this amount that has been disallowed by the Minister of National Revenue on the basis that it was a loss on capital account.

As one reads the argument in the transcript, counsel for the respondent does not dispute the fact that the appellant was a trader in his own right, but argues that a line must be drawn between the normal trading operations carried on by the appellant and the transactions whereby he purchased shares in the company to the value of $10,700.

According to the allegations of the Minister, these latter transactions constituted a capital investment made for the purpose of obtaining and retaining his position with the company, and not an adventure in the nature of trade as were his other operations.

Numerous grounds of appeal were raised by the appellant in the Notice of Appeal but, at the hearing, his counsel informed the Board that he was restricting his argument to one position and one position only, namely, that the appellant had suffered a loss in the 1967 taxation year as a trader which he is entitled to set off against the income that he earned as a trader, and all other positions were abandoned.

During the course of the argument, much appears to have been made of the fact that these shares were not reviewed from time to time and were not considered for disposal by the appellant and therefore were capital investments that he did not intend to sell as and when the time was ripe for a profit but intended to hold indefinitely. However, the evidence indicates that he could have disposed of those shares at any time a market was available and still maintained his employment with the company, although he would have lost his position as a director and have lost certain trading advantages that went with that office, as outlined above.

If one accepts the fact of the qualifications and competency of the appellant, as the Minister has done in his Reply to the Notice of Appeal, it would seem that the company made a great effort to obtain his services as a salesman and customer’s man. Also for reasons which became apparent in a very few years, the company had obviously wanted him to put up as much as $25,000 if he wished to become a director, and yet, according to the evidence, had never taken any steps to dismiss him, nor had they even threatened to dismiss him, for his failure to do so. In my view, this further indicates that his value to the company was as a salesman and that the secondary reason for the company’s offer to make him a director was its hope of replenishing its diminishing assets by getting him to purchase a substantial amount of treasury stocks as his own trading assets.

The appellant, who appears to have been an astute young man, refused to purchase more shares than were absolutely necessary to enable him to take full advantage of the benefits of a directorship, and proceeded to operate his own trading account, which is shown in the record as consisting of a number of transactions, none of which resulted in a very substantial profit but totalled in the material year a profit of some $3,000.

The respondent appears to take the sole position that the appellant purchased these shares to obtain his position of manager; did not sell them over the course of the period that he was so employed; and therefore they were not shares purchased as trading assets and must be treated differently from those other shares in which he did trade from time to time. The thrust of this argument is that the money laid out for the company’s shares was a capital outlay for the purpose of obtaining his position and therefore the loss was a loss on account of capital.

I do not think the evidence substantiates that the employment of this appellant was based upon his purchase of shares in the company but rather that it was based upon his ability to sell securities in the area in which the company planned to open a branch office, and that the company’s shares were purchased as trading assets by the appellant to the extent that he was able to obtain certain trading advantages for himself in the circumstances above set out by becoming a director of the company rather than merely an employee.

From what happened to the company in the years 1967 and 1968, that is, its eventual bankruptcy, it is questionable whether he could have disposed of the shares even if he had tried to, and they were, in my view, purely a trading asset that failed to produce a profit save and except for any advantage he may have gained in earning income from the company in excess of what he would have earned had he not been a director.

In his arugment, appellant’s counsel cites the case of Freud v MNR, [1969] SCR 75; [1968] CTC 438; 68 DTC 5279, a decision of the Supreme Court of Canada upholding the decision of Gibson, J of the Exchequer Court of Canada ([1967] 1 Ex CR 293; [1966] CTC 641; 66 DTC 5414). Counsel quoted from the Exchequer Court decision (at 296, 643, 5416, respectively), where the learned trial judge in that instance said:

In my view, if the appellant had been successful and realized a profit therefrom, this gain clearly would be income from a source outside the sources specified in section 3 [of the Income Tax Act, RSC 1952] but within the meaning of “sources” in the opening words of the section. In other words, it would not have been a windfall gain and so not -a capital gain.

It is my opinion that, in the case before this Board, if the market had been available and the appellant had chosen to sell the shares of Waite, Reid and Company Limited, and if a profit had been made on the transaction, the respondent would have been quick to tax him on the profits so made, since unquestionably he was a trader and would have been acting in the normal course of his business. I see no distinction that should be drawn in this case to the detriment of the appellant by reason of the fact that the shares, in addition to being trading assets, also qualified him as a director pursuant to the e- quirement of the Toronto Stock Exchange, thereby increasing the commissions that he was able to earn.

For these reasons, I would allow the appeal in full and refer the matter back to the Minister for reassessment in order to allow as a deductible expense in the taxation year 1967 the loss of $10,700 sustained by the appellant on shares of Waite, Reid and Company Limited.

Appeal allowed.