Frank Tyrala v. Minister of National Revenue, [1978] CTC 2905, [1978] DTC 1659

Delmer E Taylor:—This is an appeal against an income tax assessment dated December 10, 1976 in which the Minister of National Revenue revised the reported taxable income of the appellant for the year 1975, giving the following explanation:

Your interest income has been reduced by $1,061.28. Your carrying charges have been reduced by $1,061.28. Your interest and dividend income.deduction has been reduced by $1,000 as there was no bona fide acquisition or disposition of the bonds.

The taxpayer objected, and on April 4, 1977 the Minister confirmed the assessment, providing this information:

The Honourable the Minister of National Revenue having reconsidered the assessment and having considered the facts and reasons set forth in the notice of objection hereby confirms the said assessment as having been made in accordance with the provisions of the Act and in particular on the ground that there was no bona fide acquisition or disposition of the Cominco Ltd bonds.

Therefore there was no interest income or interest expense and hence no interest and dividend income deduction resulting from this transaction.

The Minister relies on section 245 of the Act.

Facts

The appellant is a businessman living in Weston, Ontario. His 1975 income tax return shows in part:

Income item (a) was intended by the taxpayer to represent the interest accrued to date of sale on certain bonds; deduction item (b) the interest accrued to date of purchase of the bonds; and deduction item

(c) his entitlement to that amount as taxfree interest income arising out of item (a). The net effect was that the accrued interest included was eliminated by the accrued interest deducted, but Mr Tyrala took the tax benefit of the $1,000 deduction nevertheless. The brokerage firm of N L Sandler & Co, Toronto and Montreal (hereinafter referred to as “Sandler” or “the Company”) participated in the transactions. The bonds in question were those of Cominco Ltd (hereinafter referred to as “Cominco”).

Contentions

The notice of appeal reads in part:

The taxpayer has in his possession documents from the broker who carried out the transactions confirming the purchase and disposition. In addition, Mr Tyrala paid the usual commission for such transactions.

It is Mr Tyrala’s contention that he has taken all of the necessary steps and paid the price for bona fide transactions.

In assessing the taxpayer, the respondent made the following assumptions:

—“Sandler did not purchase the Cominco bonds on behalf of the appellant;

—the Cominco bonds were not assigned or transferred to the appellant;

—the appellant did not become entitled to interest from the Cominco bonds;

—no interest from the Cominco bonds was receivable by the appellant in 1975.”

The reply to the notice of appeal also noted:

The respondent relies, inter alia, upon sections 3 and 110.1, subsections 9(1) and 20(14), and upon paragraph 12(1)(c) of the Income Tax Act, RSC 1952, chapter 148 as amended by section 1, SC 1970-71-72, chapter 63 (‘The Income Tax Act’).

The respondent submits that the Cominco bonds were not assigned or transferred to the appellant within the meaning of subsection 20(14) of the Income Tax Act, nor was the appellant entitled to interest within the meaning of the said subsection 20(14), and that therefore the appellant could not take a deduction pursuant to that subsection.

The respondent submits further that no interest from the Cominco bonds was receivable by the appellant in 1975 within the meaning of paragraph 12(1)(c) of the Income Tax Act, and that therefore the appellant was not entitled to a deduction pursuant to paragraph 110.1(1)(b) of the Income Tax Act.

Evidence

Mr Tyrala filed with the Board a copy of a “Bought” order (Exhibit A-1) and a “Sold” order (Exhibit A-2) between himself and Sandler for the Cominco bonds. His recollection of the circumstances surrounding these two transactions was not precise, but he stated that he acted on the advice of his chartered accountant, Mr Ceresne, now representing him at the hearing as his agent. Tyrala had not dealt with Sandler before and was quite unfamiliar with the investment market, this being his one and only investment transaction through a broker. Exhibit A-1 showed the purchase to have been on December 22, 1975 for $26,000 in Cominco bonds due Feb 15/95 (interest 10%%), at a cost of $25,545 and 137 days’ interest of $1,061.28, totalling $26,606.28. Settlement date was December 30, 1975. The sale (Exhibit A-2) was also for $26,000 Cominco bonds (10 /s%), due Feb 15/95, and the details were—gross $25,469.60, 137 days’ interest $1,061.28, total $26,530.88, settlement date December 30, 1975. Mr Tyrala stated there had been two telephone calls by him to Sandler—one on December 22 to buy, and one on December 23 to sell. His purpose had been to make a profit on the transaction since his accountant indicated there would be a great demand for the bonds in the few days immediately after December 22, but he had sold the very next day when informed by the accountant that in fact there was not going to be any such demand.

With the agreement of counsel for the respondent, Mr Ceresne gave evidence regarding his own involvement in the transactions, and that evidence (and the cross-examination which ensued) is quoted in its entirety.

Mr Chairman, as I just stated, I am a chartered accountant, and I graduated in 1960, and since that time I have had quite some experience in both the stock and bond markets.

From time to time I have advised clients regarding purchases and sales of stock and bonds. And in December of 1975 it was brought to my attention that there would be a demand created for Cominco bonds which would be in the nature of a ‘flurry’ to last a couple of days.

I am the accountant for the company owned by Mr and Mrs Tyrala, and as they are clients of mine, and have been for a few years, I spoke to Mr Tyrala and advised him that there was a possibility to make a profit on the purchase and sale of these bonds over a period of a couple of days.

I called Mr and Mrs Tyrala; they indicated to me that they were interested, and I called Mr Sandler’s office and spoke to someone I knew there and arranged with him that they were to be allowed to open an account which would be closed in a matter of a few days once the bonds were sold. So, all that they would have to do is call and place their orders and not be bothered with putting up cash, so to speak.

The following day I was advised that the reasoning that we had accepted the previous day for the bonds to go up in price no longer applied, and therefore there was no need to continue to hold the bonds.

I advised Mr and Mrs Tyrala and once again they made their call.

This was the extent of my involvement in the purchase, and the extent of my involvement in the arrangement for the purchase at the brokerage office for them.

CROSS-EXAMINATION OF MR CERESNE BY MR KERR:

Q Mr Ceresne, you indicated that you have experience in the stock and bond markets, and specifically with respect to these Cominco bonds you were advised that there would be a ‘flurry’ to last a couple of days that would create sufficient demand that led you to the belief that it was going to go up in price. Is that an accurate summation of the investment decision?

A Basically, yes.

Q Who advised you?

A A broker.

Q What broker?

A A stockbroker that I deal with on a regular basis.

Q What is his name?

A Abbiscott?

Q His first name?

A First name, I am sorry I don’t know his first name.

Q You deal with him on a regular basis?

A Yes, I nave dealt with him for approximately six or seven (6-7) years.

Q What firm is he with?

A Hector & Chism [sic].

Q Why would you get advice from him and then turn around and go to another broker.

A I was told that this other broker's office had a supply of the bonds that they -were prepared to sell, and when I asked my own broker if I should buy through him, he said you might as well just call them and possibly there would be a saving in commission. If I may continue he gave me the name of a person in that office who I called.

Q Was it Barry Grice?

A Yes, I believe so.

THE CHAIRMAN: Mr Cheresne, are you confirming that that is the man’s name with whom you made contact at the second brokerage office?

MR CERESNE: Mr Chairman, as Mr Tyrala said, that happened in 1975, I don't recall, but I would say that the name does ring a bell, and I believe that that is the name of the person that I spoke to.

BY MR KERR:

Q This advice from this gentleman at the first stock brokerage firm, Mr Abbiscott, what exactly was the import, why was there going to be a ‘flurry’? A It was his advice to me that there were several people who were buying the bonds in order to try and create an artificial deduction on their income tax returns, and in buying these bonds they would create the demand. Now, after they had held the bonds, or after several of them had bought them over a period of a few days, they would have artificially created a demand which would push the bonds up in price.

Q Now Mr Tyrala testified that his initial contact with Sandler and Company was on the 22nd. Had you talked to him previously that day, or was it the day before?

A Had I talked to Mr Tyrala?

Q Mr Tyrala.

A Yes, I probably would have talked to Mr Tyrala earlier that morning or possibly even the evening before. I don't recall exactly.

Q This is prior to the 22nd or in the morning of the 22nd that you advised him to call Sandler & Company and to specifically request the purchase of this particular bond, this Cominco bond?

A Yes.

Q How long had you anticipated that it be held at the time that you advised him to purchase it?

A I anticipated that it would be a matter of 2 to 5 days. You might say that there w^s no exact time frame as it was a matter of just monitoring the market prices, the market fluctuations, and deciding at which point one was prepared to sell.

Q Did you advise him to wait until you contacted him before he told the broker to sell the bond?

A I don't recall if I advised him to wait. I do believe that I advised him, or told him that I would be in touch with him further, but I don’t recall whether or not he was to wait with his order to sell.

Q He indicated that he did wait until the next day.

A Yes.

Q Did you advise him to wait untii the next day, did you contact him the next day?

A I did contact him the next day and brought him up to daté on the information that I had. I don’t believe that I advised him as to whether he should wait any particular number of days.

Q If he was relying solely on your advice to purchase, which he did indicate in his testimony that he was, and if you were relying on Mr Abbiscott for your information as to. the circumstances, and if you indicated that the circumstances had changed, then is it not a logical conclusion for me to make that Mr Abbiscott contacted you to advise you that the circumstances had changed and that the bond was not going to go up in price?

A No, as a matter of fact I believe it was Mr Grice from Sandler’s office who brought me up to date with the information that the circumstances had changed and that probably there would be no increase in the value of the bonds.

Q When was this?

A I don’t recall the date exactly, but I am almost sure it was on December 23rd.

Q This would have been the following day?

A It would have been that day, yes.

Q So your original plan had been to buy on the 22nd, hold a few days and sell; but Mr Grice called you the next day and told you that the circumstances had changed that it wasn’t expected to go up in price. You then called Mr Tyrala and advised him that the circumstances had changed, and that it would be propitious to sell, it would be advantageous, or advisable to sell.

A I think everything that you have said is true except for the possibility that Mr Grice did not call me, I probably called him to ask what the market price of the bonds was at the time, and at that point having been told that there was no increase, possibly even a decrease, I questioned the strategy of holding longer, and I was told by him that he felt that there would not be an increase in price because of the way that his office was handling the matter.

Q What exactly were those circumstances that led to the change in the belief that Cominco bonds were going to rise after this ‘flurry’ of activity? A The original belief was that there would be a great demand on the market for the bonds, thereby pushing up the price, subsequently I was advised that Sandler’s office was actually selling from their own, from their own inventory of bonds, and therefore the general market was not going to be affected.

THE CHAIRMAN: Who advised him of that Mr Kerr?

WITNESS: Mr Grice at Mr Sandler’s office advised me of that I guess on December 23rd.

BY MR KERR:

Q After you had called him to monitor the market, so to speak?

A Yes.

Q You have had a number of other clients that you advised also to purchase Cominco bonds, didn’t you?

A Yes.

Q How many would you Say, in excess of a dozen?

A Oh no, possibly four or five (4-5). I don’t recall now who.

Counsel for the respondent called as a witness Mr Stephen Sandler, a director of Sandler, and also administrative head of all trading in that firm. Through Mr Sandler, counsel introduced a copy of the “new client application form” of Tyrala with Sandler, which was undated but indicated the reference had been from “Ken Ceresne” (Exhibit R-1); also the internal Sandler “Buy” order for the Tyrala transaction time stamped 8:48 am December 22, 1975 (Exhibit R-2) and the internal Sandler “Sell” order time stamped 10:33 am the same day (Exhibit R-3). The spaces reserved for “Buy” and “Sell” instructions on Exhibit R-1 were both ticked off, indicating some form of such discussion with the agent who had completed the form.

The information provided to the Board by the witness in connection with a question about Exhibit R-1 was:

There is no description as to what it was. But you are supposed to put down what the initial order is, buy xyz, or sell xyz. In this case they are ticked “buy” and “sell” with no description of what he was supposed to buy and sell, so I am not sure exactly what it means. Maybe he took a buy order and a sell order at the same time.

And with respect to Exhibits A-1 and A-2, R-2 and R-3, the following series of questions and answers deal with the relevance of the dates and the time stamps:

Q . . . And looking at the time stamp on the ‘BUY’ can you tell when the buy order was actually processed by Sandler and Co Limited?

A Not processed, the purchase was 8:48 AM on December 22, 1975, that is the time of execution.

Q Would he have received his instructions previous to that?

A He would have had to, otherwise he couldn’t execute it.

Q Taking a look at the ‘SELL’ order, can you tell when the sell order was executed?

‘A The ‘SELL’ order was executed 10:33 AM December 22, 1975.

Q Would the registered representative have executed the ‘SELL’ order prior

to having received instructions to do so?

A He is not allowed to do so.

Q Just a point of clarification. Looking at Exhibits A-1 and A-2 these are, if you will recall, the documents that were introduced as a confirmation, it (Exhibit A-2) indicates the trade date of the sale which was the 23rd as opposed to the 22nd which the ticket indicates (Exhibit R-3).

A It doesn’t indicate that the trade date was the 23rd, it indicates the processing date. In most cases that would be the trade date, but if you look under the description of the security that was sold, it says “as of December 22, 1975’’, that would be the trade date.

Q Why would it be processed on the 23rd?

A I could have been rejected by IBM because of a coding error, or it could have been taken down too late for processing, or it could have been forgotten on somebody’s desk. Usually it is just a technicality, usually a processing error is the most common.

Commenting on the brokerage operation itself as it had relevance to this appeal, it was noted:

Q During December of 1975 Mr Sandler, did N L Sandler & Co have any Cominco bonds in its inventory?

A At the end of the day? Are you talking from minute to minute or on what basis?

Q At the end of a close of any particular day’s trading.

A At the end of the day’s trading, did we own them, were we net-long bonds, is that what you are asking?

Q Would you explain what are net long bonds?

A Were we long bonds, did we own bonds that is being long bonds, as opposed to being flat or short bonds.

Q Did you own bonds?

A At the end of each trading day during December we did not own any Cominco bonds.

Q Did you, in December of 1975, did N L Sandler & Co ever buy any Cominco bonds from the bond market, any of the other dealers in the inter-dealer network that comprises the market?

A Not to the best of my knowledge. We never purchased any Cominco bonds from other dealers.

Q To determine that, did you examine any documentation from N L Sandler & Co?

A I went through the trading which is a record of all trades in every day of both clients and brokers, and there were no purchases or sales to other dealers during that month.

Q Was Sandler & Co involved in any other Cominco bond transactions in December of 1975 with clients?

A For other clients.

Q Yes?

A Yes.

Q Roughly, how many?

A I don't know an exact count, but it was, I would say, 1,000 clients, maybe more.

Q Was the number of bonds in this particular transaction the size of a usual trading lot?

A If you are talking about trading a bond, in lot trading, which a lot of people do, I would say probably not.

The normal lot would be ten bonds, 25 bonds, 50 bonds, 100 bonds. When you get into the middles, under five, you go 1, 2, 3, 4, 5 bonds, when you get over 20, you probably wouldn't trade in other than multiples of 5 or 10, it becomes a broken lot.

Q This broken lot was a multiple of 26?

A Was this the trade in question, 26?

Q Yes.

A It would be strange for someone to trade 26 bonds on a trading basis.

Q Were the other transactions roughly a thousand that you mentioned, in such broken lots or odd lot amounts also?

A. Most of the transactions were in odd amounts.

Q What amounts generally?

A Twenty-six, twenty-seven, twenty-three, there were some twenty-five as well.

Q What benefit was there in using these particular amounts?

A It seemed that if you used that amount of bonds, you would get, you would produce accrued interest expenses in excess of $1,000. There is so much accrued interest per day per $1,000 of a bond. In most cases a client wanted to buy that amount of bonds, it would produce in excess of $1,000 interest.

Q Why was there such a large number of such similar transactions all with Cominco bonds, all with amounts that would produce roughly a thousand dollars of accrued interest?

A The majority, probably in excess of 90%, were referrals from accountants and lawyers, and a client would call in and ask for a salesman, tell us that that is what the accountant advised him to do.

By agreement between counsel for the Minister and the agent for the appellant, copies of Cominco bond documents were entered as Exhibits R-4, R-5 and R-6.

Argument

The position of the agent for the appellant came down to:

—“. . . Mr Tyrala was not knowledgeable in the trading of the bond market.”

_“. he was simply following the advice he received”

—. . the purchase of the . . . bonds . . . was done to create a profit”

—“. . . as such he should be entitled to whatever benefits are forthcoming from the transaction itself.”

—. . it is not our contention that it (Cominco) was obliged ‘to pay interest to Mr Tyrala’, it is only our contention that Mr Tyrala was obliged to pay interest to the previous holder of the bonds, and the subsequent holder of the bonds to Mr Tyrala was to pay the interest to him.”

—. . the confirmations of purchases and sales are considered to be the vouchers for the fact that delivery could have been taken or made if the purchaser involved in the transaction had held the security long enough . . .” fact that there were separate purchase and sale orders would indicate there was a purchase.”

. . . ‘‘physical delivery is not really part of the transaction . . .

.

‘‘the

—“I submit that the income that Mr Tyrala had was income to him in effect for the taxation year 1975 since he made his sale in 1975. And the interest income became receivable to him from the person to whom the bonds were sold. Likewise the expense was in 1975, expense to him, an actual expense just as the income was an actual income even though he did not receive the bonds for the reasons already mentioned.”

The argument of counsel for the respondent may be summarized as follows:

—. . . (certain relevant) provisions of Exhibits R-5 and R-6 which relate to the bonds are:

‘‘This debenture may only be transferred upon compliance with the conditions prescribed . . . by instrument in writing in form and execution Satisfactory to the trustee . . .’

“. . . ‘Coupon debentures shall pass by delivery unless so registered (in the Cominco Registry).

. . . ‘A fully registered debenture may only be transferred . . . in writing . . .’

■;—It was a mere purchase and a mere sale, but never was there, . . . any evidence to indicate that somebody had actually executed the transfer which could then have been presented; and was presented, to the transfer agent so that notice would be given to the debtor that the taxpayer had now become the owner of the chose in action, the owner of the debt and entitled to interest.

. . . if, in fact, what was to be purchased was a fully registered bond, then . . . the evidence disclosed that there never was an assignment of any fully registered bond to the taxpayer, and hence the taxpayer was never entitled to demand a payment from Cominco of any amount as interest.

—. . . The Board should find as a fact that at no time was the appellant ever registered in the registry, and at no time did the appellant ever receive in his possession the bond or coupon, and hence it could not be said that the appellant was a person entitled to interest.

As support for the position of the Minister, counsel referred the Board to the following: Conveyancing and Law of Property Act, pages 801-802; Fraser & Stewart, Company Law of Canada, pp. 395- 396; Halsbury’s Laws of England, 4th ed., vol 6, pp 7-9; Fraser’s Handbook on Canadian Company Law, 6th ed (1975) pp 242-245; Canadian Encyclopedic Digest Ont, 6th ed, vol 6—pp 36-181 to 36-182 & pp 36- 191 to 36-192, vol 4—pp 25-11 to 25-13; Will ingale v International Commercial Bank Lid, [1977] 2 All ER 618; Inland Revenue Commissioners v Paget, Paget v Inland Revenue Commissioners, [1938] 1 All ER 392; MNR v Cox Estate, [1971] SCR 817; [1971] CTC 227; 71 DTC 5150; Smythe et al v MNR, [1970] SCR 64; [1969] CTC 558; 69 DTC 5361.

Findings

The Board points out that whether the appellant was knowledgeable in the bond market, following advice, or attempting to create a profit are not considerations which in themselves lead to the conclusion that the appellant should be entitled to the benefits claimed. It does, however, tax one’s imagination to contemplate the intricacies of the taxpayer’s profit-making scheme as described by Mr Ceresne. He did not consider of primary importance the potential for the tax benefit which Tyrala is nevertheless claiming now, and which seemed to be the main force behind the “flurry” of activity surrounding the Cominco bonds. These bonds were already selling at a discount, on their own merits, but their attractiveness merely for the alleged advantage to other apparently less sophisticated purchasers (perhaps $500 in a 50% taxable income bracket) was going to somehow materially and dramatically increase their value. It would take an accomplished and active market analyst and trader to discern therein the latent potential for gain.

On the point at issue in this appeal, while Mr Tyrala may have been obliged to make allowance for accrued interest in order to bring about the transaction, what he was obliged to pay or expected to receive was not interest. The “Buy” and “Sell” orders submitted by the appellant as Exhibits A-1 and A-2 (his only evidence) are at best a purchase and a sale by him (and the Board is not determining that they were even those in fact), and not synonymous with an assignment or transfer. The amounts of $1,061.28 respectively charged to the trading account of Tyrala on December 22, 1975 and credited to his account on December 23, 1975, were not on those dates “interest”. They represented nothing more than the rights to interest when and if due and payable at a later date. They therefore have no application or utility in the preparation of the appellant’s 1975 income tax returns directly under paragraph 12(1)(c) as income, or under paragraph 20(1 )(c) as a deduction. (The Board makes reference to paragraph 20(1)(c) since it was difficult to determine whether or not the agent for the appellant was basing his argument partially on that section). Amounts of income arising legitimately from the application of subsection 20(14) of the Act might properly be treated as having been received and eligible for the deduction under section 110.1. In the instant case, no such legitimate application can be made since there was no assignment or transfer bringing into play that section.

The determination that there was no assignment or transfer is based on the clear requirements outlined by the legislation and case law in the careful and professional presentation on behalf of the Minister, as these terms should be applied for income tax purposes. The specific clauses in the Cominco bond instruments themselves regarding “transfer” or “assignment” would not necessarily be determinative of the point for income tax purposes, whether they had been fulfilled or not, since they are basically for the protection and the direction of Cominco itself. Entitlement to the application of the provisions respecting “accrued interest” under subsection 20(14), does not constitute and transform the amount involved to “interest received or receivable”, unless and until there has been “an assignment or other transfer”. The wording of the section also leaves grave doubts that it could be invoked for relief by any taxpayer other than the specific holder in due course of the security on the date interest became due and payable for the whole period, making him thereby “entitled to interest”.

The Board therefore finds that the appellant did not have any bonds registered in his name, nor did he obtain delivery of any bonds, thereby through assignment or transfer giving him entitlement to interest. The Board also finds that the amounts of $1,061.28 charged and credited to the appellant’s trading account at Sandler, even if considered “received” or “paid”, were not received or paid as interest.

Decision

The appeal is dismissed.

Appeal dismissed.