Pollock (J.A.) v. Canada, [1994] 2 CTC 385

Hugessen J.A. (Robertson J.A. and Gray D.J. concurring):—The appellant appeals against two judgments (supported by a single set of reasons) rendered by McNair, J. in the Trial Division ([1990] 1 C.T.C. 196, 90 D.T.C. 6142). Those judgments dismissed the appellant's appeals against the Minister’s reassessment of his income tax for the years 1979 and 1980. The issue in each year is the characterization by the Minister as business income of the sums of $117,234 for 1979 and $560,738 for 1980; those sums, according to the Minister, are the profit realized by the appellant on the disposition of shares in petroleum exploration companies in those years.

The facts for our purposes can be very shortly stated. The appellant is a mining engineer with extensive experience in exploration and development in natural resources in Canada and the United States. During the years in question he was president, director and a promoter (but not a “stock promoter") of three “junior” petroleum exploration companies, Warren Explorations Ltd. ("Warren"), Cane Consolidated Explorations Ltd. ("Cane") and Independence Petroleums Inc. ("Independence"); he was also field supervisor for a fourth such company, Jorex Ltd. ("Jorex"). The appellant received only a relatively modest remuneration for his work with the companies but was, in addition, given substantial employee stock options (and sometimes "promoters warrants" which seem in effect indistinguishable from options) in each of them. In some cases, he also received “bonus” shares but they give rise to no issue herein.

In 1979 and 1980, the appellant exercised a large number of his employee stock options or warrants in the companies. This, of course, triggered a taxable benefit on the difference between the option price and the market value of the shares at the time of exercise of the option as a deemed income from employment in accordance with the provisions of paragraph 7(1 )(a) of the Act:

7(1) Subject to subsection (1.1), where a corporation has agreed to sell or issue shares of the capital stock of the corporation or of a corporation with which it does not deal at arm's length to an employee of the corporation or of a corporation with which it does not deal at arm's length,

(a) if the employee has acquired shares under the agreement, a benefit equal to the amount by which the value of the shares at the time he acquired them exceeds the amount paid or to be paid to the corporation therefor by him shall be deemed to have been received by the employee by virtue of his employment in the taxation year in which he acquired the shares;

The amount of such employee stock option income was considerable but is not now in dispute between the parties.

In addition to the shares acquired by the appellant under his option agreements he also acquired other shares in the companies in question on the open market or by other means, although the amounts so acquired in respect of all the companies other than Independence were comparatively minor. He disposed of large numbers of shares, both those acquired by options and those acquired otherwise, in numerous transactions over the two taxation years in question. The following sets out in tabular form the numbers of shares found by the trial judge to have been acquired by the appellant through options and the numbers found to have been disposed of in each company:

Warren

		Shares
Stock options exercised		670,000
Dispositions	1979	458,000
	1980	198,500
Issued share capital		6,000,000
Cane
		Shares
Promoters warrants exercised		130,000
Stock options exercised		300,000
Dispositions	1979	105,000
	1980	430,500
Issued share capital		2,000,000
Jorex
		Shares
Stock options exercised		70,500
Dispositions	1979	5,000
	1980	55,000
Independence
		Shares
Stock options exercised		15,000
Dispositions	1980	139,200
Issued share capital		1,000,500

In his tax returns for 1979 and 1980, the gains from these dispositions were treated by the appellant as capital gains, the amount thereof, in practical terms, being the difference between the market value at the date of acquisition of the shares and the price realized upon disposition. Where, as was the case in the majority of the transactions, the shares had been acquired through the exercise of an option, the deemed remuneration under paragraph 7(1 )(a) (i.e. the difference between the option price and the market value at the date of exercise) was added to the option price in the calculation of the “adjusted cost base” in accordance with paragraph 53(1 )(j):

53(1) In computing the adjusted cost base to a taxpayer of property at any time, there shall be added to the cost to him of the property such of the following amounts in respect of the property as are applicable:

(j) where the property is a share in respect of the acquisition of which a benefit was deemed by section 7 to have been received by the taxpayer in any taxation year ending after 1971 and commencing before that time the amount of the benefit so deemed to have been received.

1 The specific figures were not brought out for us by counsel but a document in the record indicates that Revenue Canada took the view that they amounted to $275,500 in 1979 and $232,850 in 1980. (Appeal Book, Common Appendix, Vol. 2, page 235.)

By notices of reassessment, the Minister disallowed the appellant’s characterization of the sums in issue as capital gains and assessed them as business income resulting from an adventure in the nature of trade. As previously indicated, the amounts involved represent the difference between the market value at the date of acquisition and the sale price, and amount for 1979 to $117,234.37 and for 1980 to $560,738.33.

McNair J. dismissed the appellant's appeals. While finding that some of the assumptions made by the Minister, whether in the pleadings or the voluminous correspondence engaged in by the parties, had been destroyed by the appellant, he went on to find that "the other facts of the case support the conclusion that the plaintiff was in fact engaged in an adventure in the nature of trade". In particular, he found that the multiplicity and frequency of transactions indicated that they were of a "business nature". He further found that the appellant’s conduct was not typical of employees receiving stock options and that his acquisition of shares on the open market was inconsistent with his avowed intent to dispose of the optioned shares as quickly as possible in order to "lock in" the section 7 benefit.

As I understand the appellant's argument before us, it boils down to an assertion that the trial judge erred in four respects relating to:

1. the effect of his finding that some of the Minister’s assumptions had been successfully rebutted by the appellant;

2. the inconsistency in finding that transactions could give rise both to a tax under paragraph 7(1)(a) and to business income;

3. the failure to properly understand and apply the law as it applies to capital gains in share transactions; and

4. the special position with regard to the shares of Independence.

I shall deal with each of these in turn.

1. The effect of the finding that some of the Minister's assumptions had been successfully rebutted by the appellant

In his pleadings in the action in the Trial Division, the Minister asserted as follows (Appeal Book, page 13 ):

8. In reassessing the plaintiff on the basis that the gain on the sale of certain shares constituted income from an adventure or concern in the nature of trade, the Minister of National Revenue relied upon the following findings or assumptions of fact:

(a) the facts hereinbefore admitted or pleaded;

(b) during 1979 and 1980, the appellant bought and sold shares (the "shares") at a profit in the following companies, inter alia:

Jorex Ltd. ("Jorex");

Warren Explorations Ltd. ("Warren");

Cane Consolidated Explorations Ltd. ("Cane");

Jonpol Explorations Ltd. ("Jonpol");

Independence Petroleums Ltd. ("Independence");

(c) at all material times, the plaintiff was a field supervisor with Jorex and was the president of Warren, Cane, Jonpol and Independence. The plaintiff was also a promoter of shares of one or more of these corporations;

(d) in the 1979 and 1980 taxation years, the plaintiff realized gains of $117,234.37 and $560,738.33 respectively from the disposition of the shares;

(e) the possibility of reselling the shares at a profit was an operating motivation for the acquisition of the shares.

2 Court File A-76-90. The identical pleading is found at pages 8-9 of the Appeal Book in Court File A-75-90.

The trial judge found as a fact that the assumption in the second sentence of paragraph 8(c) was inaccurate in that the appellant was not what is commonly referred to as a "stock promoter" but was a promoter of Cane, Independence and Warren in the sense that he had taken the initiative in founding, organizing or reorganizing the business of those companies.

The trial judge also found that two other assumptions which were not pleaded but had been advanced by the Minister in the course of the correspondence surrounding the reassessment, namely that the appellant had used insider knowledge in his dealings in the shares and that he had indulged in "short" selling, had also been successfully rebutted.

It is significant, in my view, that the trial judge did not find that the assumption in paragraph 8(e) relating to the operating motivation for the appellant's acquisition of the shares had been destroyed.

As I understand him, appellant’s counsel takes the position that where some of the Minister’s assumptions are successfully demolished by a taxpayer, the Minister's position must necessarily fail unless he can show that the assumption or assumptions that remain are in and of themselves enough to support the assessment.

In my view, this contention is wrong and is founded upon a misapprehension as to the respective roles of pleadings in general and the assumptions made by the Minister in taxation cases in particular.

It is, of course, the general rule that every party to litigation in this Court must plead the facts upon which he relies in such a way as to put his opponent fairly on notice of the case he has to meet. Where a party's pleadings are so inadequate as to disclose no case at all he runs the risk of having them struck out and of losing for that reason. That rule is quite irrelevant here. There is no question in the present case of the Minister’s pleadings being inadequate or of the appellant not knowing clearly and beyond any possibility of doubt the basis upon which he was reassessed. That basis was and is that the appellant's dealings in shares of the companies in question constituted for him an adventure in the nature of trade so as to make the profits therefrom taxable as income.

The special position of the assumptions made by the Minister in taxation litigation is another matter altogether. It is founded on the very nature of a selfreporting and self-assessing system in which the authorities are obliged to rely, as a rule, on the disclosures made to them by the taxpayer himself as to facts and matters which are peculiarly within his own knowledge. When assessing, the Minister may have to assume certain matters to be different from or additions to what the taxpayer has disclosed. While the Minister's assumptions, if any, are generally made in the pleadings, that is not always the case and we have seen, in this very record, an example of the taxpayer taking pains to demolish assumptions which the Minister had not pleaded. Where pleaded, however, assumptions have the effect of reversing the burden of proof and of casting on the taxpayer the onus of disproving that which the Minister has assumed. Unpleaded assumptions, of course, cannot have that effect and are therefore, in my view, of no consequence to us here.

The burden cast on the taxpayer by assumptions made in the pleadings is by no means an unfair one: the taxpayer, as plaintiff, is contesting an assessment made in relation to his own affairs and he is the person in the best position to produce relevant evidence to show what the facts really were.

Where, however, the Minister has pleaded no assumptions, or where some or all of the pleaded assumptions have been successfully rebutted, it remains open to the Minister, as defendant, to establish the correctness of his assessment if he can. In undertaking this task, the Minister bears the ordinary burden of any party to a lawsuit, namely to prove the facts which support his position unless those facts have already been put in evidence by his opponent. This is settled law.

Accordingly, in my view, McNair J. was entirely right to ask himself, as he did, ''whether the facts of the case support the conclusion that the plaintiff was in fact engaged in an adventure in the nature of trade?". In answering that question he was entitled, and indeed obliged, to rely on those assumptions which had not been disproved and on the evidence as a whole.

2. The inconsistency in a finding that transactions could give rise both to a tax under paragraph 7(1 )(a) and to business income

The appellant's argument on this head is based on the necessity, well known to tax law, of distinguishing clearly between different sources of income. A single transaction cannot, at one and the same time, constitute two separate sources of income for a taxpayer. Thus, argues the appellant, the taxation, as income from employment, of the benefit received by him from the exercise of the options in accordance with the terms of paragraph 7(1 )(a) precludes him being taxed on income from a business in respect of the shares so acquired. Reference is, in particular, made to the definition of business in subsection 248(1) and to the specific exclusion therefrom of employment:

248(1) In this Act. . ."business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c). an adventure or concern in the nature of trade but does not include an office or employment.

As a subsidiary argument, the appellant submits that, since the Minister is only seeking to tax him on the difference between the market value of the shares at the date of exercise of the options and the price realized on disposition, this can only be because the Minister is calculating the "adjusted cost base” in virtue of paragraph 53(1 )(j). Since, however, the latter paragraph is only applicable to the calculation of capital gains the Minister must have conceded that appellant's gains are in fact of a capital nature.

Both branches of the argument seem to me to be equally without merit. While it is perfectly true that one transaction cannot constitute for a taxpayer two separate sources of income, this is clearly not what the Minister is seeking to do. The tax under paragraph 7(1)(a), upon income from employment, is triggered by the exercise of employee stock options, and both the timing and extent of the remuneration deemed to have been received are fixed by that event. That, however, does nothing to prevent the exercise of the options constituting the starting point for another transaction which concludes with the disposition of the shares and which may, in its turn, constitute another source of income. Indeed, the appellant concedes as much for he is seeking to have the proceeds of the sale of the shares acquired by the exercise of employee stock options taxed as capital gains, a source entirely different from and unrelated to the employment remuneration deemed received on the exercise of the options. If that disposition can trigger a Capital gain it can just as easily trigger an income from a business. The point, of course, is that the exercise of the options, while it is the closing reference mark for the calculation of a deemed remuneration from employment, may easily be the opening reference mark for some other source of income .

3 See M.N.R.v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184 (Ex. Ct.); Smythe v. M.N.R., [1967] C.T.C. 498, 67 D.T.C. 5334 (Ex. Ct.); aff'd [1970] S.C.R. 64, [1969] C.T.C. 558, 69 D.T.C. 5361; Craddock v. M.N.R., [1968] C.T.C. 379, 68 D.T.C. 5254 (Ex. Ct.); aff'd [1969] C.T.C. 566, 69 D.T.C. 5369 (S.C.C.); Brewster v. The Queen, [1976] C.T.C. 107, 76 D.T.C. 6046 (F.C.T.D.); del Valle v. M.N.R., [1986] 1 C.T.C. 2288, 86 D.T.C. 1235 (T.C.C.); Wise v. The Queen, [1986] 1 C.T.C. 169, 86 D.T.C. 6023 (F.C.A.); Sani Sport Inc. v. The Queen, [1987] 1 C.T.C. 411, 87 D.T.C. 5253 (F.C.T.D.); Baggs v. M.N.R., [1990] 1 C.T.C. 2391, 90 D.T.C. 1296 (T.C.C.); The Queen v. Leung, [1993] 2 C.T.C. 284, 93 D.T.C. 5467 (F.C.T.D.).

4 A simple example would be where shares acquired under employee stock options paid a dividend: clearly such dividend would be income from property and not income from employment.

The subsidiary argument is equally unfounded. Paragraph 53(1 )(i) is quite irrelevant to the taxation of income from business. That income is, as decreed by subsection 9(1), the taxpayer's profit from his business. The calculation of profit is made in accordance with ordinary commercial and accounting principles. In my view, it has not been shown that the Minister was wrong in calculating the profit from the sale of shares acquired on option so as to take account not only of the option price but also of the deemed remuneration received under section 7. In any event, even if the Minister were wrong, his error can only work to the taxpayer's benefit and the latter can hardly be heard to complain because he has not been subject to double taxation.

3. The failure to properly understand and apply the law as it applies to capital gains in share transactions

The appellant's submission in this connection starts from the proposition that the acquisition of shares is "presumptively an investment". It is based on the decision of the Supreme Court of Canada in Irrigation Industries Ltd. v. M.N.R.,

[1962] S.C.R. 346, [1962] C.T.C. 215, 62 D.T.C. 1131, and in particular on the following paragraph from the majority reasons of Martland J. at page 352 (C.T.C. 221 (D.T.C. 1133-34)):

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.

This passage needs to be read with care and in context. In my view, it does not support any general proposition that the acquisition of corporate shares is presumed to be for capital rather than for income account. The paragraph occurs in the course of Martland J.'s discussion of one of the well-known tests for determining whether there has been an adventure in the nature of trade, namely “whether the nature and quantity of the subject-matter of the transaction may 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". In the passage quoted, Martland J. was discussing a number of reported cases where the very nature of the property in question was such as to exclude any practical likelihood of its purchase being a simple investment. He then went on to indicate that corporate shares do not fall into that category. That, however, is a very different thing from saying that corporate shares are presumptively an investment. In my view, there is no presumption one way or the other. The Irrigation Industries case, supra, was dealt with, at some length, by the trial judge and in my opinion correctly distinguished. This is what he said at page 205-06 (D.T.C. 6148):

Martland J., writing for the majority, posed the issue thus at page 349 (C.T.C. 217-18 (D.T.C. 1132)):

The issue in this appeal is as to whether an isolated purchase of shares from the treasury of a corporation and subsequent sale thereof at a profit, not being a part of the business carried on by the purchaser of the shares, or in any way related to it, constitutes an adventure in the nature of trade so as to render such profit liable to income tax.

The learned judge resolved it thus at page 351 (C.T.C. 219, D.T.C. 1133):

I cannot agree that the question as to whether or not an isolated transaction in securities is to constitute an adventure in the nature of trade can be determined solely upon that basis. In my opinion, a person who puts money into a business enterprise by the purchase of the shares of a company on an isolated occasion, and not as a part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at that time, he did not intend to hold the shares indefinitely, but intended, if possible, to sell them at a profit as soon as he reasonably could. I think that there must be clearer indications of "trade" than this before it can be said that there has been an adventure in the nature of trade.

In my opinion, the facts of the present case evince sufficient indications of trade to distinguish it from Irrigation Industries. The most salient disparity, of course, is the number of transactions engaged in by the plaintiff. In Irrigation Industries, the Court had to consider an isolated purchase and subsequent sale of shares of one company. In the present case, I am confronted with numerous transactions involving the shares of four companies extending over a period of several years. I give some credence to the plaintiff's testimony that many of his options were exercised in stages to provide necessary financing for the corporations and his explanation for the frequency of dispositions, namely, that the state of the market at times made it impossible for his brokers to arrange for immediate sales of large blocks of shares. Nevertheless, the conclusion that the taxpayer engaged in a multiplicity of share transactions of a business nature is irrefutable.

For my part, I can find no fault in the trial judge’s treatment of this matter.

The appellant also sought to draw some comfort from the trial judge's statement in the above quoted passage that he gave "some credence" to his explanation for the manner of exercise of the options and the subsequent sale of the shares. I can only think that the trial judge was being polite for it is abundantly clear from the following passage that the credence given was a good deal less than total (Appeal Book, page 37):

Another crucial factor is the plaintiff's acquisition of shares on the open market and from third parties. The plaintiff was cross-examined extensively on this point and, although unable to recall specific dates and numbers, did admit to several purchases on the open market or from friends. While those may have been somewhat limited in number and quantity, the fact that he made such purchases is inconsistent with his testimony that his main focus of concern was the disposition of shares acquired under option as soon as possible in order to lock in his section 7 benefit. When asked in reexamination if he could recall what impelled him to buy shares from time to time, he answered:

A. Not really. Probably to make money, I only bought several on four or five occasions.

The trial judge is here dealing with the critical question of whether the appellant's dispositions were made with a view to locking in his section 7 benefit or were being timed so as to achieve the maximum realization. On that point he might well have also quoted the following passage from the appellant’s cross- examination (Transcript, Volume I, page 105):

Q. And after you received the certificate what did you do?

A. I would deliver it to the brokers or to my bank, keep it in my desk sometimes for a while. Sometimes the certificate sat in my office in Toronto if I was out of town.

Q. And then you delivered it to the brokers; were there any instructions that went along with that?

A. Well, just put it in my account.

Q. And that you would give instructions later?

A. Yes.

Q. What factors influenced your decisions to retain the shares that you had received or to sell them immediately?

À. It was a judgment on what I thought the price of the stock would do.

The trial judge concluded his reasons as follows at page 207 (D.T.C. 6149): Based on the evidence in its entirety, I find that the plaintiff's share transactions were sufficiently akin to those of an ordinary trader in securities as to constitute an adventure in the nature of trade with a view to profit.

In my view, that conclusion on what was essentially a question of fact was open to him on the evidence and has not been demonstrated to be based on any error of law.

4. The special position with regard to the shares of Independence

Appellant's final point seeks to distinguish the position with regard to the shares of Independence from that of the other three companies. It is based in part on the fact that a much smaller proportion of the Independence shares (15,000 out of a total of 164,200) were acquired through employee stock options; it is also based on the appellant's evidence to the effect that he sold most of his Independence shares because of his withdrawal from the management of the company following a falling out with the other principals.

While this argument might have been persuasive if the appellant had dealt only with the shares of Independence in the years in question, it clearly did not persuade the trial judge in the context of the appellant's numerous dealings with massive quantities of shares in the other three companies. In addition, the trial judge had noted that among the shares of Independence disposed of by the appellant were 5,000 to 6,000 which he had contributed to a “stabilization fund" upon the formation of the company; that in itself is a factor which is surely more indicative of trading than of investment.

In the circumstances, I am quite unable to say that the trial judge was wrong to include the Independence shares in the appellant's adventure in the nature of trade and to confirm the Minister’s assessment.

Conclusion

I would dismiss the appeals with costs but with one set of costs only.

Appeals dismissed.