7 February 2001 External T.I. 2001-0066435 - TRADING SHARES

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. Are a corporation's gains and losses from trading non-Canadian securities on a daily, monthly or bimonthly basis accorded the income treatment or the capital treatment?

2. Deduction of operating expenses

Position:

1. Question of fact; but more than likely the gains/losses are on income account.

2. Expenses must be claimed against the income source in respect of which they are incurred

Reasons:

1. IT- 479R

2. T4012, T2 Corporation income tax guide; T4037, Capital gains guide.

XXXXXXXXXX 2001-006643
S. Parnanzone, MBA,CMA
February 7, 2001

Dear XXXXXXXXXX:

Re : Shares Trading

We are replying to your letter of December 1, 2000, concerning the tax treatment of gains and losses on non-Canadian securities transactions of a corporate taxpayer.

Our understanding of the situation is as follows:

Two Canadian resident individuals intend to incorporate a company whose main business will be trading non-Canadian shares. The shareholders will advance funds to the corporation to be left with a financial advisor who will advise concerning the type of shares to be traded. The frequency of trading may vary depending on market conditions and may be daily or less frequently, monthly or bimonthly.

As you are of the view that any gain or loss on securities transactions would generally be treated as capital in nature, your question is whether such gain or loss would be treated on income account if the frequency of trading is very high, say on a daily basis.

Assuming that the corporation's gains and losses from the securities transactions are given the capital treatment, your second question is whether the corporation can deduct its operating expenses in the same manner as if it earned active business income.

Our comments

The particular circumstances in your letter on which you have asked for our views appears to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R4, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments which may be of assistance.

The tax treatment of gains and losses from trading in securities are discussed in Interpretation Bulletin IT-479R, Transactions in Securities. Whether the gains or losses are on income account or on capital account is a determination of fact. The tests that the courts have applied in making such a determination are those of "course of conduct" and "intention", which are discussed in the bulletin. As explained in paragraph 12 of this bulletin, the term "business" includes "an adventure or concern in the nature of trade", which the courts have held can include an isolated transaction in shares where the "course of conduct" and "intention" clearly indicate it to be such. In addition, paragraph 15 of the bulletin also indicates that the gains and losses made by a corporation whose prime activity is trading in securities will be considered to be on income account.

If the securities traded qualify as Canadian securities, it is possible for a taxpayer, including a corporate taxpayer, to file an election under subsection 39(4) of the Income Tax Act (the "Act") to treat all gains and losses from Canadian securities on capital account. However, as more fully discussed in IT-479R, pursuant to subsection 39(5) of the Act, this election is not available to certain taxpayers such as traders or dealers in securities. As stated in paragraph 5 of this bulletin, any corporation whose prime business activity is trading in shares or debt obligations is generally considered to be a trader or dealer in securities and is, therefore, unable to use the mentioned election. In addition, it is questionable whether the non-Canadian securities referred to in your letter qualify as "Canadian securities" as this term is defined in subsection 39(6) of the Act.

Based on the fact that the corporation in the case you described has as its sole purpose the trading in securities and based on the frequency of such trading, in our view the gains or losses would more than likely be considered on income account.

The comments that follow address your second question concerning the deduction of operating expenses. The Act contains rules with respect to the deduction of expenses. The general rule is that expenses are to be claimed against the source of income in respect of which they are incurred. For instance, an expense incurred to earn business income is claimed against income from that business source. The same could be said with respect to expenses incurred to earn income from property. The rules for the computation of business and property income are found in subdivision b of Division B of Part I of the Act and, for corporate taxpayers, are explained in the T4012, T2 Corporation Income Tax Guide.

Subdivision c of Division B of Part I of the Act contains the rules for the computation of capital gains and losses and they are discussed in the T4037, Capital Gains Guide. A capital gain is the excess of the proceeds of disposition over the total of the adjusted cost base and outlays and expenses for the purpose of making the disposition. The adjusted cost base is essentially the cost of the property plus or minus the adjustments set out in section 53 of the Act. It should also be noted that, pursuant to the general limitation of section 67 of the Act, an outlay or expense is deductible in computing income only to the extent that it is reasonable in the circumstances.

As provided for in subsection 9(3) of the Act, a capital gain or loss is not considered income or loss from property.

While you have not explained the type of amounts making up the "operating expenses", we would venture to generalize that to the extent that such expenses are incurred for the purpose of earning income from business or property (and subject to any specific restrictions in the Act) they are deductible in computing income from each such source, as explained above. However, with reference to capital gains, the expenses can only be "deducted" to the extent that they may be reflected in the adjusted cost base of the securities or are regarded as outlays or expenses of disposition.

You can find the publications mentioned above at www.ccra-adrc.gc.ca on the Internet.

We trust that the foregoing comments are of assistance.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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