20 July 1989 Internal T.I. 73799 F - Sale of Securities

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.

Subject: 24(1) Sale of Securities

We are writing in reply to your memorandum dated March 31, 1898 concerning certain securities transactions of the 24(1) (the "Bank") examined in the course of your audit of this taxpayer.

You advise that the Bank realized gains on the disposition of certain of its investments as set out below, and that the Bank reported these as capital gains.

24(1)

24(1)

It is our view that, while it is possible for a financial institution such as a bank to realize a gain of a capital nature on the disposal of debt or equity securities, the usual result will be a gain on income account on the basis that transactions insecurities from part of the ordinary course of a bank's business.  Examples of potential capital treatment to a bank would be in respect of gains on shares acquired to assist in thwarting a hostile takeover bid which threatened a long standing business relationship, or as in the case of Canada Permanent Mortgage Corporation v. MNR, 71 DTC 5409 (FCTD), where the shares were acquired over a period of years as part of the taxpayer's assimilation of its smaller competitors and were held as investments over a lengthy period of time.  Having reviewed the material you provided, including the taxpayer's representations, we see no basis for concluding that the Bank's securities transactions were of such exceptional nature and accordingly we agree with your proposal to assess on income account.

This general position finds support particularly through the case of Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore, 1940 4 ALL E.R., 87 as follows:

     "... the purchase and sale of shares and securities are as much a part of the (Bank's) business as receiving deposits from clients and paying them are, and therefore, the profits which arise from the former transactions are as much business profits as the profits arising form the latter transactions are ..."

Later, in Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore, {1949}, A.C. 1055, the Privy Council stated:

     "... their Lordships do not wish to give any support to the contention that, in order to render taxable profits realized on sales of investments in such a case as that before them, it is necessary to establish that the taxpayer has been carrying on what may be called a separate business either of buying or selling investments or of merely realizing them.

     The principle to be applied in such a case is now well-settled.  It was admirably stated in Californian Copper Syndicate, Ltd. v. Harris (Surveyor of Taxes), and the statement has been more than once approved both in the House of Lords and in the Judicial Committee;  see, for example, Taxes Comr. v. Melbourne Trusts, Ltd. at p. 1010.  Some dicta which appear to support the view that it is necessary to prove that the taxpayer has carried on a separate or severable business of buying and selling investments with a view to profit in order to establish that profits made on the sale of investments are taxable for example, the dicta in Inland Revenue Comrs. v. Scottish Automobile & General Insurance co. at pp. 388, 389, cannot now be relied on.  It is well established that, to cite the exact words used in the Californian Copper case at p.166;

     "... enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business ..."

In Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946-47) 73 CLR 604, the Australian High Court held that:

     "... an insurance company, whether a mutual insurance company or not, is undoubtedly carrying on an insurance business and the investment of its funds is as much a part of that business as the collection of the premiums... In Konstam, "The Law of Income Tax", 8th Edn., p. 126, it is stated that the buying and selling of investments is a necessity of insurance business; and where an insurance company in the course of its trade realized an investment at a larger price than was paid for it, the difference to be reckoned among is profits; conversely any loss is to be deducted.  This view is in line with that of the Privy Council in the case of bank in Punjab Co-operative Bank Ltd. v. Income Tax Commissioners.  In our opinion, company and that of a bank in this respect.  The acquisition of an investment with a view to producing a yield of composite character, the effective yield comprising the actual interest less any diminution or plus any increase in the capital value of the securities.

     Such an acquisition and subsequent realization is a normal step in carrying on the insurance business, or in other words an act done in what is truly the carrying on of the business of the Society."

The Punjab and Colonial Mutual Life cases were also cited in what would appear to be the leading Canadian case on the subject, namely Canada Permanent Mortgage Corporation, to which we referred earlier.  We note that the Bank, in its representations to you, had argued that the Canada Permanent decision supports its position.  However, Heald, J., in deciding that Canada Permanent's gains on securities were on account of capital distinguished a taxpayer like Canada Permanent from banks (and insurance companies) which he, in fact, felt should ordinarily treat gains on the realization of securities on income account. 

In this connection, at page 5420 Justice Heald states:

     "The respondent relies on the Privy Council case of Punjab Co-operative Bank Limited v. Commissioner of Income Tax, {1940} A.C. 1055 at pp. 1070-73.  In that case, the appellant was a bank and the nature of its business was quite different from that of the appellant."

We would also note the following comment by Justice Heald at page 5421, made in reference to the Colonial Mutual Life case:

     "It is interesting to note, however, at pages 617-18 of that judgment, that the High Court of Australia agrees that under certain circumstances, even Insurance Companies may be able to treat realization on change of investments as capital gains."

Justice Heald then went on to quote from the Colonial Mutual Life case in order to demonstrate the point he had just made.

The first observation we would make here is that Justice Heald is clearly of the view that income treatment is the norm for such taxpayers as insurers.  The second point is that while he took the Colonial Mutual Life case as providing support for the proposition that capital treatment might still be possible, in our view that case gave no such support.  In this respect, while the passage quoted by Justice Heald from Colonial Mutual Life does indeed reflect a discussion of arguments supporting capital treatment in certain circumstances, the discussion in that case continued and in fact refuted those arguments in the immediately following sentence, i.e.

     "But the insistence by Lord Shaw upon the correctness of the whole of the series of propositions enunciated in Northern Assurance Company v. Russell, supra, after he had presumably read the remarks of Hamilton, J., in the court below, and the criticism by the Privy Council of some dicta in Inland Revenue Commissioners v. Scottish Automobile & General Insurance Company in Punjab Co-operative Bank Amritsar v. Income Tax Commissioner Lahore, coupled with the willingness of the Inspector of Taxes in the Royal Insurance Company v. Stephen (supra) to allow a loss on realization amounting to 754,000 pounds as a deduction in computing its profits assessable under Case 1 tends to show that the sounder view is that profits and losses on the realization of investments of the funds of an insurance company should usually be taken into account in the determination of profits and gains of the business."

It should be remembered here that the Australian High Court saw no distinction between an insurance company and a bank in this area.

In conclusion, it is our view that gains made by the Bank, like most, if not all, gains made by banks should be on income account.  We would note, however, that it may be possible for a bank to somehow substantiate that a particular investment is made from surplus funds or funds not required to operate its business operations.  In this regard, 24(1) in their letter of November 26, 1988 made reference to fixed and circulating capital, concepts which were considered in the Canada Permanent case.  The classification of an asset as fixed capital because it can yield dividends would arguably lead to a conclusion that gains on all securities held by the Bank should be accorded capital treatment. While we have some difficulty in accepting this, we believe, as noted earlier, Justice Heald effectively restricted his judgement from applying to banks.  We cannot see any basis for distinguishing the gains in question from other gains or losses made by a bank in the ordinary course of its business operations.

We hope this will be of assistance to you.

for Director Financial Industries DivisionRulings Directorate

cc.     Mr. E. GauthierDirectorSpecialty Audits Division