Canada Permanent Mortgage Corp. v. MNR, 71 DTC 5409, [1971] CTC 694 (FCTD)

HEALD, J.:—This is an appeal from income tax assessments of the appellant for its taxation years, 1964, 1965 and 1966. For the purposes of evidence and argument the appeals were united because the three cases are one and the same in fact and in law.

The appellant objects in the three years under review to two items in the respondent’s assessments.

Item one has to do with the gains realized by the appellant in the years under review on the disposition of publicly traded shares in Canadian corporations which had been held by the appellant for fairly long periods of time. These gains were as follows :

1964 — taxation year — $ 366,327.

1965 — taxation year — 512,765.

1966 — taxation year — 1,303,604.

The appellant says that these shares were held as investments over a long period of time, that the corporation was not in the business of trading in common stocks and that the gains in question should be treated by the respondent as capital gains.

The respondent, on the other hand, says that the share transactions in question form an integral part of the appellant’s business and as such is taxable income from said business. The respondent relies on Sections 3, 4 and 139(1) (e) of the Income Tax Act.

Item two has to do with finders’ fees or commissions paid out in the years under review by the appellant to a variety of individuals and corporations who had introduced lenders of funds to the appellant. In each of the years in question, the appellant claimed as an expense in its income tax return, the amount of said finders’ fees so expended. These expense items were shown as commission on the sale of debentures and were disallowed by the respondent as follows:

For the 1964 taxation year — $224,519.47

For the 1965 taxation year — 171,783.35

For the 1966 taxation year — 217,708.19

I will deal first of all with item two.

The appellant corporation was established by special Act of the Parliament of Canada in 1899. Its incorporating statute is chapter 101 of the Statutes of Canada 1899 and empowers the corporation inter alia to carry on the business of lending money on the security of mortgages upon freehold or leasehold real estate or other immovables. The corporation is also empowered to borrow money and to receive money on deposit from the public.

Mr. Joseph William Rose, the executive vice-president of the appellant, gave evidence at the trial. His evidence was to the effect that the appellant’s business consisted of borrowing money from the public and lending it out on the security of real estate mortgages; that the company obtained this money from the public in two ways: (a) it borrowed money by issuing company debentures (usually for periods of from one to five years) ; (b) it accepted deposits from the public in savings accounts.

Mr. Rose testified that these finders’ fees were paid out to banks, lawyers, investment dealers, stock brokers, financial agents and in some of the smaller communities of Canada, to insurance agents. The object of this exercise was to attract borrowed funds.

The appellant did not keep at its head office, for the years under review, a detailed analysis of these payments but beginning in 1967, such an analysis has been kept. Mr. Rose’s evidence was that the figures for the year 1967 would be, in a general way, representative of and similar to the years under review. In 1967 there were about 400 payees covering 5,000 different payments. The evidence of Mr. Rose was that the payments for the years under review would be about the same in terms of number of payees and number of transactions.

During the years under review, the finders’ fees were paid out to those who had introduced lenders to the company (purchasers of company debentures) on the following basis:

For a 5 year investment—1% of the amount invested.

For a 4 year investment—4/5 of 1% of the amount invested. For a 3 year investment—3/5 of 1% of the amount invested. For a 2 year investment—2/5 of 1 % of the amount invested. For a 1 year investment—1/5 of 1% of the amount invested.

Mr. Rose testified that there were other years when no finders’ fees were paid, and that in still other years, one-half of the above schedule had been paid and that this was an expenditure which was directly related to the company’s need for borrowed funds and to the relative availability thereof from the investing public.

The disallowed items for finders’ fees or commissions on the sale of debentures were not the only items of this nature claimed as an expense by the appellant in the years under review.

In each of the taxation years 1964, 1965 and 1966 the appellant claimed as an expense an item entitled “Commission on loans’’. Particulars of these expense items are:

For the taxation year 1964—$463,345.78

For the taxation year 1965— 511,982.82

For the taxation year 1966— 438,945.31

These items represent expenditures to individuals and corporations as commissions or finders’ fees for loans obtained for the company, that is, to someone for obtaining a prospective mortgagor and mortgage loan for the appellant.

I think it strange that the respondent allowed commissions on loans aS an expense but disallowed commissions on the sale of debentures.

It is clear from the evidence that the appellant’s business is borrowing money from the public and then lending it out on the security of real estate mortgages. In this business, the appellant’s stock in trade is borrowed money. Surely any expense involved in acquiring the company’s stock in trade is properly deductible. The company, in the years under review, concluded that it was necessary to pay such finders’ fees in order to ensure an adequate flow of borrowed funds. One side of the appellant’s business is to obtain borrowed funds. The other side is to lend out these borrowed funds on the security of mortgages.

The debenture commissions are necessary expenses on the one side. The loan commissions are necessary expenses on the other side—that is—necessary, in the judgment of the company to ensure that all of the borrowed funds which the company has acquired can be lent out on mortgage security. And yet, the respondent disallows the debenture commissions on the one side while at the same time, allowing the loan commissions on the other side.

At the trial, I invited counsel for the respondent to explain this apparently inconsistent treatment of two expenditures, which seem to be almost identical in nature.

I think it fair to say that learned counsel frankly conceded that there was no difference in substance in these expenditures and was not able to explain the different treatment accorded these items by the Minister’s assessors.

Section 12(1) of the Income Tax Act provides as follows :

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

I am of the opinion that the debenture commissions or finders’ fees in the case at bar are expenses incurred by the appellant for the purpose of producing income from the appellant’s business within the meaning of the exception set out in Section 12(1) (a) of the Act. I am also of the opinion that the said finders’ fees are, not capital outlays within the meaning of Section 12(1) (b) of the Act. It follows, therefore, that the debenture commissions or finders’ fees are properly deductible in computing the profit from the appellant’s business in the years under review.

In the event I am in error in concluding that the said expenses come within the exception to Section 12(1) (a) of the Act, I am of the opinion that the disallowed expenses herein would be covered by Section 11(1) (cb) of the Income Tax Act which reads as follows:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(cb) an expense incurred in the year,

(i) in the course of issuing or selling shares of the capital stock of the taxpayer, or

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt), but not including any amount in respect of

(iii) a commission or bonus paid or payable to a person to whom the shares were issued or sold or from whom the money was borrowed, or for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course of issuing or selling the shares of borrowing the money, or

(iv) an amount paid or payable as or on account of the principal amount of the indebtedness incurred in the course of borrowing the money, or as or on account of interest;

This subsection operates to permit a taxpayer to deduct. expenses incurred in the course of borrowing money used by the taxpayer to earn income from his business, whether or not it is prohibited by Section 12(1) (a), (b) and (h). In the case at bar, these finders’ fees were expenses incurred by the appellant in borrowing money from the public which the appellant in turn lent out on the security of mortgages thereby earning income from its business. I also believe that the exception contained in Section 11(1) (cb) (iii) relates only to a bonus or commission paid or payable to the lender himself and therefore has no application to a situation like this where the commission is paid to divers third parties.

I would accordingly allow the appeal with respect to item two.

I turn now to a detailed consideration of item one. The only witness giving evidence was Mr. Joseph William Rose, the executive vice-president of the appellant.

Mr. Rose has been with the appellant since 1928, has served in various administrative capacities, gradually climbing the ladder of responsibility and eminence in its affairs. Since 1970 he has been the executive vice-president of the appellant and its subsidiary, Canada Permanent Trust (the appellant holds all the shares of the Trust Company excepting a fraction of 1% of the issued shares in the hands of the public as a result of the amalgamation of the Trust Company with Eastern & Chartered Trust Company in 1967).

Mr. Rose testified that the company’s business is to lend money on first mortgage security, accept deposits and issue debentures.

This is also the description of the company’s business used by The Financial Post in its Corporation Service dated June 5, 1968 and filed as Exhibit 1 by the appellant at the trial.

Mr. Rose then proceeded to describe the way in which the appellant carries on its business. He said that one way the appellant had of obtaining borrowed money was by way of deposits in savings accounts. The depositors have checking privileges and are paid interest. The appellant does not make personal loans; there are no overdraft privileges, nor do they issue letters of credit on these savings accounts.

The other way in which the appellant obtained borrowed money was by the issuance of debentures. These debentures are not secured by the hypothecation of any of the company assets and so are in reality, promissory notes. These debentures are issued for a minimum of one year and usually a maximum of five years, but in some rather isolated instances, have been issued for periods up to ten years. The debentures mature in each month in each year and can be obtained in bearer, registered, coupon registered or cumulative coupon registered form.

The appellant tendered in evidence Exhibit 2, the accuracy of which was attested to by Mr. Rose. Exhibit 2 contains a breakdown of the company’s financial structure for the years 1928 to 1966 inclusive.

I will not here reproduce Exhibit 2 in its entirety but certain of the figures and information contained therein are so revealing of the true nature of the appellant’s business as to warrant inclusion at this juncture:

Column (a) represents the capital subscribed by the appellant’s shareholders, including premiums and surplus profits in the reserve fund plus undivided profits carried forward plus inner reserves.

Column (b) represents the cost of buildings, furniture, fixtures and tenants’ improvements.

Column (c) represents the value of appellant’s shares in Canada Permanent Trust Company.

Column (d) represents the investment in the shares of Canadian companies. It is the gain on the sale of these shares in the years under review that is in issue here.

Column (e) shows appellant’s total investments.

Column (f) shows the money owed to members of the public by the appellant.

Column (g) shows the appellant’s total funds, being a total of the borrowed funds plus the shareholders’ funds.

Column (h) shows column (d) as a percentage of column (g), that is, it shows the relationship of shares of Canadian stocks as a percentage of the appellant’s total funds.

I draw the following conclusions from a perusal of Exhibit 2:

(1) From 1928 to 1966, including the years under review, the value of fixed assets plus the value of the shares in the Trust Company plus the value of all shares of stock in other Canadian companies, never exceeded the shareholders’ funds (including inner reserves), that is to say, during the entire period, the figures in column (e) never exceeded the figures in column (a).

(2) From 1928 to 1966, including the years under review, column (h) indicates that the percentage of stock in Canadian companies compared to the total funds of the company is a small percentage indeed.

In 1928 the percentage was .69, it gradually increased to a high of 5.5% in 1949 and in later years has stabilized around 3%. In the years under review, it was 3.0%; 2.9% and 2.9% respectively.

I come now to a detailed consideration of the share transactions at issue.

In the taxation year 1964, the gain on sale of shares amounted to $366,327, the particulars of which are as follows:

(a) 200 shares Canada & Dominion Sugar—for a gain of $794. These. shares were acquired by appellant as part of the assets of Montreal Loan & Mortgage which it purchased in 1946.

(b) 45,000 shares Consumers’ Gas—for a gain of $360,535. This is an old established Toronto company, has been in business for about 125 years, has gas franchises in various areas of Ontario and is considered a high-grade conservative stock. The appellant first purchased shares in Consumers’ Gas in 1910. Between 1910 and 1931 it purchased 3,847 shares. Between 1910 and 1935 it sold 2,441 shares so that in 1935 it still held 1,406 shares. Between 1944 and 1952, by acquisition of other companies whose investment portfolios also included Consumers’ Gas, the appellant’s holdings were increased to 1,756 shares. Between 1952 and 1963, as a result of “splits” of shares and the exercise of ‘‘rights’’, appellant’s holdings in Consumers’ Gas had increased to 125,000 shares at the end of 1963. In 1964, the appellant sold 45,000 of the said shares.

(¢) 1,050 shares Abitibi Preferred—for a gain of $4,998. The appellant purchased these shares in 1954, sold some of them in 1955 and 1956, acquired some more through its acquisition of Toronto Mortgage in 1959 so that in 1964, it owned 1,050 shares. These preferred shares were redeemed by Abitibi in 1964, therefore this transaction is not really a sale in the sense that the realization resulted from any positive or deliberate decision to sell by the appellant.

In the taxation year 1965, the gain on sale of shares amounted to $512,765, the particulars of which are as follows:

(a) 1,500 shares of Canadian Westinghouse for a gain of $36,955. This is a well-established Canadian company and is considered to be a very conservative investment. The appellant purchased 2,000 shares of this company in 1958, and then in 1965, sold 1,500 of them.

(b) 30,000 shares of Consumers’ Gas for a gain of $294,413. I have already detailed the situation concerning these shares when dealing with 1964. This is a further sale of appellant’s holdings in Consumers’ Gas which by the end of 1963 had risen to 125,000 shares,

(c) 4.000 shares of Consolidated Mining & Smelting Company for a gain of $127,228. As a result of acquisition of other companies (whose portfolio included shares in Consolidated Mining & Smelting) and share splits, by 1952, the appellant owned 5,000 shares in this company without actually purchasing any itself. It did purchase 500 shares in 1954 plus 700 shares in 1955. By 1959, through a further acquisition of another company, its holdings had reached 7,000 shares. It sold 4,000 of these shares in 1965. (d) 1,600 shares of Noranda Mines Ltd. for a gain of $50,072. Here again, through acquisition of other companies whose portfolios included Noranda shares and through share splits, the appellant by 1965 owned 2,600 shares in Noranda without actually purchasing any itself. It sold 1,600 of these shares in 1965 with the resultant gain set out above.

(e) 200 shares of Hudson Bay Mining & Smelting for a gain of $3,602. Here again, these shares were obtained through acquisition of another company whose portfolio included shares of Hudson Bay. This occurred in 1959. All of the 200 shares were sold in 1965 with the gain above stated.

(f) 480 shares of Loblaw Company, Ltd. Class A preferred for a gain of $885. Once again, there was no direct purchase by the appellant. This holding resulted from a company acquisition in 1959 and a share split in 1961 and the appellant’s entire holding of 480 shares was sold in 1965.

When the gains set out in paragraphs (a) to (f) hereof are totalled and there is deducted therefrom a loss of $390 on the sale of Brazilian Traction shares, we arrive at the net gain of $512,765 in 1965.

In the taxation year 1966, the gain on sale of shares amounted to $1,303,604, the particulars of which are as follows:

(a) 17,000 shares of Royal Bank of Canada stock for a gain of $691,239. Appellant’s holdings of Royal Bank shares date from 1944 and represent a combination of: acquisition through the purchase of other companies; outright purchase; and the exercise of ‘‘rights’’ issued by Royal Bank. As of 1960, appellant owned 20,000 shares of Royal Bank. None had been sold through the years until 1966 when 17,000 shares were sold.

(b) 8,400 shares of Hiram Walker—Gooderham & Worts, for a gain of $125,564. This holding commenced in 1954, was increased by : acquisition of other companies; by outright purchase and by share splits. By 1966, the appellant owned 25,000 shares and sold 8,400 thereof as set out above.

(c) 25,000 shares of Consumers’ Gas for a gain of $246,588. These shares have already been dealt with when dealing with 1964 and 1965. This is a further sale of appellant’s holdings in Consumers’ Gas which by the end of 1963 had amounted to 125,000 shares. Additionally, appellant sold 1,000 shares of Consumers’ Gas “B” preferred which had been purchased in 1969 for a gain of $1,910.

(d) 1,000 shares of Steel Company of Canada for a gain of $5,394. This holding commenced in 1956, was increased by : acquisition of other companies ; by outright purchase ; and by share splits. By 1966, appellant owned 11,025 shares, none had been sold through the years until 1,000 shares were sold in 1966 as set out above.

(e) 7,500 shares of Union Gas Company of Canada for a gain of $35,303. This investment commenced with the purchase of 425 shares in 1958—through two share “splits” and by exercise of share ‘‘rights’’ in 1964, this holding became 7,000 shares by 1966 when they were sold.

(£) 1,000 shares of Noranda Mines for a gain of $28,056. This holding was dealt with in the 1965 analysis. These 1,000 shares represent the balance after the 1,600 shares were sold in 1965.

(g) 3,175 shares of The Bank of Nova Scotia for a gain of $68,058. This holding commenced in 1931, was increased by: acquisition of other companies; outright purchase; share ‘‘splits’’ and exercise of ‘‘rights’’. By 1966 this shareholding amounted to 8,500 shares of which 3,175 shares were sold in that year as herein set out.

(h) 6,000 shares of Molson’s ‘‘A’’ preferred for a gain of $64,890. The appellant purchased 1,500 shares in 1955. By share ‘‘splits’’ in 1958 and 1966, this holding became 6,000 shares which were all sold in 1966.

(i) 200 shares of Dominion Foundries & Steel for a gain of $2,201. This holding commenced in 1954 with a purchase. By 1957, through the exercise of rights and through additional purchase it had risen to 2,420 shares which were sold in 1957. In 1959, appellant acquired 900 shares through the purchase of Toronto Mortgage, these shares were split 4 to 1 in 1964 and it is 200 of these shares that were sold in 1966.

(j) 2,600 shares of Distillers Corp.-Seagrams Ltd. for a gain of $34,401. This holding commenced in 1954 with a purchase of 1,000 shares, was increased by an acquisition and a share split to 2,600 shares in 1966 when the said 2,600 shares were sold.

After carefully considering these share transactions along with the evidence of Mr. Rose and the Exhibits filed by the appellant, it is possible to draw several conclusions :

(1) Mueh of the appellant’s portfolio of shares in Canadian companies was acquired through the acquisition by it over the years of several other smaller companies having a type of business similar to that of the appellant.

(2) The shares disposed of in 1964 had been owned by the appellant for periods of between 10 and 33 years; the shares disposed of in 1965 had been owned by the appellant for periods of between 6 and 21 years; and those disposed of in 1966 for periods of between 6 and 20 years.

(3) The appellant had its own investment counsel within the company. Its stock portfolio was not disclosed or given to investment dealers. The appellant took no outside market advice.

(4) The appellant’s portfolio of shares in Canadian companies consisted entirely of what are referred to as blue chip” stocks, all of them paid dividends regularly, they were generally speaking, high quality Canadian stocks, mostly considered to be conservative in nature.

(9) None of these shares were purchased on margin, they were always purchased outright for cash, none were purchased on future or short dealings, no shares were ever sold to meet the claims of depositors or debenture holders; none of these shares were ever sold as security for any company borrowings.

(6) The appellant never at any time invested monies borrowed from the public in common or preferred stocks. The funds from sale of debentures were invested either in mortgages or in bonds. The deposit monies received from the public were invested partly in Government bonds (or other short term securities) and the balance in mortgages. It was the shareholders’ funds that were used to purchase the stock portfolio.

(7) Having regard to the lengthy period of time most of the stocks were held and the relatively few purchases and sales over the years considering the size of the portfolio, I consider this to be basically a static as opposed to a trading portfolio containing gilt-edged securities. Commencing with the year 1928, the sum of $460,000 was invested in company stocks. This figure grew progressively through the years until in the years under review it was:

1964 — $12,897,000. 1965 — $14,176,000. 1966 — $15,512,000.

A perusal of Schedule ‘‘D’’ to Exhibit 8 is instructive. Said Schedule ‘‘D’’ is a complete record of all common stocks purchased and sold by appellant from 1908 to 1966 inclusive—a total of 59 years. In most of these years, there were purchases but this is understandable because of the very great increase in the appellant’s capital funds over the years. What is more interesting, however, is the fact that there were so few sales.

Over this 59 year span, in 39 of those years, there were no sales at all. In 8 of those years, there was only one sale each year. In 3 of those years, there were only two sales per year. The more active years for sales were as follows :

1951 — 3 sales

1955 — 3 sales

1956 — 4 sales

1957 — 7 sales

1959 — 5 sales

1963 — 10 sales

1964 — 2 sales

1965 — 4 sales

1966 — 9 sales

Taking the years under review—could we, by any stretch of the imagination, infer a trading portfolio in 1964 with a total portfolio of over 12 million dollars, and only two selling transactions or four sales in 1965 with a portfolio over 14 million dollars or even nine sales in 1966 with a portfolio over 15 million dollars?

Schedule “B” to Exhibit 8 is a complete record of all preferred stocks purchased and sold by appellant from 1931 to 1966 inclusive. Schedule ‘‘B’’ demonstrates that the preferred stock portfolio was equally static:

2 sales in 1966

1 sale in 1965

1 sale in 1964

The leading authority in this area is Californian Copper Syndicate

v. Harris (1903-1911), 5 T.C. 159, wherein the Lord Justice Clerk states at pages 165-66:

It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realize it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit . . . assessable to Income Tax. But it is equally well established that 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 . . .

What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being—Is the sum of gain that has been made a mere enhancement of value by realizing a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

In the case at bar, the powers of the corporation are set out in its incorporating statute as amended.* [1] Its powers are contained in Section 6 thereof as follows:

6. The Company may carry on the business of lending money on the security of, or purchasing or investing in,—

(a) mortgages or hypothecs upon freehold or leasehold real estate or other immovables;

(b) the debentures, bonds, fully paid-up stocks and other securities and obligations of any government or of any municipal, school or other corporation, or of any chartered bank or incorporated Company being incorporated by Canada or any province of Canada, or any former province now forming part of Canada; life insurance policies, annuities and endowments, but not including bills of exchange or promissory notes; provided that the Company shall not invest in debentures, bonds, stocks, or other securities or obligations of any body corporate, except the Canada Permanent Trust Company, to any further or greater extent than one-fifth of the paid-up capital stock of any such body corporate other than the Canada Permanent Trust Company, nor shall the aggregate of such investments exceed seventy-five per cent of the paid-up capital stock of the Company; and provided further that the Company shall not invest in or lend upon the security of the stock of any other loan Company except as hereinafter authorized.

The case of Commissioners of Inland Revenue v. The Scottish Automobile and General Insurance Company Limited (1929-

1932), 16 T.C. 381, deals with a situation similar in many respects to the case at bar. In that case, Scottish which carried on insurance business of various kinds, other than life assurance, had, under its corporate powers, wide powers with regard to investment and management of its surplus funds. Those funds were, in fact, invested only in British Government securities, the holding of which were varied from time to time. During the years 1921 to 1923 profits arising to the Company on the sale of investments were carried to investment reserve account. After 1924 the investment reserve account became merged in a general reserve account; profits from sales of investments were carried to revenue account; and allocations out of revenue account, exceeding the profits on realization of investments, were made to the general revenue account. The Court of Session held that there was evidence on which to base a conclusion of fact that the profit was not a profit of trading. Lord President Clyde says at pages 389-90 :

I think, however, it must be admitted that, within the limits of moneys not so immediately required, the terms of the memorandum and articles would not, as a matter of construction, exclude dealings similar in kind and object to those which are characteristic of the business carried on by an investment company. But this carries us hardly any distance at all, because the question is not whether the Company might possibly have traded as an investment company, but whether it was in fact trading as such, and whether this particular transaction was part of that trading. . .. It does not necessarily follow from the circumstances that the Company sees fit to sell a block of its government securities, whether the purpose be to get a better return, or whether the purpose be to increase the reserve fund by taking profit from the realization of a particular block, that therefore the Company is trading in the purchase and sale of the securities forming its reserve fund. . . . One point was much stressed, namely, that the profit on the sale of this stock was passed through the revenue account of the Company. I am very little affected by that circumstance. . . . the figures in the present case show that in the year 1928 the sums transferred from revenue account to reserve very greatly exceeded the profit made on the sale . . . The way in which a particular trader keeps his books does not determine, or help much in determining, what is a capital profit and what is a revenue profit.

Lord Sands says at page 390 :

. . . it is not legitimate to treat every object specified in the preliminary documents as indicatory of an intention to carry on a certain class of business as one of the purposes for which the Company was formed. A company formed to construct a bridge over the Water of Leith at Balerno will probably take powers wide enough to cover the bridging of the Bosphorus.

And finally, Lord Sands at page 391 :

. . . If this account of transactions had been laid before me in the case of such a trust, my impression would have been that the trustees were a conservative and cautious body. Any idea that they were trading in the buying and selling of stocks and shares would not have occurred to my mind. All the securities are gilt edged. . . .

Reference was made to the manner in which this profit was treated in the accounts. It is well settled, however, that in Revenue cases one must look at the substance of the thing and not at the manner in which the account is stated.

Applying the Californian Copper and Scottish Automobile cases {supra), the law is clear that whether a particular transaction or series of transactions is a capital gain or a trading profit is a question of fact to be determined after careful consideration of all the surrounding circumstances. Therefore, I do not attach any particular significance to the powers of the appellant corporation. Using the language of the Scottish Automobile case (supra) “ . . . the question is not whether the Company might possibly have traded as an investment company, but whether it was in fact trading as such and whether this particular transaction was part of that trading’’.

What are the facts and circumstances in the instant case? Much of the appellant’s stock portfolio was not purchased per se, but was acquired as part of the assets of smaller companies purchased over the years; many of its shareholdings increased substantially through “stock splits’’ and ‘‘right offerings’’; in the years under review, the shares in question were held for periods of between 6 and 33 years ; appellant did not disclose or advertise or even give its stock portfolio to investment dealers and took no outside market advice ; all of the shares earned dividends and this clearly shows that the appellant was interested in returns rather than speculative gains; by all odds this stock portfolio has to be considered a high quality, gilt-edged, conservative one ; all of the shares were purchased outright for cash, none were purchased on future or short dealings; no shares were ever sold to meet depositor or debenture holder claims or were ever sold as security for company borrowings; no borrowed funds were ever invested in the stock portfolio—at all times it was shareholders’ funds that were used to purchase this portfolio; the number of sale transactions over the years are comparatively few in number.

I have particularized appellant’s whole course of conduct in respect of these share transactions in view of the authorities to the effect that in determinng the true purposes for which transactions are entered into, the Court should look at the whole course of conduct of the Company throughout its life and that this course of conduct should be given precedence over the oral testimony of company officers as to intent where there is conflict between the two.

The Supreme Court decision of Gairdner Securities Limited v. M.N.R., [1954] C.T.C. 24, applies this doctrine. At page 26, Mr. Justice Rand summarizes the course of conduct in that case as follows:

. . . Between April 30, 1938, and December 31, 1946, roughly 124 purchases and 200 sales took place.

In these latter, of eight purchases amounting to 32,920 shares, 17,180 were resold on the same day, 2,475 within one month. 5,000 within two months, 5,000 within three months, 1,000 within four months and 2,265 within eighteen months. Of nine purchases made after 1946 amounting to 22,260 shares, 2,000 were resold on the same day, 1,000 in one month, 2,500 in two months, 3,500 in six months, 2,000 within one year, 9,260 within two years and 2,000 within three years.

These complementary transactions in buying and selling on their face bear the imprint of a course of action pursued with a view to making a profit through their ultimate result; . . .

. . . Investments, in the sense urged, looked primarily to the maintenance of an annual return in dividends or interest. Substitutions in the securities take place, but they are designed to further that primary purpose and are subsidiary to it. On the facts before us, there cannot, in my opinion, be any real doubt that there was no such dominant purpose here.

The course of conduct in the Gairdner case is so completely different from that of the appellant in this case as to re-inforce my opinion that the transactions here are mere changes of investments. Here, the oral testimony of the company officer is consistent with, rather than contradictory to, appellant’s course of conduct over the years.

The uncontradicted evidence of Mr. Rose is to the effect that the years under review were comparatively active years for sales for two main reasons :

(a) appellant was being caught in an ‘‘interest squeeze’’— that is to say, because of rising interest rates, appellant’s cost of obtaining borrowed funds was rising rapidly while, at the same time, much of its investment portfolio was yielding low interest rates (for example, Consumers’ Gas). Accordingly appellant decided on liquidation of some of the lower interest bearing stocks.

(b) in the years under review, appellant was expanding, setting up new branches, acquiring new premises and as a result appellant’s fixed assets rose appreciably and appellant needed more liquid funds to pay for the additional fixed assets (fixed assets increased from $8,945,000 in 1964 to $11,038,000 in 1965 to $12,188,000 in 1966).

In considering this whole matter, I find pertinent the following statement of Lord Buckmaster 1 in Jones v. Leeming, [1930] A.C. 415 at 420:

. . an accretion to capital does not become income merely because the original capital was invested in the hope and expectation that it would rise in value; if it does so rise, its realization does not make it Income.

I also believe to be helpful, the following quotation from Wheatcroft on The Law of Income Tax, Surtax and Profits Tax at page 1208 :

. . . In the case of stock exchange investments it has now become common investing practice to make regular changes, so that considerable evidence of sales and purchases is needed before an investor, or investment company, is treated as a dealer.

The prudent and. wise owner of such a large investment portfolio, can. reasonably be expected to diversify, and to convert from time to time. It is in the nature of investments to be diversified and to be exchanged for others.

I also attach some significance to the subject-matter of these transactions — i.e. corporate shares. Mr. Justice Martland in the case of Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346; [1962] C.T.C. 215, says at page 352 [221] :

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.

In Plaxton’s Canadian Income Tax Law, 2nd ed., the following observations are made at page 44:

In ascertaining the profits of a trade or business, the familiar distinction, derived from writers of political economy, between ‘‘fixed capital”, meaning property acquired and intended for retention and employment with a view to profit and “circulating capital”, meaning property acquired or produced with a view to resale or sale at a profit, comes into full play. Profits from the realization of “fixed capital” assets are not receipts on revenue account but profits from “circulating capital” assets are receipts on revenue account. A fixed capital asset is an asset. It is intended to be kept and used in a trade and a circulating asset is an asset which is acquired or manufactured for the purpose of being turned over or sold in the course of carrying on trade.

A comprehensive description of the difference between fixed capital and circulating capital appears in the judgment of Lord Justice Swinfen Eady in Ammonia Soda Company, Limited v. Chamberlain, [1918] 1 Ch. 266, at page 286-87:

What is fixed capital? That which a company retains, in the shape of assets upon which the subscribed capital has been expended, and which assets either themselves produce income, independent of any further action by the company, or being retained by the company are made use of to produce income or gain profits. . . . What is circulating capital? It is a portion of the subscribed capital of the company intended to be used by being temporarily parted with and circulated in business, in the form of money, goods or other assets, and which, or the proceeds of which, are intended to return to the company with an increment, and are intended to be used again and again, and to always return with some accretion.

Applying Lord Justice Swinfen Eady’s test to the facts in the case at bar, I am of the opinion that the value of office premises and equipment; the value of shares in Canada Permanent Trust; and the shares in other Canadian companies are fixed capital. I think that the money which the appellant borrows from the public is circulating capital.

I believe that the shares in Canadian companies are fixed capital because they have been purchased with shareholders’ funds and they produce income of themselves, independent of any further action by the appellant (i.e. dividends).

I believe that the borrowed funds are circulating capital because they are parted with temporarily and are intended to return to the company with an increment and are intended to be used again and again. The borrowed funds are lent out on the security of real estate mortgages with fixed repayment terms — usually five years and then are lent out to other mortgagors or in the case of renewal mortgages, to the same mortgagor — and these moneys return to the appellant with an interest increment. Since the shares in Canadian companies are fixed capital, the profits on realization are not receipts on revenue account.

Counsel for the respondent did not argue that appellant’s actions here were ‘‘an adventure or concern in the nature of trade” or that these profits were trading profits. His submission was, rather, that appellant’s business was one integrated business, that the share transactions in question were an integral part of that business and he relied on Sections 3, 4 and 139(1) (e) of the Income Tax Act which read as follows:

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

139. (1) In this Act,

(e) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment;

I do not agree that the facts here support this submission. Appellant was not at any time engaged in the business of trading in securities so the above quoted sections of the Income Tax Act do not assist the respondent. Nor do I agree with respondent’s submission that the appellant’s business is nearly identical to the business of banking. During the years under review and prior thereto, appellant was not a member of any clearing house; ; it had no power to make personal loans; there were no overdraft privileges on deposit accounts; it issued no letters of credit; it could not put paper money into circulation and it could not discount notes or drafts. I am satisfied on the evidence before mc that appellant’s business was borrowing money from the public and lending it out and not that of a bank or anything closely resembling a bank.

Respondent also argues that since all appellant’s assets must be available to meet the claims of depositors, that a situation could arise where the Canadian stocks might have to be sold if there was a run on the company by depositors and that this is illustrative of the unity of this business. The evidence of Mr. Rose was to the effect that the company has maintained liquidity through the years between 30% and 40%, substantially higher at all times than the statutory requirement of 20% liquidity — that in the unlikely event of a ‘‘run on deposits’’, the appellant’s cash would be used first, and then the bonds and then if they still needed cash, they would have to look at their stock and mortgage portfolio. This, of course, has never happened in 72 years of operation and the likelihood of it ever happening is remote indeed. However, even if one concedes that it might happen, I do not think this possibility makes the Canadian stock portfolio a trading asset. This Canadian stock portfolio is as much a part of appellant’s fixed capital as is the head office building in Toronto. I suppose that if a ‘‘run on deposits’’ reached catastrophic proportions, the appellant would be in the position of having to consider sale of the head office building to satisfy the depositors. And yet, surely no one would ever suggest that if the appellant made a profit on the sale of its head office building, that such a sain would attract income tax.

Respondent submitted further that these Canadian stocks were used by the appellant to ‘‘plug holes’’; that because the bond market was depressed in 1966 and because appellant suffered bond losses in that year of about half a million dollars, that the company used these stocks to “stabilize” their operations and to present a better financial picture to shareholders and potential investors and that this was demonstrative of the day to day commercial use which appellant made of these stocks.

First of all, after perusing appellant’s balance sheets for the years under review, I do not agree that a half a million dollar loss on bonds would be a decisive or even an important factor for a prospective investor or a shareholder. Appellant was in excellent financial condition ; the bond loss was a ‘‘drop in the bucket”? in its over-all operation and I accept Mr. Rose’s evidence when he says that the shares were sold mainly because of the interest “squeeze” and the increase in fixed assets from $8,945,000 in 1964 to $12,188,000 in 1966 (thereby changing investments from stocks to real property).

The respondent relies on the Privy Council ease of Punjab Cooperative Bank Limited v. Commissioner of Income Tax, [1940] A.C. 1055 at 1070-73. In that case, the appellant was a bank and the nature of its business was quite different from that of the appellant. In Punjab, the bank’s investments were mainly government bonds which could be quickly liquidated. The bank sold some of these bonds from time to time as was necessary to meet ‘‘the probable demand by depositors’’ (italics mine). The Privy Council held that such realizations were a normal step in carrying on the banking business and that the profits realized were taxable. The second difference between Punjab and the case at bar is that the Punjab bank invested a portion of its borrowed capital (depositors’ money) in shares and debentures. This is not the case here. As stated previously, the appellant did not at any time buy shares with the borrowed funds which are used solely for its business of making mortgage loans. The funds used for the purchase of shares came from shareholders’ funds including inner reserves.

This very distinct difference in the factual situation distinguishes the Punjab case (supra) from the case at bar.

Learned counsel for the respondent also cited an Australian case in support of his position — Case No. P 52 (1963-64), 14 T.B.R.D. (Australia 236). Like the Punjab case (supra), Case No. P 52 was a banking case and in both of those cases, it was not established that the share purchases came from shareholders’ (fixed capital) funds as in the case at bar.

Additionally, in both cases, the need to liquidate to satisfy depositors’ demands was ‘‘probable’’, not ‘‘fanciful’’ or “extremely remote” as in the instant case.

Respondent also cited another Australian case dealing with an insurance company, the case of Colonial Mutual Life Assurance Society Limited v. Federal Commissioner of Taxation (1946-47), 73 C.L.R. 604. In that case, the appellant was a mutual life assurance company, the members of which were its policy holders. Its gain on sale of securities was held to be income. However, the facts are entirely different. In insurance companies, the solvency depends upon the accumulated funds being at any time sufficient to meet its estimated liabilities under its policies. Any net surplus in the fund over the liabilities, after allowing for the expenses of the business, is available for distribution among policy-holders in the form of bonus or dividends — thus any accretion on realization of securities is payable to the policy-holders — and so is clearly an integral part of the business of the insurance company.

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:

On the other hand, in Brice v. Northern Assurance Co. ((1911) 6 Tax Cas. 327 at p. 345), (one of the three cases before Hamilton, J. which led to the appeal to the House of Lords in Liverpool and London and Globe Insurance Co. v. Bennett ( (1913) A.C. 610) it was proved to the satisfaction of the Commissioners that it was not part of the business or trade of the company to deal in investments or to vary its investments or to make profits by so doing; that investments were not made or sold with the intention of earning profits and were rarely realized and then only for special reasons, and that any sums realized in excess of the cost of such investments were treated as and were capital and carried to Capital Investment Reserve Fund or used in writing off depreciation on other securities and were not in any way used or dealt with as profits or gains or taken into account for dividend purposes. Accordingly, the Commissioners held that a sum of £6,690, the net proceeds of sale of investments, was not profit or gain derived or arising from the company’s trade or business and that it was capital and not subject to be assessed to income tax. There was an appeal to Hamilton, J. on this point but in view of this finding it was abandoned. His Lordship, however, appears to have agreed with the finding and said : “I take it that throughout the object of these investments it is not to do what I venture to call a stock- jobbing business, it is not to invest money with the object of getting in and getting out of rapidly moving investments, but is, as is stated expressly in the Liverpool and London and Globe Case ((1911) 6 Tax Cas. 327) in order to have a fund created out of accumulated profits in past years and not distributed, and which may be easily realizable if required” ( (1913) 6 Tax Cas. at p. 355). The same view that a profit on the sale of investments was not on the facts of that case a profit made by trading by a company carrying on an insurance business other than life assurance but was a profit made on a change of investments for the purpose of securing a higher rate of interest was taken by the Commissioners and upheld on appeal by a majority of the Court of Session, Scotland, in Commissioners of Inland Revenue v. Scottish Automobile & General Insurance Co. Ltd. ((1931) 16 Tax Cas. 382).

Finally counsel for the respondent submitted that while there could be no argument of estoppel with respect to the way in which the profit or loss on sale of shares was treated in previous years, that it was nevertheless a factor which could not be ignored, and that experienced businessmen in the appellant company had in fact treated these proceeds as taxable in earlier years.

The evidence of Mr. Rose was that up to the year 1927, these profits and losses were treated as taxable income — that there was a discussion at that time with the Income Tax Department

— a ruling was given by the Department and thereafter the appel- lant, in its returns, excluded said profits and losses from taxable income. Apparently in 1946, the Income Tax Department changed its position and re-assessed appellant’s returns for a number of years to include such profits and losses in taxable income. As a result of this ruling, appellant went along with the Department and included said profits and losses as income until 1964, when, as a result of advice received from its auditors, it excluded said profits and losses. It did likewise in 1965 and 1966.

I attach no special significance to this evidence of prior treatment of these gains. The Income Tax Department changed its view of these gains a couple of times over the years as did the appellant. The present appeal must be decided on the facts and circumstances and necessary inferences therefrom as they pertain to the taxation years in question.

I have difficulty in resisting the conclusion that respondent was more influenced by the quantum of appellant’s gains in the years under review than by any other circumstance. However, as Noël, J. (now the Associate Chief Justice of this Court) said in Foreign Power Securities Corporation Limited v. M.N.R., [1966] C.T.C. 23 at 50 :

. . . Here again the prices of the securities sold can be of little assistance in establishing that the transactions were of a business nature.

In that case (which was affirmed by the Supreme Court, [1967] C.T.C. 116) soon after the taxpayer acquired the shares in question, their value in over-the-counter trading rose rapidly before settling down and the taxpayer took advantage of the meteoric rise to make substantial profits.

The learned trial judge says further at page 50 :

The short period during which these securities were held by the appellant can be of little assistance to the respondent as their fast disposal was properly explained by Mr. Wert in that the directors of the appellant would have been remiss in their duties had they not taken advantage of the surprising high rise of the market at the time the securities were sold. The fact that the appellant entered into these transactions for the purpose of making a profit as soon as it could and took advantage of this rise as soon as it occurred, should not change the nature of its investments if this is what they were and render them taxable as trading receipts . . .

In my opinion, the facts in the case at bar, as derived both from appellant’s course of conduct and the evidence adduced at trial, permit of no other conclusion than that the shares in question were acquired by the appellant as investments and were held as a source of income as investments and that the gains in question resulted from changes in those investments which must be treated as capital gains.

Therefore the appeal will be allowed in respect of both of the items in contention.

The assessment made upon the appellant for its taxation years 1964, 1965 and 1966 will be referred back to the respondent for re-assessment on the following basis :

For the taxation year 1964 :

(a) the appellant is entitled to deduct as an expense item the sum of $224,519.47 shown on appellant’s 1964 income tax return as “Commission on the sale of debentures”;

(b) appellant’s profit on the disposition of publicly traded shares in Canadian corporations in the sum of $366,327 is not a profit from appellant’s business and should therefore not be added to appellant’s taxable income.

For the taxation year 1965 :

(a) the appellant is entitled to deduct as an expense item the sum of $171,783.35 shown on appellant’s 1965 income tax return as “Commission on the sale of debentures”;

(b) appellant’s profit on the disposition of publicly traded shares in Canadian corporations in the sum of $512,765 is not a profit from appellant’s business and should therefore not be added to appellant’s taxable income.

For the taxation year 1966 :

(a) the appellant is entitled to deduct as an expense item the sum of $217,708.19 shown on appellant’s 1966 income tax return as ‘ Commission on the sale of debentures ’ ’ ;

(b) appellant’s profit on the disposition of publicly traded shares in Canadian corporations in the sum of $1,303,604 is not a profit from appellant’s business and should therefore not be added to appellant’s taxable income.

The appellant will be entitled to be paid by the respondent its costs of the appeal, to be taxed.