12 February 1987 Income Tax Severed Letter 7-1199 - [Subsections 39(4) and (5) of the Income Tax Act (the "the Act")]

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.

February 12, 1987

VICTORIA DISTRICT OFFICE R.R. MacKinnon A/Chief of Audit

Attention: Mrs. Alice Wong Audit Review

FROM - SPECIALTY RULINGS DIRECTORATE G. Thornley (613) 957-2130

RE - Subsections 39(4) and (5) of the Income Tax Act (the "the Act")

This is in reply to your memorandum of October 15, 1986 and further to our telephone conversation of January 12, 1987, requesting our opinion on the following matters related to the application of the above-noted subsections.

1) It is your opinion that both a person who is employed by a company that is engaged in the promotion or underwriting of various security interests and who frequently buys, using leveraged financing, and sells securities in the open market after holding them for short periods and a retired person with no previous employment in the brokerage industry who trades on an active basis in a manner similar to the brokerage employee and under similar circumstances could have their dispositions of Canadian Securities treated as on account of income. XXXX is of the opposite view.

2) Your interpretation of the last sentence of paragraph 5 of Interpretation Bulletin 479R which reads in part "... which sells such investment from time to time." is that these words refer to the investor's intention at the time securities are purchased, that is, he must intend to purchase longterm investments. It is the accountant's opinion that the words in question relate directly to a time span such as periods of less than a week or perhaps longer periods.

In our view the issue raised in 1 above is a question of fact, the determination of which can only be made after an examination of all relevant facts. As District Office examiners or auditors are generally in a better position to obtain the facts, determinations of this type are usually considered their responsibility. We are, however, prepared to comment generally on the issue raised.

Our Comments

1) We have stated previously that a taxpayer should be taxed as a trader if he uses his insider information to make a quick profit, legally or illegally. However, a taxpayer may make a section 39(4) election and will not be treated as a trader on "true investments", even where he had insider information throughout the period in which he held the investments. In this regard, we will not attempt to distinguish between the two situations by using an artificial time period. The words, "unless that officer or employee transacts in securities as a result of the promoting or underwriting activities of their employer", at the end of the second sentence in paragraph 5 of Interpretation Bulletin IT-479R must also be considered. If his gains arise in this connection, he would also be considered to be a trader and thus not allowed to make a subsection 39(4) election.

Normally an insider advantage should be evidenced by a buy-sell of shares in a short period or the short sale of the shares. It is expected that it will be difficult for the Department to establish that a taxpayer has taken actual advantage of insider information and, consequently, in these situations we will not be in a position to presume that the share transactions are on income account unless the facts clearly establish that the taxpayer has used insider information and that the taxpayer attempted to realize a quick gain.

Thus in our view, both individuals sited in 1 above who are trading on their own account and have made a valid election should be afforded capital gains and losses treatment under subsection 39(4) of the Act.

Our answer assumes that neither individual uses "insider information" or holds himself out to the public as a trader or dealer in shares, bonds or other securities and that the employee of the security underwriting firm does not transact in securities as a result of the promoting or underwriting activities of his employer. In other words, the criteria in paragraph 5 of Interpretation Bulletin 1T-479R are paramount in determining whether or not a taxpayer is a "trader or dealer" for purposes of subsection 39(5) of the Act.

2) In our view the words "from time to time" as used in paragraph 5 of Interpretation Bulletin IT-479R means once in a while or occasionally and thus they relate to frequency rather than to a time frame.

Although it is not an issue raised by XXXX we are enclosing for your information a photocopy of an earlier letter in which we set out what is necessary to constitute an election under subsection 39(4) of the Act.

We trust our comments will prove helpful.

for Director Reorganization and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch