Donata Investments Limited v. Minister of National Revenue, [1976] CTC 2288, 76 DTC 1216

A J Frost:—These appeals, which were heard in camera, are from Notices of Reassessment dated November 19, 1974 with respect to the appellant’s 1970 taxation year, wherein (a) a loss on the inventory of marketable securities in the amount of $161,000 was disallowed, and

(b) the gain realized on the sale of the shares of Richmond Concrete Pipe Limited in the amount of $132,090 was added to income.

At the hearing, appeal No 75-98 was quashed on the ground that the assessment for that year resulted in a nil assessment.

In its 1970 taxation year the appellant was a land investment company engaged in a variety of business enterprises, including the purchase and sale of securities. In its 1970 corporation income tax return the appellant reported a loss on marketable securities transactions of $161,000. The auditor’s report to the shareholders, dated September 28, 1970, included a statement which reads as follows:

Counsel for the appellant, in his argument, stated that the transactions of the appellant in marketable securities constituted a business of the appellant, and that the company had complied with the provisions of subsection 14(2) of the Income Tax Act, RSC 1952, c 148, as amended, as it read at that time, by recording the inventory of marketable securities at the lower of cost or market for the purpose of computing its income. si

Counsel for the respondent contended that the appellant was not in the business of buying and selling securities.

The first question at issue in this appeal is: what constitutes being in the business of buying and selling securities for income tax purposes?

In Irrigation Industries Limited v MNR, [1962] SCR 346 at 352; [1962] CTC 215 at 222; 62 DTC 1131 at 1134, Mr Justice Martland, in allowing the appeal, said that Irrigation Industries Limited had not been engaged in ‘the sort of trading which would be carried on ordinarily by those engaged in the business of trading in securities”.

I can only conclude from the above statement that a taxpayer, in order to be considered a trader for income tax purposes, must carry on the sort of trading activity ordinarily conducted by traders employed by brokerage houses.

As most Toronto and New York brokerage firms carry on an active trading business for their own account, this Member decided to call an expert witness as a friend of the Board. Accordingly, we called John S Jenkins, Executive Vice-President of the investment firm of Dominick Corporation of Canada Limited, who, after having been sworn as an expert witness, was questioned by us and who was subsequently thoroughly examined and cross-examined by counsel for each of the parties. Mr Jenkins testified clearly as to what constitutes, in his opinion, the sort of activity normally engaged in by professional traders. On his expert evidence, the Board finds that one can distinguish three badges of trade in determining the question before it as to what constitutes, in general terms, being in the business of buying and selling securities. These three badges are as follows:

1. The constant watching of the ticker tape to take advantage of short-term market trends.

2. The cutting of losses (the witness suggested a maximum of 20%) and the maximization of short-term profits to maintain high liquidity.

3. Trading over a stock exchange is for the most part a full-time job.

Apart from these three badges of trade, which appear to be the main characteristics or hallmarks of a successful trader, a number of observations of a secondary nature were made by our expert witness which appear to me to be not without significance when considering the nature of trading over an exchange. They are:

1. Both fundamentals and scuttlebutt are relatively unimportant to the professional trader.

2. The market abounds with truths and untruths. The trader must not fall, prey to rumour.

3. Traders, as a general rule, do not trade in unseasoned stocks.

4. A trader tries to make his capital work as much as possible. Stock acquisitions must be liquid (easy to sell).

5. Traders try to pick high-priced stocks, as commissions are less, percentagewise.

6. Traders follow charts of individual companies, and charts of the market averages. Hourly charts are sometimes used because of the. volatility of stock prices and the elusive nature of trading in securities over an exchange for short-term gains.

7, Trends tend to persist.

8. Market patterns are, by and large, repetitive.

9. Psychology: It is easy to take a small profit but more difficult to take a small loss.

10. An investor buys value; price appreciation is of secondary importance.

11. A trader aims at price appreciation, whereas value is secondary.

12. Few make money on tips and rumours.

13. Short-term movements are only remotely connected with economic fundamentals.

14. Capital must be kept intact and liquid at all times.

15. The process of closing out positions and opening new ones never ends.

Trading is more of an art than a science. Its success does not depend on inside information but on a knowledge of the workings of supply and demand at an auction (stock markets are auctions). Fundamental information is only important in so far as it affects supply or creates demand. To trade successfully, the trader must watch the market continuously and look for those psychology patterns of movement which reflect the supply-demand relationship and indicate the likely direction of stock prices. No amount of inside information can. outwit the law of supply and demand. Our expert witness, in his statements, left no doubt as to the importance of the technical aspects of trading in securities, and the Board concurs in what he had to say.

Looking back at the statement of securities sales, on page 2289 it will be observed that only three positions were closed out in the taxation year and three positions were reduced in size. No purchases were made for the year ended March 31, 1970. This means that a negligible amount of trading took place and is certainly not indicative of the. appellant being in the business of trading. Further, the evidence indicates that, in buying and selling securities, the appellant relied on fundamentals rather than on day-to-day tape information. As fundamentals are not the tools of a trader, the appellant can only be considered an investor. The evidence also showed that the appellant had many other things to do and that he made no effort to cut losses quickly or cleanly.

The second question at issue in this appeal relates to the gain realized on the sale of the 100 shares of Richmond Concrete Pipe Ltd, hereinafter referred to as “Richmond”, in the amount of $132,090. In this matter, I must find in favour of the appellant. There were 100 shares outstanding, 50 were acquired by the appellant in 1956 at the time of incorporation and, on the death of the former holder of the other 50 shares, the appellant purchased the remaining shares from the executors of his estate. Here Richmond was only a vehicle for holding land which was bought for development purposes. There was no intention to resell, and the Board can only conclude that the land was acquired for investment reasons and was held over the years for investment purposes. The profit is therefore a non-taxable capital gain.

The appeal in respect of the 1971 taxation year is hereby quashed. The Board allows the appeal for the 1970 taxation year with respect to the profit from the sale of shares of Richmond but dismisses the appeal in all other respects.

Appeal allowed in part.