1981]
COMMENTS – COMMENTAIRES
Recent Developments in the Taxation of Securities
The Taxation of Securities Transactions, which was published in
two recent numbers of this journal,1 was drafted shortly after
Parliament amended the Income Tax Act2 to include business in-
vestment loss 3 and the capital gains election4 rules relating to the
taxation of securities. Subsequent regulations, statutory amend-
ments and cases are reviewed in this note.
I. Business investment losses
The business investment loss (BIL) rules confer some relief
beyond the limit of $2,000.00 in section 3(e) where investors
in Canadian controlled private corporations (CCPC) have sustained
a capital loss on equity or debt investments. The basic mechanism
of the loss relief is to treat the amount of an allowable capital loss
(i.e., half of the total loss on the transaction) as an ordinary
business loss. While the amount of the loss is halved by this
scheme, the scope of application is enlarged because the loss is
taken under ‘section 3 (d) instead of under section 3 (e). For tax-
payers who do not have large taxable capital gains, this device
generates more complete loss relief since the relief is more im-
mediate than that available under the rules governing carry-over
losses. For the taxpayer who does have large taxable capital gains,
this slight change in the method of computation of taxable income
is largely irrelevant, since ordinary losses can be used to off-set
taxable capital gains. Of course all taxpayers will still prefer or-
dinary loss treatment for the full amount of a loss on an investment
rather than a deemed ordinary loss, which is limited to half the
amount of the loss. When this legislation was introduced in 1978,
it contained several defects. Perhaps the most important flaw was
the provision’s dependence on the case law to give it meaning.
Since 1978, the cases which distinguished capital and income trans-
actions in close corporation securities have become more con-
1 Lahey, The Taxation of Securities Transactions –
I: Policy Analysis and
Canadian Treatment (1980) 25 McGill LJ. 478; The Taxation of Securities
.Transactions –
II: Recent Legislation (1980) 26 McGill L. . 45.
Income Tax Act are to this version.]
2 S.C. 1970-71-72, c. 63 as am. [Unless otherwise noted, all references tothe
3 Income Tax Act, s. 3(d), added by S.C. 1977-78, c. 42, s. 1(2), and ss. 38(c)
and 39(1)(c), which were added by S.C. 1977-78, c. 42, ss. 2, 3.
4Income Tax Act, ss. 39(4), (5), (6), added by S.C. 1977-78, c. 1, s. 16(2).
McGILL LAW JOURNAL
[Vol. 26
fused, and so this aspect of the provision is a continuing problem.
Second, the linguistic formula used in the original section 39 (1) (c)
to describe “capital losses” created technical statutory problems.
Third, the BIL rules invited double counting of dividends in com-
puting losses which qualify. These last two problems have been
largely resolved by subsequent changes in the provision.
A. Capital loss v. ordinary loss of close corporation securities
The business investment loss rules operate when the taxpayer
has incurred a loss on the disposition of Canadian controlled private
corporation securities, whether debt or equity.5 General principles
are of course applicable in deciding whether a transaction is of an
income or capital character. Thus, transactions in corporate securi-
ties will give rise to capital treatment if they are of an investment
nature and to revenue treatment if there is evidence that the tax-
payer is a trader in securities. When the corporation is closely held,
or where there is sufficient identity between the corporate decision-
makers and the shareholder-taxpayer, the courts will consider the
possibility that a single share transaction which cannot be character-
ized as being in the course of trading in shares is a revenue trans-
action, if the shares dealt with are a substitute for the property
owned by the corporation.6 An additional exception to the basic
trading-or-investment dichotomy has been made where a business
undertaking is so speculative that gains and losses on corporate
securities which are issued to finance the venture are dealt with
as revenue of a financer who is personally involved in the business
activity. This last exception was adopted by the Supreme Court of
Canada in M.N.R. v. Freud,1 when it held that loans and disburse-
ments to and on behalf of a close corporation were deductible
losses by the controlling shareholder.
Pigeon 1. was of the opinion that the corporate undertaking in
Freud would have been at the least an adventure in the nature of
trade if the taxpayer had carried it on himself instead of through
a corporation, and that the interposition of the corporate entity
did not affect the character of the taxpayer’s expenditures, but
rather the reverse: the character of the business venture imbued
the securities with the quality of an adventure. He went even further
and stated that the precise method of finance was irrelevant; volun-
5 Income Tax Act, ss. 39(1)(c)(iii), (iv), added by S.C. 1977-78, c. 42, s. 3(1)
6 See Fraser v. M.N.R. [1964] S.C.R. 647. Debt obligations are not likely to
as am. by S.C. 1979-80, c. 5, s. 11(1).
be used in the same fashion; thus there is no corollary ruling for loans.
1[1969] S.C.R. 75.
19811
COMMENTS – COMMENTAIRES
tary disbursements were to be treated no differently from debts
due by the company:
[w]hether it is considered as a payment in anticipation of shares to be
issued or as an advance to be refunded if the venture was successful,
it is clear that the monies were not invested to derive an income there-
from but in the hope of making a profit on the whole transaction. 8
The obvious implication is that in “quite exceptional or unusual
circumstances”, such as those in the Freud case, losses on loans
or shares issued by a small corporation will be treated in the same
way, and both kinds of losses will be deductible when the business
scheme can be realized either by exploiting the enterprise itself or
by using the enterprise to increase the value of the shares, which
can then be sold at a profit.
The Freud case describes a difficult and elusive standard by
which to differentiate income and capital transactions in corporate
debt and equity securities. In the last few years several decisions
have re-examined and applied that standard, and it is now possible
to draw some tentative conclusions from them. One emerging theme
is that the taxpayer whose personal business efforts are capable
of affecting the fortunes of the corporation’s business, and there-
fore the value of its securities, is more likely to have a deductible
loss, whether in shares or debt instruments, than a capital loss
(and of course more likely to have business income than a capital
gain should the securities be disposed of at a gain). In The Queen
v. Garneau,9 the Freud approach was used to justify treating the
gain on shares as a revenue item where the taxpayer had acquired a
controlling interest in a corporation in order to maintain its opera-
tions, enhance its profit picture and attractiveness to an investor,
and then quickly sell out’ 0 The element of the taxpayer’s personal
control was also the determining factor in Malone v. MAR.,”
which extended the Freud doctrine to losses on loans to controlled
corporations as well as to equity securities. In Malone the taxpayer
controlled a stock-brokerage corporation which regularly distributed
its surplus to the taxpayer, who just as regularly loaned the distri-
butions back to the company, partly to enable it to meet minimum
capital requirements. When the corporation went bankrupt, the
Board held that the loans were properly treated as revenue losses.
Mr St-Onge’s analysis of the matter stayed well within the issue as
framed in Freud: whether “a loan made by a person who is not in
the business of lending money … should be considered as a specu-
8 Ibid., 82.
9 [1977] C.T.C. 288 (F.C.T.D.) per Marceau J.
10 See McDonald v. M.N.R. [1979] C.T.C. 3001, 3003 (T.R.B.) per Taylor.
11 [1979] C.T.C. 2619 (T.R.B.) per St-Onge.
McGILL LAW JOURNAL
[Vol. 26
It has been suggested that “the
lation”. 2 He answered the question in the taxpayer’s favour but
did not analyse the relationship between control and speculation
in the written judgment. Although the reported opinion does not
fully amplify the reasoning, the facts of the Malone case should be
taken as an example of the “quite exceptional or unusual circum-
stances” that are required to bring a case within the Freud doctrine.
taxpayer was fortunate in
winning his appeal” and that “it is unlikely that the case will
become a precedent of general application”, 3 presumably because
the case was initially argued as a money-lending case.14 When
Malone is viewed as a money-lending case, it certainly is aberrant.
When it is seen as an affirmation of the Freud doctrine, however, it
takes on greater significance. Because the type of situation in
Malone straddles fact patterns appropriate to a money-lending
business and speculative securities, it is difficult to categorize it
conclusively. Perhaps because the close corporation securities cases
do shade off into the money-lending cases, where the standard for
defining a business transaction is more difficult for taxpayers to
meet, subsequent decisions have tended to go against taxpayer
appellants, at least’ where losses are in issue. Looking at 1979 and
1980 decisions generally, it appears that the Freud emphasis on a
speculative intent that expresses itself in exploitation of the un-
dertaking directly, or in the resulting value of the shares, has
shifted to the requirement that the taxpayer’s dominant intent be
to exploit securities by means of exploiting the underlying venture.
This shift in emphasis is clearest in McDonald v. M.N.R.,15 which at
least superficially resembled the Garneau case. Mr McDonald had
acquired a controlling interest in a stock brokerage company and
several years later instituted a programme of selling participating
interests to some of his colleagues. 6 Shortly after reducing his
holdings
to a minority position, difficult economic conditions
prompted him to reacquire control in order “to hold the business
together” and “to turn it around”, presumably with the intention
to dispose of the shares at a profit. When the shares ultimately
were sold at a loss, the taxpayer argued inter alia that the second
12Supra, note 7, 82 per Pigeon 3.
‘3McDonnell, Current Cases (1979) 27 Can. Tax J. 604, 605.
‘ 4 See Lahey, supra, note i, Pt II, 66-70.
15 Supra, note 10.
16 ne of these was George Sher, the unsuccessful appellant in Sher v.
The Queen [1980] C.T.C. 168 (F.C.T.D.) per Grant D.J., aff’g [1978] C.T.C.
2486 (T.R.B.) per Taylor (appeal
to Federal Court of Appeal pending).
Although he received a directorship and a higher commission rate as a
shareholder, he remained a salesperson. When he sold his shares at a loss
he was held to have incurred only a capital loss.
1981]
COMMENTS – COMMENTAIRES
share acquisition was intended to result in a profit, but Mr Taylor
held that the share losses were on capital account because “Mr
McDonald did not … allege that in the acquisition of the capital
stock his major motivation was to sell that stock at a profit.”’17 Mr
Taylor also distinguished Malone on the form of the investment,
observing that the loan of money to a company cannot be equated
with the purchase of equity capital from third parties 38
The application of cases such as these present a challenge to
the litigant, especially since they will not be accepted automatically
as authority. One should rely upon them as persuasive analyses of
similar problems, with the caveat that the policy objectives of the
business investment loss rules run counter to the Minister’s per-
ception of the purpose of the system which they modify.
B. Technical statutory defects
1. Definition of capital loss
When section 39 (1) (c) was added to the Act, 9 it defined business
investment losses as losses determined according to subdivision c,
which deals with taxable capital gains. Until its amendment in
1979, the preamble to section 39 (1) (c) reiterated the clumsy formula
in sections 39.(1) (a) and (b) which defines capital gains and losses
by’reference to pre-1972 ordinary income and losses. Not only was
this a cumbersome way of making a simple point, but it allowed
taxpayers to take the position that sections 39 (1) (b) and (c) were
not mutually exclusive and were designed to treat half of a capital
loss as an allowable capital loss, and the other half as an allow-
able business investment loss. A subsequent amendment” has sub-
stituted the words “capital loss” for the verbose formula, and now
1 Supra, note 10, 3004 [emphasis in the original].
18 Ibid., 3002. For two other recent Board decisions which held that in-
vestments by controlling shareholders were of capital nature, see Santel
Investments Ltd v. M.N.R. [1980] C.T.C. 2353 (T.R.B.) per Tremblay (loans
to protect corporate investment) and Whitehouse v. M.N.R. [1979] C.T.C. 2448
(T.R.B.) per Goetz (loans for working capital). It is not surprising that where
there is an element of personal control over the enterprise and some specula
tive risk which results in a gain on close corporation securities the courts
have been more anxious to apply the Freud dictum. See Perkins v. The
Queen [1980] C.T.C. 199 (F.C.A.) per curiam, aff’g [1978] C.T.C. 389 (F.C.T.D.)
per Collier J. (taxable profit on acquisition of book debts in revival of loss
company); The Queen v. Eidinger [1979] C.T.C. 296 (F.C.T.D.) per Walsh J.,
aff’g unreported T.R.B. decision, noted in (1979) 27 Can. Tax J. 596 (gain on
debt assigned to controlling shareholder taxable as profits from adventure
due to element of personal control).
19 S.C. 1977-78, c. 42, s. 3.
20 S.C. 1979, c. 5, s. 11, applicable to 1978 and subsequent taxation years.
McGILL LAW JOURNAL
[Vol. 26
section 39 (1) (c) clearly creates special treatment for certain capital
losses and the term “capital loss” is defined in section 39 (1) (b).
It is no longer open to taxpayers to argue that they are entitled
to utilize more than a total of fifty per cent of an amount lost for
tax purposes.
2. Double counting dividends
The new technical provision in section 39(1) (c) (vi) is an in-
teresting addition. At its simplest, it ensures that when a capital
loss on a share is partially attributable to the payment of taxable
dividends since 1971, the capital loss cannot be treated as a business
investment loss. The formula in this section is arbitrary in that it
limits the amount of a business investment loss to the excess over
post-1971 taxable dividends. The new sub-section also appears to
ensure that when a CCPC has paid taxable dividends since 1971,
which reduce its cumulative deduction account or trigger refundable
dividend tax,2 1 those taxable dividends will not also be counted
in computing the amount of the business investment loss. Note
that the distributions are still counted, in effect, in computing the
amount of a capital loss on the shares. As of yet, capital losses on
shares are not adjusted to exclude the effect of such events.2
Section 55 has not yet been applied by the Minister in an attempt
to reduce capital losses by the amount of dividends paid on the
shares.2
An interesting aspect of this amendment is that it adjusts the
quantum of business investment loss arising only on shares (or
shares substituted therefor) issued before 1972. Because of this
limitation, its operation is severely restricted. It will not block
double counting of taxable dividends for corporations organized
after 1971, and this omission makes CCPC shares attractive tax-
planning vehicles. However the 1972 cut-off does mean that another
technical anomaly relating to pre-1972 undistributed surplus has
been eliminated, at least in some instances. Before 1979, undistribut-
ed surplus which was earned before 1972 could be tax paid at a
21 See Income Tax Act, ss. 125, 129.
22 Except in Income Tax Act, s. 112(3): see also s. 46(4).
23The Minister’s chances of success in such an enterprise are questionable,
given the artificial nature of the corporate entity and of the tax rules
dealing with corporations. For a discussion of the possible implications of s.
55, see Friesen & Timbrell, Shams and Simulacra 11 –
The Capital Gains
Aspect (1979) 27 Can. Tax J. 135. For an analysis of the avoidance difficultieg
of the ,capital gains v. dividends planning prompted by the present structure
of the Act, see Gould & Laiken, Dividends v. Capital Gains Under Share
Redemptions (1979) 27 Can. Tax J. 161.
19811
COMMENTS – COMMENTAIRES
fifteen per cent rate at the corporate level and then distributed as
tax-exempt dividends if the corporation made, a special election. 4
Shareholders were required to reduce the cost base of their shares
by the amount of TPUS distributions, 5 which in effect levied, a
deferred capital gains tax on the distributed amount on the ultimate
distribution of the shares. For taxpayers who were taxed at a
high marginal rate, the effective rate of the two taxes together was
lower than the personal rate on taxable post-1971 dividends20 and
reflected an initial reluctance to treat pre-1972 corporate surpluses
as fully taxable income on distribution when pre-1972 capital gains
on corporate shares which were attributable to pre-1972, retained
earnings were exempt in most cases from capital gains taxation by
the Valuation-Day rules. In effect, the TPUS rules functioned as
Valuation-Day rules for pre-1972 surpluses, and created a partial
shelter for on-going distributions and almost all other corporate
transfers including reorganization.
For the 1979 tax year a number of fundamental changes were
made in the corporate tax rules, one of which was the abolition of
the TPUS system. Heralded as a major component of a tax sim-
plification program, 8 the termination of the TPUS shelter for all
private and most public corporations widened the gap between the
tax payable on pre-1972 retained earnings brought out as capital
gains and those brought out as taxable dividends. 9 The original
drafting in section 39(1) (c) in effect invited taxpayers who found
the deemed dividends plus capital loss useful to exploit this differ-
ential by converting the capital loss which arises on liquidation or
redemption into an even more useful ordinary loss.
Although there is no fixed formula for valuing corporate shares,
as a general proposition the amount of paid-up capital
(PUC),
capital or other surplus and undistributed profits attributable to a
share bears some relationship to the value of the share. This pro-
24 The rules concerning tax-paid undistributed surplus (TPUS) were con-
tained in old ss. 83(1) and 89 (1)(k), repealed by S.C. 1977-78, c. 1, ss. 37(1)
and 44(5) respectively, effective after 1978.
251ncome Tax Act, s. 53(2)(a)(i).
26 Even before the dividend tax credit was enriched in 1978, low rate tax-
payers were better off with taxable dividends than with deferred taxable
capital gains.
27 See Income Tax Act, ss. 83(1), (6) and Income Tax Regulations, s. 2107.
28Also scrapped were admittedly complex provisions relating to capital
deficiencies, pre-1972 capital surpluses and the computation of various special
surplus accounts. See generally Subdivision h. Ironically enough all of these
concepts still operate in some circumstances.
29See, e.g., Income Tax Act, s. 84.1.
McGILL LAW JOURNAL
[Vol. 26
position is especially true for smaller corporations or those which
have ceased regular business operations and hold assets in highly
liquid forms. Using a simplified example which assumes that the
market value of a share equals a pro rata share of the corporation’s
capital and surplus, we can quantify the discrepancy left by the
elimination of the TPUS shelter for most corporations. (The ex-
ample deals only with pre-1972 earnings in order to minimize the
numerical factors that affect the result.) Assume a corporation with
one issued share with PUC of $50.00 and pre-1972 undistributed
income of $100.00. Using our simplified valuation method, the
Valuation-Day value of the share would have been $150.00 and
current market value is roughly $150.00.30 There are two basic
methods that the shareholder can use to extract the capital and
surplus or equivalent value from the share; arm’s length sale of
the share3 l or liquidation of the corporation.2 Without the TPUS
shelter, and assuming that the modified rule in section 39 (1) (c) (vi)
has not yet been brought into application, the taxpayer who uses
the liquidation route recognizes a deemed dividend of $100.00 and a
capital loss of $100.00,3 while the taxpayer who disposes of the
share in an arm’s length sale recognizes no capital gain or loss
nor any ordinary income 3 4
While the impact of the elimination of the TPUS shelter on
liquidating distributions of pre-1972 profits will vary with the
individual taxpayer’s marginal rate and overall financial position,
it seems fair to say that the two extremes invite abuse. The discre-
3 0 For these purposes of illustration, inflation is not taken into account.
31 S. 84.1 of the Income Tax Act offers a hybrid result in a sale to a
controlled corporation, but the technique is not central to the analysis here.
32 Other corporate transfers such as redemption, or a full distribution
of undistributed income followed by the sale of the share, will achieve
roughly the same result as liquidation.
33 S. 84(2) yields a deemed dividend of $100.00 (amount received in excess
of PUC). The combined operation of ss. 88(2), 84(2) and 54(h)(x) give the
taxpayer deemed proceeds of disposition of the share for capital gains
purposes of the amount received in excess of the amount of any deemed
($50.00). With deemed proceeds of $50.00 and deemed cost of
dividends
$150.00 (V-Day value) the capital loss is $100.00 –
the same amount as the
deemed dividehd. If the taxpayer has a low marginal rate, there will be an
excess dividend tax credit plus an allowable capital loss of $50.00 which can
be off-set against other ordinary income under the $2000 limit. At present
there is no mechanism for limiting the amount of the creditable dividend
to the net after capital losses. But see Income Tax Act, s. 112(3), which
disallows capital losses on shares to corporations which exhibit a certain
degree of control.
34 If the market value of the share was the same on Valuation-Day and the
date of disposition, cost and proceeds are the same.
19811
COMMENTS – COMMENTAIRES
pancy between the two routes was increased when the original
version of the BIL rules deemed taxable capital losses such as
the one in this example to be allowable business losses. Apparently
this may have been an unintended result, for section 39 (1) (c) (vi)
now reduces the amount of the business investment loss recognized
on a share by the aggregate of all taxable dividends paid on the
share 5 While the modification minimizes this anomaly, it creates
new ones. Liquidation of a controlled corporation will not generate
a business investment loss because the disposition is not at arm’s
length,”” and thus the amendment has no application. Liquidation
of a corporation that does not fall within the arm’s length rules
will result in a reduction of the business investment loss by the
amount of the deemed dividend. The statute does not indicate
what happens to the amount of the reduction of the business in-
vestment loss, but presumably it reverts to its original condition
as a capital loss, which should be perfectly acceptable to many
taxpayers.
II. Lifetime election
The lifetime election rules, which very broadly permit a taxpayer
to make an irrevocable election to treat all transactions in “securi-
ties” as capital transactions, have not yet reached the courts, nor
will they for several more years. Interim litigation will affect the
interpretation of key’terms in the provisions, however, and thus the
courts should take some care when deciding securities cases, lest
ill-considered language turn up as “precedent”
in unanticipated
contexts. A few recent cases deserve mention in this regard. In
addition, the regulations under section 39(6) attempt to foil some
of the more obvious non-arm’s length abuses of the election.
A. Litigation
Dub6 J. made some provocative remarks about the legal defini-
tion of “trader” in Montfort Lakes Estates Inc. v. The Queen.37
The controlling shareholder of the taxpayer was an immigrant who
alleged a need for a large landed estate because he was from
35Or predecessor shares. Note that this opportunity for abuse has not
been completely closed off. If a taxpayer received distributions out of TPUS
before that account lost its special status as a source of tax deferral dividends
for other than the privileged few corporations, those were not taxable divi-
dends and the stop-loss rule in s. 39(1)(c)(vi) will not apply unless other
taxable dividends have been paid since 1971.
36See Income Tax Act, s. 39(1)(c)(ii).
37 [1979J C.T.C. 27 (F.C.T.D.): see note in (1980) 28 Can. Tax. J. 190.
McGILL LAW JOURNAL
[Vol. 26
landed nobility; the family jewels were sold to finance the $100,000
purchase of 2000 undeveloped acres in what appeared to be prime
Quebec wilderness near a small town. The year after buying the
land, the shareholder began a systematic course of improving a
small section of the land for subdivision and sale. The proceeds
were used to finance further business activities and to improve the
holdings generally. Particulars of the improvements and expendi-
tures were not given in the judgment. Some seventeen years after
acquiring the land, now held by the taxpayer corporation to which
the development business had been transferred, the taxpayer ac-
cepted an unsolicited and somewhat staggering offer of $1.2 million
for the remaining land (still over 1800 acres). In ruling that the
sale of the balance of the land was a capital
transaction, Dub6 3.
was of the opinion that
while the plaintiff … was a trader with reference to the sub-divided
lots which it sold throughout the years, and on which it paid business
income tax, it was not a trader with reference to the sale of the re-
mainder of the undeveloped estate.38
This position is relevant to the construction of section 39(5) (a),
which denies the benefit of the capital gains election to “a trader or
dealer in securities”. The statute does not indicate whether this
exception will apply to all securities transactions of a taxpayer
who carries on the vocation of securities trading, including those
on personal account, or whether the courts will be inclined to read
the proviso “with relation to the transaction in issue” into section
39 (5) (a).
More persuasive authority for a schizoid view of “trader in
securities” is Mr Taylor’s ruling in Sher v. M.N.R., which was re-
cently affirmed by the Federal Court.39 When the taxpayer stock-
broker argued that his professional status as a securities trader
imposed a business character on all of his securities transactions,
Mr Taylor stated that “trader” in the sense of a commission sales-
person of investment securities “is not synonymous with being a
trader in securities in his own right. ’40 He went further and con-
cluded that on the evidence the taxpayer was not a trader “in his
own right” or as a principal. Keeping in mind that this case is of
course not concerned with the actual application of section 39(5)
(a), and that it involves a loss on shares and not a gain, it is
interesting that the Minister viewed professional trading as sever-
able from the taxpayer’s personal financial transactions. The parties
38 Ibid., 31.
39 See note 16, supra, and accompanying text.
40 Supra, note 16, 2489 (T.R.B.) per Taylor.
19811
COMMENTS – COMMENTAIRES
did not explore the relationship between the taxpayer’s profes-
sional expertise and his choice of personal investments.
In the companion case, McDonald v. M.N.R.,4 1 the applicant
would have been in a stronger position to argue that his status
governed the tax treatment of all of his securities transactions,
since he controlled the corporation in question, but he was also
found not to have engaged in trading or an adventure with respect
to the shares in question. If Sher and McDonald do not assist tax-
payers in establishing that section 39(5) (a) applies only to the
professional activities of participants in the securities industry,
they at least give “investment” broad meaning for securities sales-
people and would be favourable authorities for taxpayers who are
denied the blanket election.
Aside from a few minor Board decisions which might be con-
sulted when applying other aspects of the election,42 recent de-
cisions do little more than raise interesting questions as to the
eventual interpretation of the election provisions. Will an interest
in a partnership which owns real estatebe treated as a “security?” 4z
Will the election override circumstances which suggest that a
capital gain was manufactured to provide an employment benefit?44
Are people who take over and resurrect loss companies “traders in
securities” or will they be able to take advantage of the election? 45
B. Prescribed securities
The election does not apply to “prescribed securities” of electing
taxpayers. The Income Tax Regulations, Part LXII,4 define pres-
cribed securities in a manner designed to block the most blatant,
41Supra, note 10, and see text at note 15, supra.
42 E.g., Jack Dichter Developments Ltd v. M.N.R. [1979] C.T.C. 2707 (T.R.B.)
per Bonner (appeal to Federal Court pending); Swystun Management Ltd v.
M.N.R. [1979] C.T.C. 2476 (T.R.B.) per Bonner; Whitehouse v. M.N.R., supra,
note 18, (all dealing with whether taxpayers carried on the business of
lending money).
43See Gamble v. The Queen [1979] C.T.C. 463 (F.C.T.D.) per Grant D.J.
(capital gains treatment denied because legal documentation for major long-
term investment would have been more meticulously prepared).
44 See Mountjoy v. M.N.R. [1979] C.T.C. 2232 (T.R.B.) per Bonner (an
employee was allowed to make a superficial gain on shares issued by
employer as an inducement to remain; held income from employment).
45See Spencer v. M.N.R. [1978] C.T.C. 2109 (T.R.B.) per Taylor (profits on
redemption of shares and notes held income from adventure where taxpayers
took over loss company).
46For purposes of s. 39(6) of the Income Tax Act, amended by P.C. 1978-
3729, December 14, 1978 (S.O.R. 78-946).
McGILL LAW JOURNAL
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non-arm’s length abuses of the election. Non-public company shares
are prescribed securities when their value is “wholly or primarily
attributable” to real property owned by the issuing company or,
apparently, by anyone else. This is an open-ended category because
of the vagueness of “primarily attributable”. The provision appar-
ently attempts to prevent taxpayers from taking advantage of the
Fraser47 analysis, but does not provide an escape clause for arm’s
length transactions.
The definition of prescribed securities prevents taxpayers from
simply transferring investment portfolios to electing corporations
as surrogate legal entities. In the Regulations the key provisions are
sections 6200(c) (iii) and (iv), which deny deemed capital gains
treatment to debt or an equity security “that was acquired by the
taxpayer in a transaction in which that taxpayer was not dealing
at arm’s length” or that was acquired in a section 85 (1) or (2)
rollover. Given the broad reach of the non-arm’s length concept in
sections 251 (1)-(5) of the Act, even taxpayers who are willing to
recognize accrued gain in order to transfer securities to controlled
corporations will be blocked by this rule. This subsection can still
be avoided by a taxpayer who finances a controlled corporation
which makes all acquisitions from arm’s length parties, but the
holding company is thus limited to a forward-planning function.
Some caution must be used in financing the holding company,
for ITR section 6200(e) extends prescribed securities to include
debt or equity securities acquired by that taxpayer as proceeds of
disposition for another prescribed security, and securities acquired
“as a result of one or more transactions that may reasonably be
considered
to have been an exchange or substitution” of the
acquired security for a prescribed security. Where the use of an
electing holding company is restricted to acquisitions of new se-
curities, this provision should be no threat.48 However, it does
prevent a taxpayer from eventually making an election that would
apply to the issued securities of the holding company, which means
that taxpayers should not form holding companies rashly. The
election remains irrevocable.
Kathleen A. Lahey*
47 Supra, note 6.
481ote also s. 6200(b) of the Income Tax Regulations, which included
certain non-public company debt instruments as prescribed securities –
again where the transaction is not at arm’s length.
* Of the Faculty of Law, University of Windsor.
