The Taxation of Securities Transactions –
II:
Recent Legislation
Kathleen A. Lahey*
Two recent amendments to the Income Tax Act’ affect the
taxation of securities transactions. Capital losses on certain securi-
ties can now be set off against ordinary income 2 and certain
taxpayers can elect to treat all ordinary gains and losses on securi-
ties as capital gains and losses.3 Neither device is completely origi-
nal, for there are well-known statutory precedents for each in the
United States.4 They are challenging provisions to analyze in the
Canadian context because their authors departed from the American
models in intriguing ways, and these deviations promise to attract
litigation or further amendment of the Act.
I. Operation of the provisions
A. Business investment losses
Section 3 (d) permits taxpayers to deduct from ordinary income
allowable capital losses on the shares or debt of Canadian con-
trolled private corporations, 5 instead of restricting their application
* Associate Professor, Faculty of Law, University of Windsor. This article
states the law as of May, 1979.
– S.C. 1970-71-72, c. 63 as am. [Unless otherwise noted, all references to the
Income Tax Act are to this version.]
2 lncome Tax Act, s. 3(d), added by S.C. 1977-78, c. 42, s. 1(2), applicable
from the calendar year 1978 onward: s. 3(d) must be read with the amend-
ments in ss. 38(c) and 39(1)(c), which were added by S.C. 1977-78, c. 42, ss.
2, 3. The allowable capital losses that may be off-set against ordinary income
are “business investment losses” [hereinafter also “BIL”].
3 lncome Tax Act, s. 39(4), added by S.C. 1977-78, c. 1, s. 16(2), applicable
to calendar years beginning 1977. The commentators refer to this device as
“guaranteed capital gains”: see R.D. Hogg, “1977 Tax Changes –
Implications
for Individuals and Business”, in Canadian Tax Foundation, Tax Conf.
Report (1977), 364, 382; Grover and Iacobucci, Materials on Canadian Income
Tax, 3d ed. (1976), Supplement (1978), 5.
4I.R.C. 1244 permits
incorporators of small businesses
to treat all
gains and losses on that corporation’s stock as ordinary income and-losses,
if such an election is made at the time of incorporation. I.R.C. 1221 deems
all gains and losses on transactions in securities to be capital gains and
losses for all taxpayers except dealers in securities.
5Income Tax Act, ss. 39(1)(c)(i)(A),
(B). “Canadian controlled private
corporation” is defined in s. 125(6)(a) and will be alternatively referred to
herein as “CCPC”.
McGILL LAW JOURNAL
[Vol. 26
to capital gains. If a loss on CCPC shares is generated by a
business transaction or an adventure, the full amount of the loss
may be off-set against ordinary income, but if the loss is a business
investment.loss only half of it may be applied to ordinary income.
The BIL rules do not attempt to clarify the distinction between
capital and income transactions, and so eligibility will rest on
tests devised by the courts
The provisions governing business investment losses are found
in three statutory fragments: sections 39(1) (c), 38(c) and 3(d).
Section 39 (1) (c) is the starting point, defining “business investment
loss” as non-income losses from dispositions of CCPC shares or
debt:
loss for the year determined under this subdivision (to the extent of
the amount thereof that would not, if section 3 were read [without
reference to the expression “other than a taxable capital gain from the
disposition of a property” in paragraph (a) thereof and without reference
to paragraph (b) thereof], be deductible in computing his income for the
year or any other taxation year) from the disposition after 1977 of any
property ….
Section 38 (c) then provides that half of that business investment
loss is an “allowable” business investment loss, and section 3 (d)
instructs the taxpayer to deduct allowable business investment
losses at the time that income losses are taken into account.
The most important effect of this provision is that it takes some
of the sting out of forming a corporation which is so unsuccessful
that its shares are sold at a loss. Previously, tax advisers could
offer only partnership organization to entrepreneurs who foresaw
the possibility of losses: now the limited liability that flows from
incorporation can be acquired while sacrificing only half the tax
benefit of eventual losses, although application of the losses will be
postponed until the actual disposition of the shares.,
I:
6 See generally Lahey, The Taxation of Securities Transactions –
Policy Analysis and Canadian Treatment (1980) 25 McGill L.J. 478, 480-7.
7 Quaere whether the “BIL” rules have any effect on the non-recognition
by s. 85(4) of loss on the non-arms-length disposition of shares to a con-
trolled corporation. Also, s. 54(c) gives an elaborate definition for the
“disposition” of property, but does not allow the taxpayer to recognize loss
in a year in which the obligations become worthless, even if the formal
steps of redemption, cancellation and so forth have not been taken. If the
American experience with stock is any guide, as contemplated in I.R.C.
1244, tax administrators may prove receptive to such a position: see e.g.,
I.R.C. Regs. 1.1244(a)-1(a) which state that 1244 extends to a loss on a
sale or exchange, “including a transaction treated as a sale or exchange,
such as worthlessness”.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
in business operations. However, considering
This improved loss relief is designed to increase the rate of
that
investment
operating losses of a partnership are fully allowable, this partial
allowance for dissolution losses to holders of corporate obligations
may not eliminate the disadvantage of early incorporation. Instead,
to incorporation of
it may simply reduce present disincentives
existing businesses. An entrepreneur can operate an unincorporated
business during the initial loss period, incorporate when the enter-
prise becomes profitable and enjoy the reduced rate of taxation
until the total business limit is exceeded,’ and then take advantage
of the limited protection provided by the BIL rules if the shares
are disposed of at a capital loss in the future.9 A similar scheme is
to be found in the United States, but the Canadian approach is less
generous by comparison. 0 A noteworthy feature of the Canadian
scheme is that losses on holding-company shares qualify for the
special business investment loss relief even if their operations
did not qualify for the small business credit.”
Since section 38 (c) qualifies only half of a business investment
loss for treatment as an ordinary loss, the only real benefit to the
taxpayer is its greater scope of application, because the quantum
of loss relief available is the same in both cases. An inevitable
question is whether a taxpayer may choose to forego the “benefit”
conferred by the new rules, due to hardship or any other cause, or
whether the business investment loss relief is mandatory in all
cases. Circumstances in which this desire will arise may be un-
8 lncome Tax Act, s. 125(2)(b), as am. by S.C. 1976-77, c. 4, s. 49(1), raised
the total business limit to $750,000 for 1976 and subsequent tax years.
9 Note that under s. 125(6)(b) of the Income Tax Act a net loss does not
reduce the cumulative deduction account; it can be reduced only by the
payment of taxable dividends. A corporation which has a significant net
operating loss will not ordinarily be able to distribute enough taxable
dividends to requalify itself for the credit in anticipation of re-establishing
a profit; hence no tax purpose is served in postponing disposition of shares.
10 See I.R.C. 1371 (sub-chapter “S” corporations, which consist largely of
“active business” corporations, are mere conduits for shareholders, as net
profits or losses flow through to the shareholder each year), and 1244
(losses on dispositions of small active business corporation shares are
treated as ordinary losses, not capital losses, and thus are fully allowable
up to $25,000 each year).
1 Cf. I.R.C. 1244(c)(1) (E), which denies special relief if the corporation
derived 50% or more of its income from “royalties, rents, dividents, interest,
annuities, and sales or exchanges of stock or securities”. See also 1244(c)
(2), which defines the small business corporation for purposes of the stock
rules in 1244.
McGILL LAW JOURNAL
[Vol, 26
common, but they are not unimaginable. 12 Section 39(1) (b) is not
coordinated with the new 39(1) (c), nor do sections 38(b) and (c)
complement each other. One may argue that the taxpayer can
compute both the allowable capital loss and the allowable business
investment loss with respect to the same disposition, but section
3 (b) (ii) limits recognition of allowable capital losses in the com-
putation of income for the year to non-business investment losses.
It will be interesting to see whether the courts recognize that
section 39(1) (c) is permissive and that a mandatory construction
would thwart one purpose of the provision, namely, improved
loss relief. This provision continues the trend of favouring in-
corporated businesses in the expectation that this will stimulate the
overall rate of business investment. As a consequence, the rate at
which new corporations are formed will probably continue to
increase even if the rate of formation of business entities remains
stable. 13
B. Lifetime election
The election provided in section 39(4) permits all individuals
to treat all their securities transactions as capital transactions,
provided that they are not dealers or traders in securities. In effect,
the controversy over capital/income classification will now focus
on the determination of who is a dealer or trader in securities.
The lifetime election operates by a deeming mechanism. In the
year in which the election is made, “every Canadian security owned
by him in that year”, as well as Canadian securities owned by the
taxpayer in “any subsequent taxation year”, are deemed to have
been capital property “in those years”. For good measure, every
disposition of those deemed capital properties is deemed to be a
disposition of a capital property. 4 The election may be made in
12 E.g., excess allowable business investment losses will go to make up
non-capital loss carry-over accounts, and not all taxpayers will prefer to have
non-capital loss carry-overs with their limited viability when net capital
loss carry-overs exist indefinitely: see Income Tax Act, ss. 111(1)(a) and (b).
13The total number of corporations in Canada grew from 258,501 in 1973
to 281,831 ir 1974. This figure includes foreign and Canadian controlled,
business and not-for-profit, public offering and non-public-offering corpora-
tions: Canadian Tax Foundation, The National Finances (1977), 73; (1978), 62.
141ncome Tax Act, s. 39(4). “Capital property” is defined in s. 54(b)(ii) as:
:.. any property … , any gain or loss from the disposition of which would,
if the property were disposed of, be a capital gain or a capital loss ….
Since s. 39(1) defines a capital gain as excluding pre-1972 ordinary income,
it is difficult to see exactly how deeming shares as capital property forces
19801
THE TAXATION OF SECURITIES TRANSACTIONS
respect of any tax year after 1976,15 and once it is made it is
effectively a lifetime election which controls the character of all
dispositions of securities as long as the taxpayer continues
to
possess legal personality under tax law. There is at present no
mechanism for revoking the election, although its operation can
be suspended by disqualification. The limitations on the election
refer to the taxpayer and to the subject-matter of the disposition.
If the taxpayer is “a trader or dealer in securities”, or is a corpora-
tion that carries on the business of lending money or of factoring
commercial obligations, or falls into narrow prohibited categories,
the election is inoperative with respect to a year in which the
taxpayer has that disability. 6 The subject-matter limitation provides
that the election applies only to securities which are “issued by a
person resident in Canada”.’ 7 This phrase can be construed broadly
as indicating all obligations which fit within the notion of a
security and are Canadian issues, or it may be construed narrowly
as meaning only the types of securities mentioned in the provision,
with the additional requirement that they be issued by a “person”’18
resident in Canada.
C. Timing considerations of the election
The nature of the election raises some problems in timing which
the taxpayer should consider carefully. These include: (1) when the
decision must be made, relative to the tax year in which the election
is made; (2) factors that should affect the decision;
(3) avoiding
the disadvantages of an early election by the use of a holding
company, and (4) using an early election to protect against future
disqualification.
1. When the decision must be made
The election is made in the taxpayer’s return for the year, which
allows time for reflection. The legal character of the taxpayer does
not affect the election itself, and once the election is made, all of
the shares owned by the taxpayer in the year to which the election
gains to be classed as capital gains. The problem with the scope of
“business” has been that the character of the transaction, and not the type
of property, determined the treatment of the proceeds, so that s. 54(b)(ii)
would not seem to achieve the desired result.
15Income Tax Act, s. 39(4).
16Ibid., s. 39(5).
17bid., s. 39(6).
1s See s. 248(1) of the Income Tax Act for the definition of “person”.
McGILL LAW JOURNAL
[Vol. 26
relates and any securities owned in subsequent years are deemed
to be capital property, beginning with the year of the election.
However, under section 39(5), “an election under sub-section 4
does not apply to a disposition of a Canadian security by a tax-
payer who, at the time the security is disposed of”, falls into one
of the enumerated classes. Only the deemed capital aspect of section
39(4) is nullified, and thus a taxpayer could intermittently treat
gains and losses as capital rather than as income amounts, de-
pending on his or her current occupation. During the years in which
the dispositions are unprotected by the election, the tax treatment of
a sale would be governed by the traditional concepts of adventure,
business and capital gains.
2. Factors to consider in making the election
As the election is effectively permanent, it will always apply to
a taxpayer’s dispositions unless the taxpayer falls into one of the
disqualifying categories set out in section 39(5). But the election
applies equally to gains and losses, so that valuable losses in future
years may be lost if there are no off-setting capital gains available
at the right time. Taxpayers and their advisers should be cautious
in making the election. It should never be made by a taxpayer
anticipating losses, and taxpayers should assure themselves that
their gains actually will be treated as ordinary income before
committing themselves to this irrevocable decision.
3. Electing through a holding company
The most serious shortcoming of the scheme is that it does not
contemplate the taxpayer who deals or trades in securities but who
engages in investment transactions in a personal or private capacity:
the benefit of the election is denied to such taxpayers.
It is suggested that disqualified taxpayers who wish to employ
the election could form controlled corporations which can then
elect. Provided that the corporate formalities are observed, the
subsequent transactions are bona fide and do not involve any
off-market valuations or breaches of fiduciary duties, the cor-
poration would certainly have the right to elect as an independent
legal person. Taking this approach one step further, it would seem
reasonable for all taxpayers to use the election through controlled
corporations, as long as all of the above precautions are taken.
The legal personality of the corporation is terminable at will; that
of a human being is not, at least in a commercial seilse. If this
approach to tax planning is unacceptable to the legislature, a battery
19801
THE TAXATION OF SECURITIES TRANSACTIONS
of anti-avoidance rules will undoubtedly be appended to what is
now a relatively uncomplicated provision. 9
4. Advantages of an early election
The effect of the election is that all of the taxpayer’s Canadian
securities in the year of election, and in subsequent years, are
deemed to be capital property.20 Thus if the election applies to a
disposition it is deemed to be a disposition of capital property.2′
Whether the election applies to a disposition is determined by
section 39(5), which provides that the election does not apply to a
disposition by a taxpayer who, at the time the security is disposed
of, falls into the class enumerated in section 39 (5). Thus a taxpayer
who becomes a dealer or trader in securities, or “tainted” in some
other way, may elect to treat all securities as capital property (by
disposing of some security and making the election) before being
disqualified. The taxpayer can then wait until he or she loses the
disability under section 39(5) before disposing of any securities
held or acquired during that time. Presumably section 39 (4) (a)
would operate
to have been capital
property during the holding period, even if dispositions during that
period would not have been be protected by the election.
to deem such securities
It is not clear whether the election was intended to produce
this result, but the policy of letting tainted taxpayers use the
election to protect earlier acquisitions after leaving the tainting
activity is consistent with the rationale for the capital gains pre-
ference: if such a taxpayer holds securities until after retirement
from trading or financial business, the length of the holding period
would rebut the presumption that the trader or financier intended
to trade rather than invest in securities.
5. Relationship between section 39(1)(c) and section 39(4)
The provisions for the business investment loss and the capital
gains election do not refer to each other. However, since both
operated on the categorization of losses on CCPC shares, questions
as to their ranking and interaction will arise in cases of conflict.
There will be no such conflict unless the taxpayer has made the
19 Quaere the effect of incorporation on the formation of such corporations
and the classification of investment income received by corporations. S. 129
tends to support the contention that the fact of incorporation is no longer
relevant in classifying sources of income, but compare Birmount Holdings
Ltd v. The Queen [1977] C.T.C. 34, 77 D.T.C. 5031 (F.C.T.D.) per Sweet D.i.,
aff’d [1978] C.T.C. 358, D.T.C. 6254 (F.C.A.) per Heald J.
20 1ncome Tax Act, s. 39(4) (a).
21Ibid., s. 39(4)(b).
McGILL LAW JOURNAL
[Vol. 26
election under section 39 (4): if the transaction is a capital trans-
action, the capital loss will be treated as a business investment
loss, and if the transaction is an adventure in the nature of trade
or an ordinary business transaction, the loss will be fully allowable
as a business loss.
Conflict exists between the two provisions only when the follow-
ing conditions are present: (1) the taxpayer has made an election
under section 39(4),
(2) the “securities” in question are CCPC
obligations, and (3) the disposition of the securities generated a
loss. If the transaction in question was in fact a capital trans-
action, and not a deemed capital transaction under section 39(4),
the question is which provision will prevail –
section 39(4),
because any disposition of a security will be deemed to be a dispo-
sition of a capital property, or section 39(1) (c), because a business
investment loss is any loss that is not an income loss under
section 3 (a). Section 39(1) (c) is more specific in its scope than
section 39(4), and thus it may be argued that the loss should be
classed as a business investment loss. This position is further
supported by the argument that section 39 (4) was not enacted in
order to guarantee capital treatment for capital transactions but
was intended to confer greater certainty on transactions that fall
into the middle ground between business and capital transactions.
A more serious version of- the same conflict arises when the
taxpayer realizes a loss on CCPC obligations in a transaction
which is characterized as an adventure by the jurisprudence, but
which is deemed to be a capital disposition because an election
has been made. Is the loss then to be treated as an allowable
capital loss (allowing half to be off-set against taxable gains), or
is it an allowable business investment loss (with half written off
against all income, including taxable capital gains)? The conflict
arises by virtue of the deeming mechanism in the election: is a
loss that is generated by a deemed capital disposition the same
as a loss
determined [under the capital rules] (to the extent of the amount
thereof that would not, if section 3 were read [without reference to the
expression “other than a taxable capital gain from the disposition of a
property” in paragraph [39(1)]
to
paragraph [39(1)] (b) thereof], be deductible in computing his income for
the year … ) from the disposition … of any property [?J
(a) thereof and without reference
The legislation does not attempt to resolve this conflict; but the
traditional rules of interpretation, as well as the apparent intent
of section 39(1) (c), suggest that business investment loss rules
govern, even when the mandatory relief granted by the section is
not particularly beneficial to the taxpayer.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
Once the election has been made, the effect of the combined
election-capital loss relief rules on business losses should alert
the prudent taxpayer to careful consideration of the treatment of
transactions at common law before making the election. A pre-
mature election can disallow half of the taxpayer’s business losses
if they are losses on CCPC obligations, and will further .reduce
the scope of their application if they are losses on non-CCPC
securities.
II. Qualifications for election
The principal reason for providing the election in section 39(4)
is to enhance the certainty of tax treatment of securities trans-
actions by persons who are active in the market22 This is not
the only taxation provision aimed at strengthening the ailing Cana-
dian securities industry;23 and where it does not achieve its purpose
directly, it may do so indirectly by making capital treatment of
securities transactions available to a wider class of taxpayers.
The structure of the election is interesting when compared with
the American approach to the taxation of securities gains. 24 During
22 See the Hon. D.S. Macdonald, Minister of Finance, 1977 Budget Resolution
14 (31 March 1977), quoted in CCH Canadian Ltd, 270 Tax Topics 8 (31
March 1977):
An important impediment to venture capital investment is the tax un-
certainty relating to investments in new enterprises. Under the existing
rules, certain investors face the possibility that any gains on their
investments will be taxed fully as ordinary income rather than as a
capital gain. To remove this uncertainty, a taxpayer will be permitted to
make a permanent lifetime election to have capital gains treatment in
respect of his investments in most types of Canadian securities. This
option will not be available to security dealers, banks, trust companies
or similar financial institutions.
23The amendments of 1977 greatly simplified the rules governing corporate
transfers, but firmly locked capital and pre-1972 surpluses into corporations by
eliminating tax-deferred dividend elections after 1978 (subsequently extended to
1991). This move has somewhat reduced the attractiveness of shares which
previously yielded tax-deferred dividends. However, countervailing
induce-
ments are provided by the “disintegration of integration”, although the
combined effect of these two developments is to draw equity investments
from corporations with large capital or pre-1972 surpluses to those primarily
engaged in property investments. Other tax measures designed to attract
equity investment in incorporated businesses are the enriched dividend tax
credit introduced in 1977 and 1978, the dividend and interest-received deduc-
tions, the elimination of the designated surplus rules and the small business
tax credit.
24The cohesiveness of the North American securities industry justifies a
closer examination of the United States approach. Recognition of the need
for greater uniformity governing the securities industry in Canada and the
McGILL LAW JOURNAL
[Vol. 26
the black days of the U.S. securities markets, section 1221 of the
Internal Revenue Code was enacted to limit the widespread applica-
tion of stock market losses to otherwise taxable incomes.25 That
section limited ordinary loss (and gain) treatment to those who
were “dealers”, holding shares as inventory for sale to customers.
Thus the active trader, who was previously denied capital treatment
because of the frequency and organization of transactions,” had
“guaranteed” capital gains on all securities gains and losses.
The effect of the American approach is to lock in losses in a
declining market, and in rising markets to give investor-traders
the same tax concession that is used to encourage participation by
more modest investors. The American distinction between dealer
and trader is easier to administer than the Canadian distinction
between trader and investor,2 7 as it turns on the capacity in which
the taxpayer acts, while the Canadian distinction depends on the
analysis of various facts, including the frequency of transactions,
for which determinating criteria cannot be precisely defined. When
Parliament drafted an analogous provision for Canada, the notion
of a “guarantee” took on a different aspect. “Traders” as well as
“dealers” are now denied the benefit of the lifetime election, with
the result that the only real guarantee exists for those whose
activities do not constitute trading or dealing but who are too
active to be treated as investors. With a potentially large class of
traders unable to treat securities transactions as capital trans-
actions by election, the lock-in of losses which is experienced in the
United States is lost. The narrower scope of the guarantee also
limits any impact that the provision may be expected to have on
levels of equity investment.
United States dates back at least to the Interim Report of the Ontario
Committee on Company Law (1967). Although the lifetime election does
not go as far as I.R.C. 1221 in guaranteeing traders the capital gains pre-
ference, at least it takes a small step in that direction and thereby lessens
the overall discrepancy in the tax burden borne by speculative investors in
the two countries.
25H.R. Report No. 1385, 73d Cong., 2d Sess., 1939-1 CB (Part 2) 627, 632,
cited in Bittker, Federal Income, Estate and Gift Taxation (1972), 564.
25As Bittker points out (ibid.), it is unlikely that the courts would have
achieved a markedly different result in the absence of I.R.C. 1221(1).
E.g., in Higgins v. Commissioner of Internal Revenue 312 U.S. 212
(1941)
the United States Supreme Court denied business status to the full-time
management of the taxpayer’s portfolio of twenty-five million dollars.
27Slitor, “Can Capital Gains Confusion be Removed by Legislation”? in
Canadian Tax Foundation, Tax Conf. Report (1956), 29, 46.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
Over twenty years ago taxation specialists predicted that legisla-
tion which attempted to define capital gains, or that interfered
with judicial approaches to the separation of capital and income,
would be inadequate.2 8 In so far as the language of section 39 (5)
represents the first step in the codification of “capital”,
their
prediction was correct. The language in that section is too vague
to achieve the intended result.
A. “Trader” in securities
Despite the importance of the concept of “trader” in taxation
law in the United Kingdom, the term has never carried precise
meaning in Canada, having been superseded by “business”. In legisla-
tion regarding the regulation of securities, a trader is one who is en-
gaged as principal or agent in the “business of trading in securi-
ties “, 9 a definition which emphasizes that trading is a form of
business, but that business does not necessarily constitute trading.3
For purposes of section 39 (5), tax jurisprudence can define “trader”
(1) a “trader” is
narrowly or broadly. These are the possibilities:
any taxpayer whose gain is treated as ordinary income on basic
principles established in decided case-law; (2) “trader” applies only
to taxpayers who are carrying on the business of trading in securi-
ties, either as principal or agent; or (3) “trader” refers only to
taxpayers who act as principal in carrying on the business of
trading securities, whether using a broker as an agent or not.-In
this last alternative “dealer” is being reserved for taxpayers who
trade as agents.
1. Technical knowledge of market behavior
Though dealers, like traders, are disqualified from the election,
each category should be defined narrowly enough to permit the
other to operate without ambiguity. Dealing implies the creation
and maintenance of a market in which buyer and seller are brought
together; thus a dealer acts as agent, although some trading may be
done on his or her own account. Yet, even if “dealer” is reserved for
those taxpayers who act as agents, the ambit of trading is difficult
28Eg., McDonald, Capital Gains and Losses in Canada (1951)
29 Can.
Bar Rev. 907; Slitor, supra, note 27.
29 E.g., The Securities Act, 1978, S.O. 1978, c. 47, s. 1(1)7, 42. See citations
collected in (1977) I Canadian Securities Law Reporter 3035 for specific
statutory references.
80 Litigation on the factual criteria of a “trade” in securities legislation
formula, but with
falls back on the familiar frequency-and-organization
somewhat less precision than is found in tax decisions.
McGILL LAW JOURNAL
[Vol. 26
to ascertain because of the ambiguity among “adventure”, “trading”
and “business” in the Income Tax Act. The difference between an
adventure in securities and the conduct of a professional securities
trader is great, but the distinctions are factual and susceptible of
varying interpretation in different contexts. The continuum of trans-
actions on one’s own account looks something like this:
(1) Taxpayer infrequently purchases securities and holds them for long-
term increase in value.
(2) Taxpayer makes informal arrangements to get advice on securities,
occasionally promoting purchases when feeling particularly confident
of trends.
(3) Taxpayer works hard at choosing and timing lucrative transactions,
consulting brokers, investment analysts, conducting crude market
studies –
trading on primary trends and the knowledge of others. All
transactions are made through brokers.
(4) Taxpayer has some special knowledge of the issuer, the industry or
the particular market, and this special knowledge is used to select
and time transactions.
(5) Taxpayer is a securities adviser, promoter or other participant in the
securities industry who also applies knowledge to own account.
(6) Taxpayer is a professionally trained or licensed securities expert who
is the principal in all transactions and does not use the services of
a broker agent.
(7) In addition to the facts in (6), the taxpayer also acts as agent for
other principals in the acquisition and disposition of securities.
Although the factual variations are infinite, this breakdown de-
monstrates that there are really only three important aspects of
securities transactions:
the number and frequency of the trans-
actions, the quality and source of the taxpayer’s knowledge, and
the taxpayer’s status in relation to securities professionals. The
taxpayer described at stages (3), (4) and (5) is difficult to classify
as trader. At stage (6) the taxpayer performs the normal functions
of a trader in securities, while the taxpayers in (1) and (2) are
investorsY’ Where the taxpayer makes a considerable effort in his or
her private and personal capacity, the courts have asked whether the
level of the taxpayer’s activity constitutes a business or a series of
adventures and, though the use of special knowledge is involved, the
tendency has been to classify the transaction as an adventure.
The term “trader” raises the same definitional problems as
“adventure”, and one may ask how it differs from the broader
31 Contrast Bossin v. M.N.R. [1974] C.T.C. 2311, 74 D.T.C. 1231 (T.R.B.) per
Frost; rev’d [1976] C.T.C. 358, 76 D.T.C. 6196 (F.C.T.D.) per Collier J., which
held that speculative investments inspired by a “tip” were adventures in the
nature of trade and the losses therefrom fully deductible from ordinary
income.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
term “business”. If it does, how should the difference be ex-
pressed? The courts have not conclusively resolved the ambiguity
and review board members take conflicting views. Girard [No. 1]
illustrates a broad concept of trading. The taxpayer in
v. M.N.R.
this case was an unlicensed stockbroker and promoter who was
treated as a trader because of the volume and frequency of his
transactions:
[Njot only brokerage houses, licensed stock brokers, agents or sellers of
in the field may carry on the
securities or professional consultants
business of trading in securities. The nature of the transactions, their
frequency, volume and purpose are, in my opinion, valid criteria for
distinguishing between investments per se and business transactions and,
to my mind, can be applied to any taxpayer or transaction. I believe
that, even though he may have neither a licence nor professional status
in the field of -securities, a taxpayer who, in the course of a single year,
buys and resells a substantial volume of securities apparently for the
purpose of realizing a profit from their short-term resale, is carrying on
the business of trading in securities. 3
What Mr Cardin does not make clear is whether stock brokers,
agents, sellers or consultants carry on the business of trading in
securities by virtue of their status as participants in the securities
industry, or whether they are classed as traders only with respect
to their securities transactions. The passage above suggests that the
actual purchase and sale of securities are the touchstones of the
trading classification, but the facts of this case would also support
the view that it was the taxpayer’s status as a participant in the
securities industry which justified the result.
Mr Frost took a narrower view of trading in Donata Investment
Ltd v. M.N.R., 4 in which the taxpayer engaged in a number of
activities, including land investment, some business enterprises and
security transactions. In ruling that share transactions which yield-
ed a $161,000 loss and a $132,000 gain were capital transactions,
Mr Frost stated that a taxpayer must carry on the sort of trading
activity ordinarily conducted by traders employed by brokerage
houses in order to be considered a trader for tax purposes. He
considered expert testimony which left no doubt as to the technical
aspects of trading in securities, and he deduced from this evidence
32 [1976] C.T.C. 2159, 76 D.T.C. 1130 (T.R.B.) per Cardin [hereinafter cited
to C.T.C.]; see also Georges Girard Inc. v. M.N.R. [1976] C.T.C. 2157, 76
D.T.C. 1128 (T.R.B.) per Cardin.
88 Ibid., 2160.
4 [1976] C.T.C. 2288, 76 D.T.C. 1216 (T.R.B.) per Frost [hereinafter cited
to C.T.C.].
McGILL LAW JOURNAL
[Vol. 26
“three badges of trade” exhibited by those who are “in the business
of buying and selling securities”:
1. Constantly watching the ticker tape to take advantage of short-term
market trends.
2. Cutting losses (the witness suggested a maximum of 20%) and
maximizing short-term profits to maintain high liquidity.
3. Trading over a stock exchange is for the most part a full-time job.3a
Mr Frost elaborated this view in Geddes v. M.N.R.,36 which involved
the characterization of gains on commodity futures. While he did
not deny that a non-professional could “trade”, he stipulated that
such a person would have to exhibit the same technical knowledge
as possessed by the professional, “a knowledge of the significance
of trend lines, odd lots, volume, short interest ratios, breadth,
Elliott theory, Dow theory and all the other tools or approaches
which professional people use to interpret market trends
-..
The view expressed by Mr Frost is not unduly restrictive. A
taxpayer who trades as a licensed professional and as principal
will of course be classified as a trader. An unlicensed taxpayer
who brings the requisite degree of technical market knowledge to
the transaction will also be treated as a trader. There is little
support for the proposition that the employment of a broker
insulates the taxpayer from classification as a trader. Ladin v.
M.N.R.3 8 takes the opposite view, citing the payment of $15,000 in
broker fees as evidence of trading.39
The only positive authority for the proposition that use of a
broker is evidence of investor status is Mr Weldon’s ruling in
McLaws v. M.N.R.40 The appellant was the lawyer who had re-
presented Irrigation Industries Ltd in its tax appeals. Relying on
35Ibid., 2290 [emphasis added]. Mr Frost lists fifteen additional criteria
which he gleaned from the testimony, but they merely elaborate on the
three major tests set out in the text.
36 [1976] C.T.C. 2449, 76 D.T.C. 1338 (T.R.B.) [hereinafter cited to C.T.C.].
37 Ibid., 2450.
38 [1977] C.T.C. 2604, 78 D.T.C. 1007 (T.R.B.).
a’ But note this passage from Mr Justice Martland’s decision in Irrigation
Industries Ltd v. M.N.R. [1962] S.C.R. 346, 354:
[The purchase and sale of treasury shares through brokers] is not the
sort of trading which would be carried on ordinarily by those engaged
in the business of trading in securities. The appellant’s purchase was not
an underwriting, nor was it a participation in an underwriting syndicate
with respect to an issue of securities for the purpose of effecting their
sale to the public, and did not have the characteristics of that kind of a
venture.
40 (1964) 37 Tax A.B.C. 132, 65 D.T.C. 1 [hereinafter cited to Tax A.B.C.].
19801
THE TAXATION OF SECURITIES TRANSACTIONS
the “volume and frequency of transactions” test of carrying on
business, he had convinced himself that his stock market trans-
actions amounted to a business and accordingly sought to deduct
a $5,000 loss. Mr Weldon ruled that the loans were generated neither
by trading nor by a series of adventures in the nature of trade. In
rejecting the trading argument, Mr Weldon referred to The Shorter
Oxford English Dictionary definition of trading and commented:
“trading” [is] the carrying on of trade; buying and selling; commerce,
trade and traffic. It is hard to see how Mr. McLaws did any stock trading
in his 1960 taxation year as he dealt with a broker in the same way any
other customer would do. The broker is the trader in each transaction.
He is the one who brings a seller and a purchaser together, and com-
pletes the transaction. When a person buys or sells stocks solely for
himself, he would not appear to be engaged in trading within the usual
meaning of that term.4 ‘
Mr Weldon made special note of the items that defeated the
taxpayer’s contention: he was -not a promoter or an underwriter,
he did not spend much time in studying market behaviour, and he
did not attempt to attract customers.
2. Special knowledge concerning securities
Not all knowledge which is brought to bear on securities trans-
actions is technical knowledge of market trends. As discussed in
the first of these. articles, special knowledge relating to the per-
formance of a particular issue or of a sector of industry can
form the basis for including securities gains in ordinary income.4
‘
Where such special knowledge or ability falls short of the technical
knowledge the trader possesses, it can still form the basis for
including such gains in business income. For example, in Ladin
v. M.N.R.43 a taxpayer employed as a cattle purchaser was found to
have earned ordinary income from transactions in beef, corn and
pork futures. The taxpayer’s knowledge of market trends was
characterized as fundamental, not technical, and the knowledge
that was relevant to the ruling was the taxpayer’s special know-
ledge of the beef futures market.44
The distinction between this type of ordinary business and an
adventure in the nature of trade is difficult to define, and the courts
have treated them as overlapping in many instances. Because of
the substantial similarity between business and adventure where
41 Ibid., 137-8.
42 Supra, note 6, 487 et seq.
43 Supra, note 38.
44 For consideration of whether commodities futures contracts are securi-
ties, see infra, text accompanying notes 120 and 131.
McGILL LAW JOURNAL
[Vol. 26
special knowledge is involved, it is submitted that there is no
logical basis for excluding one, but not the other, from trading.
Adventure in the nature of trade can be excluded from trade on
grammatical and legal grounds. 45 Where the special knowledge is
insider information, knowledge of an industry and the like, the
transaction can be classed as a non-trading business transaction.
Any other approach requires the courts to forge a distinction
between trade and adventure in the nature of trade, an endeavour
which would be highly artificial. If such a course were chosen
and the distinction between adventure and trade could not be
sustained, the election under section 39(4) would be rendered
nugatory because it could not “guarantee” capital gains except to
those who would be treated as investors by jurisprudential criteria.
The category of people included in the proposed definition of
trader is diverse. Corporate insiders and their families or friends,
industry observers plus acquaintances, promoters and controlling
shareholders all have access to the kind of information that in-
creases the possibility of successful transactions, yet none of them
may possess technical market knowledge that would classify them
as traders. Depending on the scope of “dealer”, however, such
taxpayers may still be denied the election.
B. “Dealer” in securities
1. Relationship to “trader”
The term “dealer”, when used in conjunction with “trader”,
implies a distinction in meaning, so that “dealer” would include
acting as agent in purchase and sale transactions, whereas “trader”
would apply to the principal. However, “dealer” is likely to be in-
terpreted as denoting more than agents trading over an exchange.
Judicial decisions indicate incidentally that dealing includes trading
and that it may even include adventures in the nature of trade in
securities. This is not to suggest that earlier judicial discussions
should control the definition of “dealer or trader in securities”.
The legislative purpose of the section should prevail, but Canadian
courts have concerned themselves with these concepts for more
45 Although the broad proposition that adventure and business are mutually
exclusive can be criticized, the suggestion that trade and adventure in the
nature of trade are distinguishable is the proper reading of Lord President
Clyde’s judgement in C.I.R. v. Livingston (1926) 11 T.C. 538 (Ct Sess., Scot.),
and it is the only proposition that counsel for the Minister should have
attempted to establish before Thorson P. in M.N.R. v. Taylor [1956-60] Ex.
C.R. 3.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
than sixty years and the meanings thus established are at least a
point of departure for the interpretation of the same terms in
current legislation.
One approach is to give “dealing” and “trading” the same
meaning as business in general, so that all of the terms are inter-
changeable. In Admiral Investments Ltd v. M.N.R.,46 the appellant
corporation had been formed for the purpose of engaging in security
transactions. It took the position that it was a dealer in securities,
even though it carried out the transactions through the medium
of investment and security dealers. The evidence relied upon by
the corporation consisted of the corporate charter and the volume
of transactions, taken together with testimony as to the intention
of the controlling shareholder. In holding that the gains and losses
in question were from business, Cattanach J. stated:
While the appellant was not a trader in securities in the sense of that
term that it was an underwriter and held a seat on a stock exchange, but
rather made its purchases and sales through a stock exchange in the usual
manner, nevertheless, the acts of the appellant were just the ordinary
transactions of a person who deals in shares.47
This case suggests that a corporation which devotes $90,000 to
securities transactions and acts within its corporate objects will
be classified as a dealer in securities for the purpose of the election.
However, it should be noted that the legal authority upon which
Cattanach J. relied was I.R.C. v. Livingston, 8 which turned on
adventure or concern in the nature of trade. In concluding that
the transaction was carried on in a manner characteristic of those
engaged in ordinary trading in securities, Cattanach J. reduced
dealing, trading and adventuring to synonyms, which, in the con-
text of section 39 (4), reduces the election to meaninglessness.
Gairdner Securities Ltd v. M.N.R.4 9 illustrates a narrower con-
cept of trading and dealing, but again the two terms are used
interchangeably. The appellant corporation had resigned its member-
ship in an investment dealers’ association and had sold its equip-
ment, records and goodwill to an associated corporation that
carried on a business dealing in securities. The appellant retained
its securities at the time of reorganization and then sold them over
a period of time at considerable gain, using the associated company
as a trading agent in each transaction. Mr Justice Rand held that,
46 [1967] 2 Ex. C.R. 308 per Cattanach J.
47Ibid., 319 [emphasis added].
48Supra, note 45.
49 [1952] Ex. C.R. 448 per Archibald J.; af’d [1954] C.T.C. 24, 54 D.T.C. 1015
(S.C.C.) per Rand J. [hereinafter cited to C.T.C.
McGILL LAW JOURNAL
[Vol. 26
notwithstanding its formal resignation from the dealers’ associa-
tion, the company continued to carry on the business of dealing in
securities. The definition of business had not yet been amended
to include an adventure or concern in the nature of trade. The
fact that the trading of the shares was performed by another legal
entity, albeit an associated corporation, did not affect Rand J.’s
conclusion that the corporation was a dealer or trader in securities.
He stated that evidence of one hundred and twenty-four purchases
and two hundred sales after the corporation changed its objects
demonstrated that it was “completing the business admittedly
carried on by the company as a dealer before 1938”.5o
McMahon and Burns Ltd v. M.N.R.5 1 supports the proposition
that the relation of dealer and trader connotes an agency role,
although both terms can also refer to a principal as well. The
appellant corporation was a securities dealer which purported to
purchase debentures as an investment, but Dumoulin J. held that
the debentures could not be distinguished from the larger class of
transactions in which it acted as agent. However, even where the
inventory are clearly segregated, 2
taxpayer’s
classification of the taxpayer’s business as dealing or trading
precludes use of the election for the investment gains, unless a
holding company can be used to create a surrogate legal entity.
investments and
2. Non-trading participants in the securities industry
It should be noted that securities legislation generally divides
the dealer category into sub-categories: brokers, broker-dealers,
investment dealers, mutual fund dealers, securities dealers, and
the like. The characteristic that unifies these participants is their
engagement in the “business of trading in securities” as principal
or agent.5 3 All dealers who so trade must be registered under the
applicable securities legislation, and evidence of registration would
establish that the registrant is a dealer or trader for purposes of
the election. But what of the other participants in the securities
industry? Sales people, promoters and advisers are traders in the
context of securities legislation. For example, in Ontario, a trade
includes “any act, advertisement, solicitation, conduct or negotia-
tion directly or indirectly in furtherance of” an actual transfer of a
50 Supra, note 49, 27.
51 (1954)
11 Tax A.B.C. 140, 54 D.T.C. 370, aff’d [1956] Ex. C.R. 364 per
Dumoulin J.
52See, e.g., Crddit Foncier Franco-Canadien v. M.N.R. [1970] Tax A.B.C.
950, 70 D.T.C. 1609.
53E.g., The Securities Act, 1978, S.O. 1978, c. 47, s. 24(1).
19801
THE TAXATION OF SECURITIES TRANSACTIONS
security.54 The tax usage of “trade”, on the other hand, has been
limited to cases of purchase and sale of property,55 but “dealer”
appears to be more flexible.
The tendency in judicial analysis is to treat promoters and
advisers as having enough special knowledge concerning the securi-
ties in question to classify the transaction as a business trans-
action. Where there is not enough evidence to support a finding of
“business”, “adventure” has sufficed, leaving the definitions murky
once again. Whether such a combination of facts will push all
participants in the securities industry into the category of dealer
is difficult to predict at this time, but there are some guidelines
which the courts may follow.
One criterion is the definition of “dealer”
in the American
scheme of taxing gains on securities
transactions. Those rules
define a dealer as a taxpayer who holds property “for sale to
customers”,56 which implies that the dealer buys at wholesale for
resale to persons other than the seller, and that the transaction
will not be carried out by brokers. Using this approach, the pro-
moter or adviser who occasionally engages
in securities trans-
actions will not be classified as a dealer because he or she would
not be offering securities for sale to customers, but would be
using an intermediate entity (often the taxpayer’s employer) to resell
the securities. Frequency and organization of the transactions would
not be crucial evidence if this approach were used, for the sole
issue would be whether the persons who acquired the shares were
Icustomers”.
Another approach would be to take the definition of a dealer
in securities legislation as including all those who are engaged in
the business of trading securities. This can be a sweeping definition,
as illustrated in an obiter dictum by LeDain J. in Cooper v. M.N.R.: 57
The question … is when as a matter of fact an officer or employee should
be considered to be carrying on the campaign to sell shares to the public
for which his company is primarily responsible. It would not be reason-
able to fix every employee of an incorporated securities dealer, re-
gardless of his function, with participation in the campaign
. One
view might be that the officer or employee must have a certain control
or direction over the campaign so that it can reasonably be considered
to be his campaign. On the other hand, it does not seem reasonable to
…
per Fisher.
TMIbid., s. 1(1)42(v).
55 E.g., No. 429 v. M.N.R. (1957) 17 Tax A.B.C. 270, 298, 57 D.T.C. 338, 353
56 I.R.C. 1221(1)
57 [1977] 2 F.C. 280 (F.C.A.).
(1954).
McGILL LAW JOURNAL
[Vol. 26
exclude one, who, though not in a position to control or direct, is never-
theless actively engaged as a salesman in promoting the market for his
own shares. A “campaign” to sell shares is a course of action that in-
volves not only juridical acts but non-juridical activity of an organiza-
tional and promotional nature. The juridical act of sale is the culmination
of an effort to create and develop a market for the shares and to induce
persons to purchase them. It is that effort that is the campaign. Where
it is not carried out by a single person it requires some organization
involving more than one person. In my view, anyone actively involved
in that organization and effort must be held to be carrying on the
campaign. It must at least be true of a salesman who is actively pro-
moting the shares and who actually sells a considerable number of
them to several individuals0 s
There is considerable authority for the proposition that a pro-
moter is engaged in the business of trading securities, at least when
he or she’ has an allotment of shares being sold at a gain. For
example, McAdam v. M.N.R 9 held that gains on the disposition
of mining shares by a promoter-prospector were business receipts
because the promoter had always been in the business of mining
“in the widest sense” and because he had actively promoted the
corporation.6 0 Similarly, a taxpayer who is an officer and a found-
ing shareholder with a history of dealings related to those of the
corporation,61 or who combines the talents of promoter and securi-
ties specialist, 2 will be denied capital gains treatment.
Can these cases also be taken as describing the promoters as
traders or dealers? The only case that discusses whether promoters
are traders is Davidson v. M.N.R.13 The appellant was an individual
stockbroker, a promoter and the president of an underwriting and
security trading company. With an associate, he held the controlling
interest in a steel company, shares of which produced a loss of
half a million dollars. In holding that the loss was deductible,
Gibson J. observed that the taxpayer acted as a trader throughout,
as illustrated by sales of the steel company’s shares to dealers at
below market value in an attempt to sustain interest in the company.
The reference to the taxpayer as a trader may well have been
transactions and not by the
prompted by the stock-brokerage
58Ibid., 292 [emphasis added], applying Appleby v. M.N.R. [1975] 2 S.C.R.
805, affg [1972] F.C. 703 (F.C.A.) per Thurlow J.
59 [1973] C.T.C. 215, 73 D.T.C. 5189 (F.C.T.D.) per Collier J. [hereinafter cited
to C.T.C.].
60 Ibid., 218.
61 Angle v. M.N.R. [1969] C.T.C. 624, 69 D.T.C. 5423 (Ex.) per Sheppard
D.J.62 Morgan Securities Ltd v. M.N.R.
Davidson v. M.N.R. [1964] Ex. C.R. 48 per Gibson I.
63 Supra, note 62.
[1967] Ex. C.R. 535 per Gibson J.;
19801
THE TAXATION OF SECURITIES TRANSACTIONS
promotions. Except in cases where the intention to capitalize
business profits is judicially discernible,64 it would seem better to
reserve classification as a trader for these promoters whose
other activities constitute trading, whether as agent or as a prin-
cipal.
3. Salespeople
Securities legislation ordinarily defines a salesman as “an indi-
vidual who is employed by a dealer for the purpose of making trades
in securities on behalf of such dealer”.65 The issue arising under
section 39(5) of the Income Tax Act is whether the salesperson’s
trading in securities on behalf of an employer requires that he or
she be designated a trader for the purposes of an election. There
is no authority for the proposition that trading on behalf of an
employer only would be sufficient ground for ruling a salesperson
a trader.”4 On the contrary, Argue v. M.N.R. would appear to estab-
lish the converse proposition.6 7 Most Canadian litigation in this
matter has considered whether securities transactions of a sales-
person constitute business or adventure, and so the, question is
whether a salesperson whose transactions are clearly of an invest-
ment nature may take advantage of the election. Swansburg v.
M.N.R.6s would resolve that issue in the affirmative. The taxpayer
was an employee of a brokerage firm who placed orders on his own
account and lost some $5,000, which he sought to deduct as a
trading loss. Mr Frost ruled that the taxpayer did not himself
carry on the trading business as an employee and was not a pro-
fessional trader: thus it is presumably the employer, and not the
employee, that is the trader in such a case:
[I]n so far as his own accounts were concerned, [the taxpayer] was in
the same position as any other client. When he placed an order for
himself, he was performing the same services as he normally would for
other clients of his firm.6 9
64 See, e.g., Fraser v. M.N.R. [1964] S.C.R. 657, a case concerning the sale
of shares as a means of effecting the transfer of underlying land as a subs-
titute for the transfer of title in the land itself, which was held in the
ordinary course of the taxpayer’s business as a real estate developer.
65 E.g., The Securities Act, 1978, S.O. 1978, c. 47, s. 1(1)39: see also (1977)
I Canadian Securities Law Reporter 1115 for collected references to legisla-
tion in other Canadian jurisdictions.
66 Except perhaps by analogy to Appleby, supra, note 58, or Cooper, supra,
note 57: see supra, text accompanying notes 59 and 60.
67 [1948] S.C.R. 467: see infra, note 76, and accompanying text.
68 [1972] C.T.C. 2125, 72 D.T.C. 1096 (T.R.B.) per Frost [hereinafter cited to
C.T.C.].
69 Ibid., 2126.
McGILL LAW JOURNAL
[Vol. 26
Other decisions suggest that it is possible for a securities sales-
person to be classified as a trader. For example, the taxpayer in
Marcus v. The Queen 0 acted as a promoter and then as a director
of a goldmining company in which he had a substantial interest.
The profit arising from the disposition of his shares was treated
as income from a business because he was much more involved in
the corporation than an ordinary securities salesman would be.
Heald J. gave specific illustrations of this involvement:
(1) he
assisted materially in the marketing of the securities, (2) he pro-
moted the shares as actively as possible, and (3) he used “inside
information” in pursuing his objectives. The full implications of
statutory insider-trading rules for the tax treatment of securities
transactions cannot yet be predicted, but it would seem possible
for the Department of National Revenue to argue that an employee
can be treated as a trader or dealer in his or her own right where
there has been a breach of the statute.
When will an employee who earns business income from share
transactions be classed as a trader? If McLaws7′ is followed, never,
unless the employee acts as an agent on his or her own time; if
Donata Investments Ltd”2 is followed, the test will be the number and
frequency of the transactions. Smith v. M.N.R. 73 suggests that such
“extracurricular” activities must reach a significant level in order
to be treated as business transactions. Mr Smith was a full-time,
commissioned securities salesman who engaged in an increasing
number of transactions over a period of seven years, and allegedly
gained expertise each year. Unfortunately he lost heavily at the
end. The losses were deductible because he was carrying on a
business with these transactions; he used borrowed money, the
shares were speculative, and his transactions disclosed a “syste-
matic and extensive scheme”. It was not suggested that Mr Smith
was a trader, but merely that the transactions constituted a
business.
C. The business of lending money
One of the prime disqualifications in section 39 (5)
is the lend-
ing of money as a principal business. The concept of “security”
includes not only corporate obligations but also secured and un-
70 [1974] C.T.C. 435, 74 D.T.C. 6346 (F.C.T.D.) per Heald J.
71 Supra, note 40.
72 Supra, note 34.
73 [1973] C.T.C. 714, 73 D:T.C. 5526 (F.C.T.D.).
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
secured loan obligations. 74 “The business of lending money” serves
the same function in respect of loan obligations that “trader or
dealer in securities” does in respect of corporate obligations and
other securities. The function of these phrases is to draw a distinc-
tion between investment and business transactions. But the money-
lending exclusion affects only corporations. The Act permits indivi-
duals who would be classed as carrying on a money-lending business
to avail themselves of the election, and this option remains because
to some extent the rules relating to “deep discounting” have dis-
placed jurisprudential criteria for the tax treatment of the capital
element in discounted obligations.7 5
When is a taxpayer in the business of lending money? The
leading Canadian authority on the question is Argue v. M.N.R.76
The taxpayer in that case earned money from a number of sources:
in addition to receiving commissions from a loan company which
he managed, he earned insurance commissions, interest on mort-
gages and promissory notes, and discounts and bonuses on obliga-
tions. The Minister contended that these receipts were income from
1one or more businesses”, but Mr Justice Locke held that the em-
ployment income could not be considered income from business
and that the loan transactions themselves did not constitute a
business. The factors which motivated his characterization of the
loan transactions were the amount of money invested, the number
of mortgages involved, the source of the funds loaned, the quality
of the mortgages, the extent to which the taxpayer personally
involved himself in producing the income, and the taxpayer’s entire
course of conduct in relation to the mortgages over a period of
years. These factors were considered because Locke J. believed that
the transactions were mere investments unless the activity carried
on by the taxpayer was an identifiable commercial business. 77
Locke J.’s approach has been followed in determining whether
the taxpayer is carrying on the business of lending money, whether
or not he is incorporated. Orban v. M.N.R.7 8 illustrates the approach
74See infra, text accompanying notes 102-109.
75Income Tax Act, s. 16(2), (3).
76 Supra, note 67, per Locke J. This case arose under the Excess Profits
Tax Act, S.C. 1940, c. 32, s. 2(g) of which used “carrying on business” in a
context similar to that found in current income tax legislation.
77 Ibid., 473.
78 (1954) 10 Tax A.B.C. 178, 54 D.T.C. 148 per Fordham [hereinafter cited
to Tax A.B.C.]. Although this is only an administrative ruling, it has been
relied upon extensively in personal corporation cases and cases under s.
125 of the Income Tax Act. Whether it will play a central role in the applica-
tion of s. 35(5)(d) remains open to question.
McGILL LAW JOURNAL
[Vol. 26
well and Mr Fordham’s analysis of the evidence is now classic.
Mr Orban had brought some $120,000 with him from Hungary and
eventually he extended three unsecured loans: $20,000 to his em-
ployer, $8,000 to a friend and $20,000 to a company of which he was
a shareholder. The debtors of the latter two defaulted and the tax-
payer treated the amounts as business losses. Mr Fordham ruled
that the taxpayer could not be considered a money lender unless
there was a system or continuity to his transactions, or he held
himself out to “all and sundry” as a money lender, or he engaged
in a multiplicity of transactions.79 Applying this test to Mr Orban’s
case, he found that the taxpayer did not hold himself out as a
money lender, only a few acquaintances knew that he would lend
money, and that he neither advertised nor listed himself as a money
lender.8 0 Hence the losses were not deductible.
Subsequent taxpayers have found it difficult to achieve the
status of professional money lender without incorporation. In
Mullaney v. M.N.R.8
the appellant had devoted $250,000 in per-
sonal savings to mortgages, but was precluded from deducting
travel expenses incurred in the administration of his affairs because
he did not carry on a business of lending money, notwithstanding
the clear fact that he did lend it. This conclusion was based upon
evidence that the taxpayer was retired, and that he did not have
a business office, telephone or advertising program.
Litigation involving incorporated taxpayers has yielded similar
results. Sixteen loan transactions over seven years were held to
fall outside the ordinary course of an exporting company’s business
in Anderson and Miskin Ltd v. M.N.R.8 2 Even twelve loans, with
an aggregate value of $1,200,000, by a company that had wound up
its manufacturing business and had amended its charter, were
classified as investments in W.H. Enterprises Ltd v. M.N.R.,8 3 where
the real basis for decision seems to be that loans to non-arms-length
parties are not in the ordinary course of business.
Valutrend Management Services Ltd v. M.N.R.8 4 raises some
compelling questions in light of Anderson and Miskin Ltd and W.H.
79Ibid., 180. These factors were deduced from English cases which
determined whether an individual was a money-lender within the meaning of
The Money-lenders Act, 63 & 64 Vict., c. 51.
80 Ibid., 181.
81 [19681 Tax A.B.C. 444, 68 D.T.C. 376 per Snyder.
82 [1969] Tax A.B.C. 809, 69 D.T.C. 536 per Fordham.
83[1971] Tax A.B.C. 530, 71 D.T.C. 381 per Davis.
84 [1972] C.T.C. 2170, 72 D.T.C. 1147 (T.A.B.) per Fordham [hereinafter cited
to C.T.C.].
19801
THE TAXATION OF SECURITIES TRANSACTIONS
Enterprises Ltd. The corporation described its business as “the
business of rendering management and administrative services,
lending money and trading in securities”.85 It had outstanding loans
of approximately $1.2 million and had taken reserves for doubtful
debts. Mr Fordham ruled that the reserve was properly taken
because “the making of judicious loans of substantial sums was a
part of the appellant’s income-earning process”. 8 He did not con-
sider that the corporation was “a money-lender within the restrict-
ed meaning of Orban”, though he did describe it as “a lender of
money … to a much larger degree”.
The question raised by this reasoning is whether “the ordinary
business [of] lending money”, which was the issue of statutory
interpretation in Valutrend Management,88 is similar to “the prin-
cipal business of lending of money” in section 39 (5) of the Income
Tax Act. The similarity in expression is striking, and it would appear
that Valutrend Management should displace Orban as the authority
for defining “lending of money” in section 39 (5). Thus, Mr Ford-
ham’s twofold test for money-lending corporations rests upon a
consideration of (a) the volume of transactions and (b) a deter-
mination whether the loans are of a commercial nature.
The differences of approach in Mullaney and Valutrend Manage-
ment may be attributable to a shift in the policy which underlies the
‘statutory provisions at issue. In Mullaney, the travel expenses which
the taxpayer claimed were perhaps more jealously guarded than
corporate reserves which would eventually be brought into income
if the doubt turned out to be ill-founded. The same sort of shift
in administrative attitude is seen in the application of the old
personal corporation rules and the small business credit under
the 1972 Act. Under section 68 it was virtually impossible for a
corporation to establish that interest income was earned from
the “active” business of lending money. 9 However, since 1972 a
number of small money-lending operations have qualified as active
85 Ibid., 2171.
86 Ibid., 2172.
87 Ibid.
88S. 11(1)(e) of the Income Tax Act, R.S.C. 1952, c. 148, now s. 20(1)(1) of
the Income Tax Act.
89 See Finning v. M.N.R. [1961] Ex. C.R. 403 per Dumoulin J.; Graham v.
M.N.R. [1970) Tax A.B.C. 1185, 70 D.T.C. 1747 per Fordham; Smith v. M.N.R.
(1963) 34 Tax A.B.C. 259, 64 D.T.C. 49 per Fordham; Glaspie v. M.N.R. (1963)
33 Tax A.B.C. 274, 63 D.T.C. 828 per Fisher; No. 74 v. M.N.R. (1952) 7 Tax A.B.C.
25, 52 D.T.C. 410 per Fisher.
McGILL LAW JOURNAL
[Vol. 26
businesses for the purposes of section 125.00 Further, the effect of
incorporation has a remarkable impact on these decisions, as’
illustrated by a comparison of the results with LeDain J.’s decision
in Chaffey v. M.N.R.9 In that case the taxpayer (an individual) had
made large advances to corporations in which he held an interest
and then sought to deduct losses on the obligations as losses
suffered in the ordinary course of carrying on a business of
lending money.9 2 In denying the claim, LeDain J. reiterated the
definition of “the business of lending money”:
In my opinion shareholder’s advances do not constitute the business
of lending money; they are simply a particular form by which capital
is put into a company. The loans made by the partnership did not have
as their principal object the accommodation of persons in return for
income in the form of interest;
they were merely a device for the
financing of projects through which profit was to be made by other
means.93
Although this statement of the principle depends upon an assess-
ment of the taxpayer’s intention, it allows that, if the taxpayer’s
financing is motivated by a gain on other property, the prime object
is not only to profit from the investment interest.
D. Factoring commercial obligations
Section 39(5) (f) (ii) precludes a corporation whose principal
business is “the purchasing of conditional sales contracts … or
other obligations representing part or all of the sale price of
merchandise or services” from taking advantage of the election.
The distinctions and rationale elaborated above apply with equal
force to this exclusion.
One problem is suggested by earlier cases. Where two associated
corporations have been established in order to separate the mer-
chandising and financing aspects of a business, will the fact that
they may be subject to common control affect the determination
whether the financing corporation falls under section 39 (5) (f) (ii)?
This possibility is suggested by cases such as Finning v. M.N.R., 4
in which Dumoulin J. held that where the operating corporation
90See M.R.T. Investments Ltd v. The Queen [1976] 1 F.C. 126
(F.C.A.)
per Jackett P.; Lazare Investments Corp. v. M.N.R.
[1975] C.T.C. 2036,
75 D.T.C. 26 (T.R.B.) per Flanigan; Parico Ltde v. M.N.R. [1975] C.T.C. 2234,
75 D.T.C. 173 (T.RB) per Cardin.
91 (1978) 78 D.T.C. 6176 (F.C.A.).
92 1ncome Tax Act, s. 11(1)(e), (f).
93 Supra, note 91, 6179.
94 Supra, note 89.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
in such an arrangement made all the day-to-day business decisions,
reducing the financing company to a passive holding company, the
financing company did not strictly have a financial business, and
thus did not carry on an active business for purposes of the personal
corporation rulesY5
Although this view of a holding company is consistent with the
legal criteria for determining that a taxpayer is carrying on a
business,96 the policy of the provision makes such a result absurd.
A taxpayer could separate its commercial obligations from other
operations simply by transferring them to a controlled corporation;
accordingly, it could retain eligibility for the election in respect of
other securities transactions.
E. Other exclusions
The remaining exclusions are not complicated. Chartered banks,
incorporated trustees, credit unions and life insurance corpora-
tions97 are major holders of securities, and to permit them the
election would allow them to treat all securities transactions as
capital transactions. But that does not mean that the only alterna-
tive is to force large institutional owners of securities to defend
each individual claim to capital treatment. It should be possible to
require identification and segregation of securities to facilitate a
limited “guaranteed capital gain” for institutional holders. 98 Other-
wise, institutions may keep what they consider adequate records,
yet discover in litigation that more was required.9
F. Summary
The broad policy of the election is clear: it is intended to give
investors “guaranteed” capital gains in order to make the tax
treatment of securities transactions more certain, to broaden the
class of investors who are eligible for capital gains and to limit the
951Ibid., 407-9.
96See, e.g., Hannan & Farnsworth, Principles of Income Taxation (1952),
152 et-seq.
97 Income Tax Act, s. 39(5)(b)-(e).
98 Again, the American experience offers a useful model:
I.R.C. 1236
provides that “dealers”, who are denied capital gain treatment on securities,
may still qualify for such treatment on securities that are identified for
long-term investment and held in separate accounts. Gains on such securities
are automatically on capital account, but when a position is challenged
by the I.R.S. the taxpayer bears the burden of proof.
9 9 See, e.g., Rosslyn Estates Ltd v. M.N.R. [1972] C.T.C. 65, 72 D.T.C. 605
(F.C.T.D.) per Walsh I.
McGILL LAW JOURNAL
[Vol. 26
class of investor-speculators who are eligible for ordinary losses.
However, to achieve these objectives, the nature of the election
depends on the scope of exclusionary clauses in the Act, which leave
the taxpayer in no better position than did earlier jurisprudence.
The precise relationship between ordinary business, trading, dealing
and adventuring has never been the focus of Canadian tax litigation,
yet the authors of section 39(5) apparently expect that the scope
of “dealer or trader in securities” can be settled in light of previous
decisions. The courts will find no easy way out of the maze created
by the section. If they rule that “trader or dealer” includes adven-
turers, in order to rest eligibility on a pre-existing distinction
between investment and business, the tax treatment of share gains
is no more certain than before the statutory provision for the elec-
tion, and in the result there will have been no modification in
eligibility for the capital gains preference. If
the definition of
”trader or dealer” is based on a formalistic distinction between
trading and adventuring, then fewer losses will receive ordinary loss
treatment and uncertainty will be further compounded. It will be
interesting to see whether the increase in revenue that should
flow from a restricted application of losses, coupled with the effect
of the new “incentive” to seek securities gains, will justify the
continued expenses of administration, compliance and litigation
promised by these vague rules.
III. What is a “security”?
The uncertainty spawned by the election does not end with the
problems posed by a “dealer or trader”. “Security” is also an elastic
term and the courts can control the scope of the election by its
definition. Two problems arise in defining a Canadian security as
a “share, bond, debenture, bill, note, mortgage, hypothec or similar
obligation”. 0 0 The first question is whether “similar obligation”
will be read ejusdem generis with the enumerated items or whether
it will receive an expanded definition as it has in securities legisla-
tion. The second question is whether the qualification “issued by a
person resident in Canada” will be construed as limiting the class
of issuers to “persons” as defined in section 248(1) of the Act, as
well as to residents of Canada, or whether the phrase will merely
be viewed as stipulating a residence requirement for unincorporated
issuers. “Person” is defined as “any body corporate and politic, and
the heirs, executors, adiministrators or other legal representatives
IOO Income Tax Act, s. 39(6).
19801
THE TAXATION OF SECURITIES TRANSACTIONS
of such person”. It has been suggested that “securities” will not
include those issued by unincorporated associations,101 even though
the policy behind the qualification seems to be “buy Canadian
securities”, and not “buy corporate securities”.
A. Scope of “security”
The factors which connect the types of securities named in the
Act are not articulated, and thus the salient criteria in defining
the term are not expressed. There are two approaches that can be
used. In the first, the meaning of “securities” in tax jurisprudence
may be used to show that the definition has been widened where
the context of the statute so requires. The second is patterned
after that employed in securities legislation, and it assumes that
the policies underlying securities legislation and the election pro-
vision are sufficiently similar to warrant analogy.
1. Tax concept
There are two opposing notions of what constitutes a security
in tax law. First, it may be argued that as a term of art there must
be an element of security inhering in property for it to be classified
as such. Thus, at trial in Manitou-Barvue Mines Ltd v. M.N.R., 12
common shares which were issued in lieu of interest on debentures
were held not to be securities for purposes of section 24 (1) of the
1952 Act, “simply because there was no element of security attached
to them”. In appeal however, Gibson J. ruled that vernacular usage
would support the characterization of common shares as securi-
ties. 0 3 This more liberal concept of security is consistent with the
expanding definition of security in securities legislation and con-
notes an investment of any kind, and it implies that evidence of
“secured” interests is not required for the classification. For ex-
ample, Heald J. held in Canadian and Foreign Securities Co. Ltd
v. M.N.R.’04 that a temporary demand loan note on an unsecured
promissory note is a security in the context of legislation governing
tax treatment of investment companies. He rejected the conten-
tion that a security must be “secured”, 10 5 and looked favorably on
101 Hogg, supra, note 3, 384.
102 (1964) 37 Tax A.B.C. 199, 211-2; 65 D.T.C. 45, 53 per Weldon.
103 [1966] Ex. C.R. 329, 332.
104 [1972] F.C. 904 (F.C.T.D.).
105 To be more precise, he distinguished all of the cases which supported
the proposition that a “security” must be ‘.’secured”, although it is clear
from the way in which he distinguishes the cases that he is rejecting the
proposition and not just calling for a stronger analogy.
McGILL LAW JOURNAL
[Vol. 26
the proposition that the word should be given the common-sense
connotation of an investment. A broad analysis like this invites
expansive definitions where the policy of the provision requires
it. An appropriate model for this expansion may be found in the
judicial notion of “security” in Canadian securities legislation.10
2. Securities legislation concept
Re Pacific Coast Coin Exchange of Canada and Ontario Securi-
ties Commission’0 7 points the way to the expansion of the meaning
of securities in provincial legislation. The appellant sold bags of
silver coins to customers on margin with the understanding that
the buyers would not take delivery of the coins but would sell
them to the appellant when and if the price went up. The appellant
engaged in a great deal of market activity in order to promote
the price of the coins for its own benefit and that of its customers.
If the commodity account agreement between the customer and
the appellant were to constitute a security, it had to fit into one
of the following descriptions of a security given in The Securities
Act: :os
“Security” includes,
i. any document, instrument or writing commonly known as a
security,
ii. any document constituting evidence of title to or interest of any
capital, assets, property, profits, earnings or royalties of any
person or company, …
xiii. any investment contract, other than an investment contract within
the meaning of The Investment Contracts Act …
It was held to fall into the last category.
Judicial reasoning has given narrow ambit to paragraphs (i) and
(ii) , 09 but “investment contract” has been treated as a term of
106 By comparison, I.R.C. 1236(c) defines “securities” for purposes of
1221(i) as including shares, bonds, debentures, notes or “evidence of in-
debtedness”, and this is in principle similar to the definition of “security”
in s. 39(6) of the Income Tax Act. There has been considerable litigation
over the meaning of “evidence of indebtedness”, but that phrase is narrower
than the Canadian equivalent (“similar obligations”) and thus the American
case law is not very helpful on this point.
107 (1975) 7 O.R. (2d) 395 (Div. Ct), aff’d (1975) 8 O.R. (2d) 257 (Ont. C.A.).
108 R.S.O. 1970, c. 426, s. 1(1)22(i), (ii), (xiii); now The Securities Act, 1978,
S.O. 1978, c. 47, s. 1(1)40(i), (ii), (xiii).
10 9 See, e.g., Re Pacific Coast Coin Exchange of Canada, Ltd and Ontario
(Div. Ct): cf. R. v. Dalley
Securities Commission, supra, note 107, 407
[19573 O.W.N. 123, 118 C.C.C. 116 (C.A.); Swain v. Boughner [1948] O.W.N.
141 (H.C.); Re Ontario Securities Commission and Brigadoon Distributors
(Canada) Ltd [1970] 3 O.R. 714 (H.C.).
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
unspecified and broad meaning. “Investment contract” and “similar
obligations” in the capital gains election serve the same function,
that is, to expand the meaning of a security beyond the rigid notion
of documents giving evidence of secured transactions, and to make
it possible for the courts to find a security wherever there is a
significant investment interest.
In Pacific Coast Coin Exchange Houlden J. quoted with approval
the American view of “investment contract”:
The phrase “investment contract”, as used in the securities acts is a
“nebulous term, difficult of definition and even more difficult of applica-
tion”. It is designed, of course, “to meet the countless and variable
schemes devised by those who seek the use of the money of others on
the promise of profits”.110
In section 39(6), “similar obligation” serves the same function, and
thus it is submitted that “similar obligation” should receive the
same expansive reading as “investment contract”. In reaching the
conclusion that the commodity account agreements did constitute
securities because they were investment contracts, Houlden J. posed
no less than three different methods of determining whether the
transaction gave rise to an investment contract: the Howey test, the
risk capital test and the investment approach.
(a) The Howey test
The Howey test originated in the United States Supreme Court.,’
Four elements must be present for a “contract, transaction or
scheme” to be classed as an investment contract: (1) the investment
of money (2) in a common enterprise (3) with the expectation of
profit (4) solely from the efforts of others. 1 2 Each of these four
elements received broad application by the Ontario Court of
Appeal in Pacific Coast Coin Exchange. A common enterprise exists
when the ordinary activities of the issuer affect the value of the
property acquired by the customer:
[T]he ultimate profit to the customer is not dependent merely on the
price established in the bullion market for silver, but on the efforts of
the appellants to make a market for silver, their ability to hedge against
future obligations, and the price set is the appellant’s own price de-
pendent in part at least on the supply and demand within the appellants’
own operation. In my opinion, the effect of the transaction that the
appellants entered into with their customers is one which involved the
investment of money in a common enterprise with the expectation of
110 Supra, note 107, 408 (Div. Ct), quoting from Sinva, Inc. v. Merrill, Lynch,
Pierce, Fenner & Smith, Inc. 253 F. Supp. 359, 365 (S.D.N.Y. 1966).
(1946) per Murphy J.
11 Securities Exchange Commission v. W.J. Howey Co. 328 U.S. 293, 298-9
112 As put by Houlden I., supra, note 107, 408.
McGILL LAW JOURNAL
[Vol. 26
profit, the amount of which is for all practical purposes, if not solely,
dependent on the efforts of the appellants. 113
The fourth element has also received broad application in Ontario.
It
is apparent from the above passage that the value of the com-
modity account agreements depended partly on general market
forces and partly on the activities of the issuer, thus ruling out any
possibility that the expected profits were derived solely from the
efforts of the issuer. “Solely” has been defined narrowly in similar
legislation in the United States, 114 but evidence of a contributing
factor will apparently suffice before the Ontario Court of Appeal.
In Pacific Coast Coin Exchange both the trial court and the Court
of Appeal accepted the expanded Howey test as a valid basis for
classifying the commodity account agreement as a security.
(b) The risk capital test
Disagreeing with some of the restrictions of the Howey test,
especially its emphasis on the expectation of profit, Professor
Coffey developed what is known as the risk capital analysis of
“security”. 1″ 5 This test is based on the Howey approach but is
modified heavily by a consideration of the economic realities of
security transactions:
(1) An offeree furnishes initial value to an offeror, and
(2) a portion of this initial value
is subjected to the risks of the
enterprise, and
(3) the furnishing of the initial value is induced by the offeror’s promises
or representations which give rise to a reasonable understanding
that a valuable benefit of some kind, over and above the initial
value, will accrue to the offeree as a result of the operation of the
enterprise, and
(4) the offeree does not receive the right to exercise practical and actual
control over the managerial decisions of the enterprise.110
This test of a security was referred to with approval by the British
Columbia Court of Appeal in Re Bestline Products of Canada Ltd
IL Supra, note 107, 262 (C.A.).
114The rigid American definition of a security in this regard was one of
in
the factors that impelled Coffey to suggest the “risk capital analysis”
The Economic Realities of a “Security”: Is There a More Meaningful Formula?
(1967) 18 Case W. Res. L. Rev. 367, 374-5, adopted by the Supreme Court of
Hawaii in Commission of Securities v. Hawaii Market Center Inc. 52 Hawaii
642, 485 P. 2d 105 (1971).
115 Ibid., 375.
116Re Pacific Coast Coin Exchange of Canada and Ontario Securities
Commission, supra, note 107, 410. See Coffey, supra, note 114, 377 for the
original presentation of these characteristics and a discussion of what
constitutes a security in the context of American litigation.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
and the Securities Commission,117 and formed the second basis for
the result in Pacific Coast Coin Exchange,”8 although in the latter
case neither the trial court nor the appellate court analysed the
components of this test in detail.
On a risk capital analysis, there are still several transactions
which do not give rise to securities. Houlden J. explained that
ordinary commodities futures contracts did not constitute securi-
ties merely because delivery after sale is deferred.” 9 The purchaser’s
control over most unincorporated ventures would tend to nullify
the attractiveness of this test.
(c) The investment test
legislation, that is,
In Canada, the broadest approach to defining a security is set
out in Houlden J.’s decision in Pacific Coast Coin Exchange. Al-
though he reached his conclusion on the basis of the Howey and risk
capital tests, and was affirmed on those two grounds, he stated that
“the tests propounded in the American cases are too rigid and
restrictive and if literally applied, could defeat the purposes of
‘the protection of the investing
securities
public’ …”120 He proposed that “investment contract” should refer
to all contracts which provide for investment, and he adopts from
tax law the concept that an investment is the transfer of value in
exchange for “income or profit from its employment”.’ 2 1 To off-set
the possibility that such a sweeping concept would lead to un-
warranted expansion of “security”, he suggests that the courts “can
narrow its sweep by applying the test of economic reality”. 2 2 The
appellate court did not comment on this aspect of Houlden J.’s
reasoning.
The practical effect of this investment concept would be to
r.emove the requirement that the purchaser’s expectation of gain
or profit be causally related to any representations by the issuer
or seller. The gain or profit can be wholly dependent on unrelated
forces, such as market forces or fortuitous events, yet the guiding
objective of the purchaser would be disposition of the investment.
(1973) 29 D.L.R. (3d) 505 (B.C.C.A.).
117 Re Bestline Products of Canada Ltd and the Securities Commission
“18 Supra, note 107, 411 (Div. Ct); aff’d 262 (C.A.).
“19 Ibid., 412.
120 Ibid., 411.
121 Ibid., quoting Commissioner of Taxes v. Australian Mutual Provident
Society (1903) 22 N.Z.L.R. 445, 450 per Stout CJ., and citing Securities
Exchange Commission v. W.J. Howey Co., supra, note 111, 298.
2 Ibid., 412.
McGILL LAW JOURNAL
[Vol. 26
In defining an investment, the emphasis is on the investor’s lack
of control over circumstances that determine gain or profit.
Of the three current approaches to defining securities in securi-
ties legislation, the investment test given by Houlden J. is most
appropriate to the capital gains election, especially since its origin
reflects the nature of an investment for speculative purposes. Essen-
tially, this test is a modification of the risk capital test, the modifi-
cation being that inducement by the seller and reliance on the
efforts of the issuer for gain or profit are eliminated from considera-
tion. A schema for the test may be set out as follows:
(1) A transferee furnishes initial value to a transferor, and
(2) a portion of this initial value is subjected to the risks of an enter-
prise, and
(3) the furnishing of the initial value is induced by the transferee’s …
reasonable understanding that a valuable benefit of some kind, over
and above the initial value, will accrue to the transferee as a result
of the operation of an enterprise, and
(4) the transferee does not receive the right to exercise practical and
actual control over the managerial decisions of the enterprise.123
Such a sweeping concept of a security or similar obligation would
apply to almost any obligation in which there is some sort of con-
tinuing commitment, either expressed or implied, running from the
other party to the taxpayer. However, the types of securities listed
in section 39(6) of the Income Tax Act should not be disqualified
if they fall within the enumeration in form but fail to meet the
substantive test set out by Houlden J. The policy which motivates
the enactment of the election is to confer as much certainty as
possible on the investing taxpayer, and that policy cannot be served
by the use of an expansive concept of “similar obligation” which
cuts down the plain meaning of the Act’s words. 12 4 The third element
in the above scheme would not by itself prevent even a promoter
from treating an investment in shares of a wholly owned corpora-
tion as securities, but when the promoter gains “the right to
exercise practical and actual control over the managerial decisions
of the enterprise”, the fourth element would disqualify the corporate
shares from the class of securities. However, corporate shares are
123 This entire formulation is merely a variation of an otherwise verbatim
reproduction of Professor Coffey’s risk capital analysis, but the modifica-
tions change the scope of the definition.
124 Cf. Coffey, supra, note 114, 403-7 where he argues that the substantive
result of the risk capital analysis should override the express terms of
the statute if the results of the statutory rules are to be consistent with the
underlying policy.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
specifically listed as securities in section 39(6), evidencing clear
parliamentary
the definition of
“similar obligations” by administrators and judges, corporate shares
shall be treated as securities.
intention that, notwithstanding
The use of any of these three approaches to the definition of
a security is subject to one theoretical difficulty. In so far as all
three approaches exclude those documents revealing title in an
enterprise actually managed by the taxpayer, the distinction between
securities and all other participating interests is the same as that
between investment and non-investment transactions. While actual
control over management of the enterprise will probably be an
easier standard to apply than the multiplicity of factors usually
relied upon, the focus of the issue has merely been shifted from the
nature of the purchase and sale to the subject-matter thereof. Yet
the same concept arises in determining the nature of the taxpayer
in section 39(5), and the overlap is further complicated because
section 39(5) (a) and section 39(6) require an election but for
different reasons. “Dealer or trader” must be defined narrowly so
that the ordinary promoter is not included, and by defining “similar
obligations” as investment contracts, “investment” must receive
its broad vernacular meaning.
In summary, it should be clear that if the election is going to
bring certainty to transactions which have always had uncertain
tax consequences, “securities … or similar obligations” will have
to be construed broadly. If only corporate shares and the other
enumerated securities are affected by the election, the old ambiguity
will be compounded by uncertainty as to whether the property in
question constitutes an enumerated security.
B. “Issued by a person resident in Canada”
An expansive reading of “security” may be of little use if
“issued by a person resident in Canada” is given the restricted
meaning advocated by Mr Hogg.1 5 Noting that “person” is defined
in section 248 (1) as “any body corporate and politic”, he concludes
that a number of specific types of securities will be excluded from
the application of the election because they are not issued by a
“person”. The disqualified issuers fall into two groups, certain
governmental issuers and unincorporated issuers, yet it may be
possible to get around some of the obstacles he discusses.
125 Supra, note 3, 384.
McGILL LAW JOURNAL
[Vol. 26
1. Governmental issuers
Hogg states that “federal and provincial governments do not
appear to be included within the legal definition of ‘person’ (i.e.,
government is not an incorporated body and cannot be sued) “.520
This conclusion presupposes that “and” in the phrase “any body
corporate and politic” is to be read so that a “body” is a person
only if it is not merely incorporated but a body politic was well. How-
ever, legal usage has established that the “and”
is to be read
disjunctively. A private corporation which is in no way a body
politic is of course a “person” under the Income Tax Act. To be
consistent, an unincorporated body politic would also be a person.127
Provincial and federal governmental issues would constitute securi-
ties within the meaning of section 39 (6), as would securities issued
by incorporated municipalities and governmental agencies.
2. Unincorporated issuers
Hogg also takes the position that “options, commodity futures,
currency contracts and interests in real estate ventures, such as the
likely be excluded” 12
recent public issues of MURB’s, 1 2 will
because they are not issued by any body corporate. There are, at
least, two ways to get around this narrow view of “securities issued
by a person resident in Canada”, and possibly three if one dis-
regards the statutory definition of “person” because of context.
The first weakness in the narrow view of “person” is that the
word denotes not only bodies corporate and politic but indivi-
duals. 0 Although a partnership is not a person under the Income
Tax Act, 3
1 an obligation which purports to be issued by a partner-
ship in law would be issued by its partners because they bear
responsibility for all obligations undertaken. The same rationale
would apply to other obligations which purport to be issued by
unincorporated associations but which are in law the obligations
of individuals or corporations which are members of the associa-
tion. Commodity futures, currency contracts and interests in real
estate ventures would thus be issued by persons, and whether they
constitute securities will depend entirely on the substantive terms
of the obligation.
126 Ibid.
127 See M.N.R. v. Braithwaite [1969] C.T.C. 677, 70 D.T.C. 6001 (Ex.).
128 See Income Tax Regulations, Sch. B, Classes 31 & 32, as am.
129 Hogg, supra, note 3.
1 0 See Income Tax Act, s. 248(1), “individual”.
131 Storrar Dunbrick Ltd v. M.N.R. (1952) 6 Tax A.B.C. 163, 52 D.T.C. 154:
see also No. 116 v. M.N.R. (1953) 9 Tax A.B.C. 97, 53 D.T.C. 344 and No.
117 v. M.N.R. (1953) 9 Tax A.B.C. 100, 53 D.T.C. 345.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
The second weakness of the narrow view of “securities issued
by a person .. .” is that “person” need not be construed as referring
only to incorporated bodies. Section 248(1) states that “person”
includes bodies corporate, so that an expansive reading of the
statute may be employed. Further, “person” includes any legal
representative of a person, and that is indeed a wide concept. While
the issue has never arisen under the Income Tax Act, the Exchequer
Court stated that a slightly different definition of “person” in the
Income War Tax Act’u included a trust 13 or an association.134 But
as with every other difficult definitional aspect of the lifetime elec-
tion, the meaning of “person” that is adopted by the courts will
reflect the courts’ understanding of the policy by which the elec-
tion was enacted. By refusing to be distracted by an arcane and
technical reading of “person”, the courts would affirm that the
meaning of “person” in section 2(1) is quite different from that in
section 39 (6).
It is submitted that a reasonable construction of “person” would
operate to qualify the words “resident in Canada” and not to cut
down the substantive meaning of securities. While it is true that
there may be some difficulty in fixing the residence of unincorporat-
ed associations where more than one person stands behind the
obligation, the problem is not insurmountable. 13 5
132R.S.C. 1927, c. 97, s. 2(h): “Person includes any body corporate and
politic and any association or other body, and the heirs, executors, adminis-
trators and curators or other legal representatives of such person, accord-
ing to the law of that part of Canada to which the context extends”.
133 McLeod v. Minister of Customs and Excise [1925] Ex. C.R. 105 per
’34 Port Credit Realty Ltd v. M.N.R. [1937] Ex. C.R. 88 per Angers J.
‘3 E.g., Green, The Residence of Trusts for Income Tax Purposes (1973)
MacLean J.
21 Can. Tax J. 217.
