The Taxation of Securities Transactions –
Policy Analysis and Canadian Treatment
I:
Kathleen A. Lahey*
Introduction
Capital gains form only a small portion of the tax base,’ but
they are an important component of the incomes of wealthy Cana-
dians.2 Securities transactions are a significant source of capital
gains and losses.3 Securities transactions not only involve large
numbers of taxpayers but also account for a large percentage of
the net gains and losses reported by taxpayers. Although only general
breakdowns of income by source and income class are” available,
they provide an adequate basis for concluding that securities trans-
actions are a major source of capital gains and losses. Since capital
gains taxation was introduced,4 securities transactions have been
a major source of gain in an inflationary economy5 and the major
source of losses in a recession.0
The percentage of gain or loss from real estate transactions
has been growing steadily since 1971, as taxpayers find it harder to
delay dispositions However, realizations of shares should continue
to outstrip dispositions of real property, even though real property
constitutes one of the major sources of wealth in Canada. One
* Associate Professor, Faculty of Law, University of Windsor.
‘ Figures are available only through 1976. In 1972, total net taxable capital
gains amounted to .22% of all incomes reported. In 1973, the figure hovered
around .3% and in 1975 jumped to 3.65% of all incomes. See App. 1.
2 Ibid.
3 Of all taxpayers who reported net gains or losses in 1975, 50% reported
that these gains or losses resulted from the disposition of shares. In addition,
12% of all taxpayers who reported capital gains or losses realized gains or
losses on bonds in that year. In comparison, only 28% of that class of tax-
payers reported gains or losses on real estate and 18% on “other capital
property”, which consisted largely of personal use property. Comparable
figures for share gains and losses in 1972, 1973 and 1974 are 65%, 50% and
48% respectively: see App. 2. App. 3 illustrates the same figures graphically.
4 Income Tax Act, S.C. 1970-71-72, c. 63 as am. [Unless otherwise noted, all
references to the Income Tax Act refer to this version.]
see App. 4.
5 In 1972, share transactions accounted for 89% of gains; in 1973, for 56%:
The share of loss attributable to shares alone grew from 29% in 1973 to
90% in 1974: see App. 4.
” See App. 3.
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THE TAXATION OF SECURITIES TRANSACTIONS
reason is the cumbersome and expensive nature of real estate trans-
actions. Another is the propensity of business to use its land as
business premises, thereby ruling out frequent dealings. In addition,
businesses are incorporated; a transfer of the business assets will
frequently take the form of a share transaction. As well, almost all
business real estate can be transferred with tax consequences
deferred,8 and owner-occupied real estate is exempted from capital
gains taxation if the taxpayer treats it as a principal residence.’
Since the typical taxpayer is most likely to encounter the capital
gains provisions through securities transactions, it is desirable that
the rules governing those transactions reflect sound policy and be
capable of administration with minimal public and private com-
pliance costs.
I. History of the taxation of securities transactions
Until 1972, the taxation of securities transactions was governed
by the general principles of taxation. If a gain or loss arose in the
course of business or amounted to an adventure in the nature of
trade, it was classified as an ordinary gain or loss. If it was on
capital account, it was excluded from the tax base entirely. The tax
consequences of classification thus placed considerable pressure
on the distinction between capital and income transactions. The
concept of adventure in the nature of trade 0 was designed to catch
speculative gains on securities that would otherwise have been
treated as capital assets.
When capital gains taxation was introduced in 1972, the adven-
ture device could have been dropped in order to simplify the
classification procedure. This was not done, but the few securities
cases decided since 1972 indicate that the courts may be moving
toward a concept of adventure that is more favourable to tax-
payers. 11
8 See, e.g., Income Tax Act, ss. 85 and 86.
9 See generally Seltzer, The Nature and Tax Treatment of Capital Gains
(1966), 146-49 for a more detailed analysis of real estate gains which includes
an explanation of their relative unimportance as a source of taxable gains in
the United States. In Canada, it has been estimated that in 1975 alone the
total capital gains sheltered by the principal residence exemption amounted
to $5,100 million. There are no estimates of the magnitude of the gains
sheltered by business rollovers. See Smith, Tax Expenditures (1979), 120-22.
‘l Income Tax Act, s. 248(1) states that “business” includes an adventure in
the nature of trade.
“See Hiwako Investments Ltd v. The Queen [1978] C.T.C. 378; 78 D.T.C.
6281 (F.C.A.); Chaffey v. M.N.R. [1978] C.T.C. 253; 78 D.T.C. 6176 (F.C.A.).
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Even though the tax consequences of classification are no longer
so drastically different, classification has remained a difficult area.
The tests and guidelines used by the courts to determine whether
a securities transaction is capital or income in nature are unwieldy
and difficult to apply, and Parliament has taken steps to make lia-
bility more certain. Since 1977, taxpayers can elect to treat all gains
on certain securities as capital gains, so long as the statutory con-
ditions are met.12 For nonqualifying taxpayers and securities, how-
ever, the common law rules continue to govern classification.
II. Competing frameworks for analysis of specudative transactions
Because of the capital gains tax, and the more recent lifetime
election on securities transactions, the taxation of speculative gains
and losses on securities is in a period of transition. The language
of the election shifts the focus of litigation from terms such as
Itcapital gains” and “investment” to terms like “dealer” and “carry-
ing on business”. Because those terms have no fixed meaning, the
courts are given the opportunity to define them. The courts and
litigants face the major problem of formulating an analytical frame-
work capable of yielding a predictable result in a multiplicity of cir-
cumstances. There are several competing frameworks: a cynical
analysis, which claims that there is no such thing as capital; the
common law business test; an economic realities or causation
analysis; and a distributional analysis, which looks at the timing of
cash flows.
A. “There is no such thing as capital”
“Capital” is a bundle of policy considerations that form the
justification for giving some receipts preferential tax treatment.
This fact is frequently obscured because the meaning of “capital”
varies with usage. To an individual who is starting a business,
“capital” is the entire fund of cash, borrowed money, property and
expertise which will be dedicated to the enterprise. When the un-
dertaking is established, “capital” will have the narrower connota-
tion of specific depreciable assets; this includes intangible items
which may not even constitute property in the conventional common
law sense z3 To a taxpayer without an established business, the term
12 S.C. 1977-78, c. 42, s. 3 added s. 39(l)(c) to the Income Tax Act.
13 “Eligible capital expenditure” is defined in Income Tax Act, s. 14(5)(b) as
an expenditure which is for the purpose of gaining or producing income from
the business and which is “on account of capital”, but which does not bring
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
“capital” connotes a legal category which correlates with investment
or nonbusiness use, and which carries with it a tax preference
granted for reasons that are not articulated in the controlling le-
gislation. The concept of capital pervades the way in which we
think about commerce and property. In property law, “capital” is
that part of an estate which is reserved for those with remainder
interests. 4 Accounting practice follows business usage, and labels
the initial fund of a business as “capital stock”, while treating
tangible and intangible property as “capital assets”.
‘-On a functional analysis, it can be said that “capital” takes on
a meaning which is an outgrowth of the function assigned to the
term in the particular context. A business person who applies a
fund of capital to a new enterprise must determine whether the
enterprise is productive of economic power; such a person will want
to measure capital in monetary units so that there is some standard
according to which increases or decreases in economic power may
be assessed. Capital has the same function in accounting, an art
which has developed in response to the business person’s desire
to measure increases in economic power against a static standard.
In contrast to business usage, property law has used capital to
function as a regulator of the rights of the remainderman. While
it is true that the business and property uses of the word coincide
when they refer to a fund at the beginning of a period of receipts,
the two usages diverge when specific types of receipts are consider-
ed. In property law, payments out of wasting assets, such as oil
wells, are treated as returns of capital except for a small income
element.15 In the accounting or business context, however, the
into existence depreciable property. The capital which falls into this class
will include such things as goodwill, rights over land for an indeterminate
term, costs of improvements to another’s property and similar expenditures.
See Dept of National Revenue, Taxation. Interpretation Bulletins
IT-143R
(Dec. 29, 1975) and IT-386 (July 4, 1977).
As “property” is not an immutable concept, notions such as “eligible
capital property” have had to be devised. See generally Jackson, Principles
of Property Law (1967), 28; Ross, TA-Tt
(1957) 70 Harv. L. Rev. 812 (a
sophisticated semantic and linguistic analysis that demonstrates thAt a
term such as “property” has no independent substance but is merely “a tool
for the technique of presentation serving exclusively systematic ends”: ibid.,
825).
-14For an interesting (albeit undocumented) account of the early develop-
ment of the concepts of capital and income in property law and taxation, see
Seltzer, supra, note 9, 25-29.
15 See Waters, Law of Trusts in Canada (1974), 697-700; Cullity, Trusts Inter
Vivos: Duty to Convert Under-Productive Property (1972) 50 Can. Bar Rev. 116.
Cf. Revised Uniform Principal and Income Act, 7 Uniform Laws Annotated 9
McGILL LAW JOURNAL
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same receipt might be viewed wholly as a receipt of income except
to the extent of a depletion allowance. To reduce the two usages to
their simplest terms, capital serves as a measure of growth for the
business person while keeping the res of the estate intact for the
bolder of the remainder interest.
The divergence of the property and accounting concepts of
capital demonstrates that capital is an artificial category defined
by the needs of the competing interests that bring it into issue.1″
Nonetheless, there is a tendency to assume that capital in the taxa-
tion context does have an immutable meaning –
handed down,
perhaps, from the House of Lords. However, different authorities
have different definitions of capital for taxation purposes, 17 and in
any one jurisdiction there is likely to be a collection of competing
approaches which overlap and produce conflicting results.1 8
The root of this confusion lies in the fact that capital is created,
not by the nature of the subject matter, but by the social and legal
relations which surround it. If we could say that all land is capital
for taxation purposes, then tax liability can be resolved by reference
to whether the subject matter of a transaction is land. At present,
however, a piece of land will be capital or a capital asset if it is
owned for the purpose of producing a usufruct, or if it is held for a
long time as a fund or holding place for economic power. If it is
held for the purpose of resale or as inventory, it is not capital and its
disposition will give rise to ordinary income. Every conceivable
type of asset – whether it is property or not –
has the potential
to be either capital or inventory, and at any given moment in time,
any asset can move from one category to another.
Since the capital/income classification depends on the way in
which the asset is exploited, the classification must rely more on
surmise than on fact. The only evidence which is truly objective
is the asset’s record of usufruct, and even then a subjective inten-
tion to sell a productive asset for a gain can still operate to classify
the asset as inventory. “Capital” is not defined by objective and as-
(1962), under which the value of the wasting asset is amortized over its income-
producing life and deducted from royalties to preserve the corpus, the balance
being allocated to the income beneficiary.
18 Conway & Smith, “The Law Concerning Capital Gains” in Studies of the
17See, e.g., American Law Institute, Definitional Problems in Capital Gains
Taxation (1960 draft); Note, A Spreading of Receipts Formula for Creating
a Capital Gains/Ordinary Income Brightline (1978) 87 Yale L.J. 729.
Royal Commission on Taxation (1967), vol. 19B, 98-139.
Is8See generally Grover & Iacobucci, Materials on Canadian Income Tax
3d ed. (1976), 228-53.
1980)
THE TAXATION OF SECURITIES TRANSACTIONS
certainable facts: capital is a state of mind, an intention in a
moment of time that may be modified again and again while the
manifestation of the asset remains unaltered. Hence the argument
that there is no such thing as capital; capital is only a function of
intention without physical reality. The only physical manifestation
of the existence of capital is a stream of receipts caused by the
asset during the period of ownership, and proceeds of disposition
when title is relinquished. The stream of receipts arising during
ownership is easily classed as income; it is the proceeds of disposi-
tion which are troublesome. The presence or absence of an income
stream does not affect the inherent quality of the proceeds of dis-
position; the gain on disposition will represent the same increase
in economic power whether it is from the sale of an inventory item,
a nonproductive asset whose classification is ambiguous or a pro-
ductive asset.
The proposition that there is no such thing as capital may be
restated in various ways. The Carter Report assumed that capital
and income can be distinguished, but took the position that the
economic power of a capital gain dollar and an income dollar are
identical, so that arcane legal distinctions actually result in a dis-
crimihatory tax base. 9 Seltzer examined the causes or sources of
capital gains and concluded that a significant proportion of capital
gains can be attributed to ordinary income sources –
personal
services, use of capital, risk-taking –
and should not be granted
a preference merely on the basis of the form of the receipt. Every
time the proposition is restated, the issue is whether capital gains
should receive any kind of preference (in which case differentia-
tion is necessary) or whether all receipts should be fully included
in taxable income.
The elaborate legal doctrine defining “capital” is tolerated only
because the tax preference which is given to capital is thought to
be economically desirable or necessary. The economic effects that
indicate the need for this preference are “lock in”, “bunching”,
inflation, change in the interest rate, and formation of capital.21
In the end, it is the economic consequences of eliminating the pre-
ference which form the continuing rationale for the preference;
if there is to be a preference, there must be some definition of the
“capital” to which it attaches.
19 Royal Commission on Taxation, Report (1966), vol. 3, 325.
20 Seltzer, supra, note 9, 4-5.
21See Brooks & Peltomaa, The Case for Full Taxation of Capital Gains
(1979) 1 Canadian Taxation 7; Blum, A Handy Summary of the Capital Gains
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1. Lock in and force out
When a taxpayer owns an asset which has increased in value, the
(1) retain the asset, (2) sell the
taxpayer has three alternatives:
asset and spend the proceeds on current consumption or (3) sell
the asset and reinvest the proceeds. If the second or third alter-
native is selected, then the increase in monetary value will be exposed
to taxation and the after-tax proceeds of disposition prevent the
taxpayer from acquiring a new asset of equal value to the old one.
Over time, the taxpayer who holds only one asset – who is “locked
is in a much better position than the taxpayer who has
in” –
changed investments frequently, and left a bit of the gain in the
government’s bands with each transaction. The magnitude of the
lock-in effect depends in part on the extent to which capital gains
are included in taxable income. Any exclusion of capital gains re-
duces the magnitude of the lock-in effect and the mobility of
capital is greater. 22
“Force out” is the opposite phenomenon; the present value of
the tax benefit of an immediate disposition is greater than the pre-
sent value of the future receipts that the asset is expected to
generate. Force out will occur when an asset is in a negative gain
position or when the tax system overcompensates for the lock-in
effect.24
2. Bunching
Gains that are realized on the disposition of an asset frequently
accrue over a period of time. When such gains are realized, however,
they are included in taxable income in the year of realization (in
the absence of relieving legislation) and increase the taxpayer’s
effective rate of taxation for that year.24
Arguments (1957) 35 Taxes 247 for a discussion of these and other justifications
for the capital gains preference. The justifications discussed in the text were
selected because they are the most compelling rationales developed in the
literature.
22 See American Law Institute, supra, note 17, 137, which presents a graphi-
cal illustration of the lock-in effect relative to the length of the anticipated
future life of the asset.
2 Ibid., 138-39.
24 S. 118(1) of the Income Tax Act grants some relief in the form of general
averaging, which is available to all taxpayers regardless of the nature of their
income sources, and s. 61 allows for forward averaging through the purchase
of income averaging annuities. Under the latter, the maximum period of
spreading is fifteen years, and the taxpayer’s enjoyment of the gain is limited
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THE TAXATION OF SECURITIES TRANSACTIONS
3. Inflation
When all price levels move up or down, gains and losses are
sometimes described as “illusory” because they do not represent
an accretion to economic power but merely reflect changes in the
monetary value of goods and services. Inflation is popularly cited
as a justification for a capital gains preference, but it is interesting
to note that when rates of inflation are increasing, theoreticians
begin to suggest adjusting cost figures for inflation.2 These sug-
gestions themselves raise the possibility that the effect of inflation
is not a sound rationale for the capital gains preference, or that the
fifty per cent exclusion is not an adequate offset against inflation
when rates of inflation exceed two to three per cent a year.
4. Changes in interest rates
When interest rates rise or fall, the price level of assets falls
and increases, respectively. This effect can be seen most clearly in
assets which bear a fixed rate of interest, such as bonds. A $100 face
value bond bearing eight per cent simple interest will increase in
value when the prevailing rate of interest falls to six per cent. Con-
versely, an increase in the prevailing interest rate to ten per cent
will cause the market value of the bond to fall. In the first case,
the receipt of interest at eight per cent actually represents a return
of capital; in the second case, the taxpayer experiences a decrease
in the value of the bond relative to the maturity value, so that the
taxpayer who acquires it at its depressed price will receive a gain
on maturity which compensates for the low interest rate received
during the life of the obligation. Changes in interest rates affect
price levels of capital assets in precisely the same way, but because
the internal rate of interest yielded by assets used in an enterprise
is not easily ascertainable and would be unstable, measurement of
the effect is difficult.26
to the amount of the annuity paid in each year. In comparison with the
strictures of forward averaging, the deemed recognition proposals of the
Carter Commission are more favorable to the taxpayer, since the Carter ap-
proach would effect spreading while the taxpayer continued to own and enjoy
the asset: supra, note 19, 276-81. However, the value of the deferral that is
generated by the present system is some compensation to the taxpayer.
25 Bossons, Implementing Capital Gains Tax Reforms (1979) 27 Can. Tax J.
145; Bucovetsky, Inflation and he Personal Tax Base: The Capital Gains
Issue (1977) 25 Can. Tax J. 79; Kelley, Hall & Aronsohn, Indexing for Inflation
(1977) 31 Tax Lawyer 17.
26 Seltzer, supra, note 9, 60-61 also notes that other factors have more in-
fluence on the price levels of assets, thus changes in the interest rates tend
to be obscured.
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5. Capital formation
“Capital formation” refers to the process of saving, instead of
consuming, current income; it can be used interchangeably with
“rate of investment” or “rate of saving”. Capital formation is
“impaired” or reduced when taxes increase, for after-tax incomes
and the rate of saving are reduced. When taxes are reduced, then
after-tax incomes are increased and the rate of saving also increases.
Capital formation is also connected to the redistributive effects of
the tax system: capital formation will be discouraged even when
after-tax incomes rise, so long as those increases are limited to
individuals who have no capacity to save. Thus a program of
(1) reducing
favouring capital formation envisions two effects:
the overall tax load in order to make greater saving possible, and
(2) tempering the redistributive aims of the system in order to
grant the reduction to those who are able to save and defer con-
sumption.-
The proposition that there is no such thing as capital has one
major drawback: in a climate of increasing political and economic
conservatism, any proposal to include all capital gains in the tax
base is likely to be politically unacceptable. The best case for full
inclusion was made in the Carter Report,2 8 but the political atmos-
phere has since changed. Aided by the argument that inflation is
eroding the fifty per cent preference, lobbyists are now pressing
for an increase in the preference or for complete abolition of
capital gains taxationf 9
Outside Canada, full inclusion has been treated less seriously.
The United States has moved to a tax on tax preferences in order to
prevent wealthy taxpayers from taking excessive advantage of the
partial exemption of capital gains.0 While this can be interpreted
27 See David, Alternative Approaches to Capital Gains Taxation (1968), 2-5
and 192-97 for a discussion of the relationship between saving and growth.
28 Supra, note 19, 337-82.
2 9 Bossons, supra, note 25, 153-55 argues that suspension of the capital gains
rules in relation to securities transactions would encourage corporate in-
vestment and Canadian ownership. Elimination of capital gains taxation on
particular assets is becoming an increasingly popular demand by those who
seek to justify preferential treatment as an economic panacea.
30 I.R.C. 301 as am. The minimum tax rate on tax preference items such
as capital gains is 15%; tax preference items are exempt from the minimum
tax if they are less than the greater of $10,000 or one half of the taxpayer’s
nonpreference tax liability for the year. There is also a maximum tax system
which operates to lift the 50% ceiling on earned income to the extent that
the taxpayer has tax preference income; in those cases, the tax rate on
19801
THE TAXATION OF SECURITIES TRANSACTIONS
as a move toward fuller inclusion, the more realistic view is that it
further entrenches the preference. The tax preference tax touches
a minuscule number of taxpayers who enjoy -the preference. In
Australia, the debate still focuses on whether capital gains should
be recognized at alLl1 In England, the Meade Report advocated a
shift to an expenditures based tax but recognized that some pre-
ference would have to be created for capital expenditures. 2
The entrenchment of the capital gains preference makes any
case for full inclusion seem idealistic; tax reform circles now seek
an acceptable “second best” solution that remedies the worst defects
of the present system while taking account of political realities.
The second best alternatives that are considered in this paper
are (1) the common law business test, (2) an economic realities
model and (3) a redistributive model.
B. Common law business test
If a gain or loss on the disposition of property arises in the
course of business or as an adventure in the nature of trade, the
amount is classified as being on income account. This rough method
of classification was imported from England and governed the tax
treatment of all property dispositions until 1972. After 1971, the tax
consequences of the classification were varied, but not the method
of arriving at the classification. While it is difficult to make any
general statements about the aggregate operation of the case law
on business and adventure, it is fair to say that a court will hold
that an activity is a business or an adventure if there is objective
evidence of the conduct of a business or if evidence of the taxpayer’s
intention shows a profitmaking motive. Unpredictability is a major
disadvantage of this method of differentiating capital and income.
As well, the lack of system in the cases and the ease with which
taxpayers can manipulate the type of evidence available to revenue
agents and the courts cast doubt on the ability of the taxation
earned income can rise as high as 70%. See Rabinowitz, Some Reflections on
the Social and Economic Impact of the Tax Reform Act of 1976 (1977) 31 Tax
Lawyer 163, 172-76 for details of the scheme.
31lncome Tax Assessment Act 1936, Act No. 27, 1936, as am. S. 26(a)
classifies property gains as taxable income where the property was acquired
“for the purpose of profitmaking … from the … carrying out of any profit-
making undertaking or scheme” and s. 26AAA establishes a one year holding
period for assets; gains on property sold within a year of acquisition are fully
included in income as well.
-2 The Institute for Fiscal Studies, The Structure and Reform of Direct
Taxation (1978).
McGILL LAW JOURNAL
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process to meet equitable or redistributional objectives in respect
of property dispositions.
1. Origins of adventure
Adventure in the nature of trade is a classification which is
used to justify a limited capital gains tax on speculative transactions
in property. Classifying a transaction as an adventure results in full
inclusion of the gain in taxable income. It can be characterized as
a limited capital gains tax because the types of transactions
it
catches fall outside the scope of business income in the ordinary
sense. The notion of adventure has been continued in the 1972 Act;
in effect, there are now two types of capital transactions –
spe-
culative and nonspeculative.
The concept of an “adventure or concern in the nature of trade”
and modern income tax legislation in Britain emerged contempora-
neously. The 1688 revenue act
followed the usual pattern of im-
posing a levy on the annual value of personal estates and the profits
of “offices or employments”. No mention was made of trades,
businesses or adventures. Shortly thereafter, the General Aid assess-
ed one shilling in the pound on the “true yearly profit” from pro-
perty in goods, merchandise, money and debts –
a tax base which
again omitted any direct reference to trades or adventures. The first
true “direct income tax” was the invention of William Pitt (the
elder), who proposed it as a means of financing a lengthy war with
France. The first income tax statute enacted under his influence
came into effect in 1799, and here the phrase “Trade or Manufacture,
or any Adventure or Concern” is found throughout the act. When
direct income tax legislation became permanent in 1842, the lan-
guage was modified to its present form –
“Trade, Manufacture, Ad-
venture, or Concern in the Nature of Trade” 6
As litigation arose over the scope of the source described as
“trade, manufacture, adventure, or concern in the nature of trade”,
it became apparent that the entire formula did not have to be
a3An act for a grant to their Majesties of an aid … for the necessary
defence of their realms, 1688, 1 Wm & Mary, c. 20 (Imp.).
34 See Coffield, A Popular History of Taxation (1978), 78.
a5 An act to repeal the duties imposed by an act … for granting an aid and
contrelation for the prosecution of the war; and to make more effectual
provision for the like purpose, by granting certain duties upon income in
lieu of the said duties, 1799, 39 Geo. III, c. 13, ss. 82, 83 (U.K.). Thorson, P., in
M.N.R. v. Taylor [1956-60] Ex. C.R. 3, erroneously pinpointed the first ap-
pearance of “adventure” in the 1803 Finance Act.
36 The Income Tax Act, 1842, 5-6 Vict., c. 35, ss. 101, 120 (U.K.).
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THE TAXATION OF SECURITIES TRANSACTIONS
reiterated in giving reasons for decision in each case, and the judi-
cial tradition of using one or another aspect of that phrase in
giving reasons developed. In 1926, argument by counsel in C.I.R. v.
Livingston led Lord President Clyde to consider the possibility that
an isolated transaction might not be taxable because of its isola-
tion.
In order to overcome this proposition as forcefully as pos-
sible, Lord Clyde reasoned that an isolated transaction could not be
“in the nature of trade” where the trade consisted of buying pro-
perty in the hope and expectation of a rise in value, but that an
isolated transaction could be an adventure if the transaction is
“of the same kind” and “carried on in the same way” as trans-
actions which are “characteristic of ordinary trading in the line of
business in which the venture was made” 3 8
Lord Clyde’s reasoning has proven devilishly difficult to apply.
The difficulty exists because his Lordship was convinced that his
test described something very different from trade in its ordinary
sense; the facts of the case, however (which must be taken to
illustrate the guidelines he propounded), support a finding of
ordinary trade3 9 In the same case, Lord Sands concluded that the
taxpayers, in converting the vessel for resale, were engaged in “a
manufacturing process which changed the character of the arti-
cle”, 40 and he exhibited no reluctance in concluding that the tax-
payers had engaged in ordinary trade. He did not agree that the
transaction should be described only as an adventure. Of the two
judgments, Lord Sands’ is to be preferred; it is illogical to consign
such an elaborate undertaking to the category of a mere adventure.
A few years later, Lord Clyde had another opportunity to apply
his concept of adventure in the nature of trade in Rutledge v.
C.LR.4 1 The taxpayer in that case was a moneylender and a business
person with divergent interests. While he was on an overseas
business trip, he purchased a large quantity of toilet paper from a
37 (1926) 11 T.C. 538 (Ct Sess., Scot.). In this case, three tradesmen –
a
purchased an old ship,
ship repairer, a fish salesman and a blacksmith –
refitted it and sold it for a profit.
38 Ibid., 542.
39See also McDonald, Capital Gains and Losses in Canada (1951) 29 Can.
Bar Rev. 907, 912-13; Shinder, The Taxability of Capital Gains in Canada (1961)
19 U. of T. Faculty L. Rev. 87, 94-95.
40 Supra, note 37, 544. “Economic transformation” as a basis for treating
gains from property as business profits instead of capital gains was brought
to the attention of Canadian tax specialists at least once, but it has never
gained much acceptance. See McDonald, supra, note 39, 912, n. 16, referring to
Miller, The Capital Asset Concept (1949) 59 Yale LJ. 837 & 1057.
41 (1929) 14 T.C. 490 (Ct Sess., Scot.).
McGILL LAW JOURNAL
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bankrupt, took it back to London and immediately sold the entire
lot to a single buyer. Instead of simply recognizing that there are
entrepreneurs who take every available opportunity to turn a profit,
Lord Clyde went through his elaborate rationale to conclude that
the taxpayer had behaved like a toilet paper dealer, and that the
resulting profit was from an adventure in the nature of trade, not
from an ordinary trade. This time there was no dissenting opinion
to point out that the transaction was an ordinary trade even though
it was rather singular.
We are not concerned here to criticize what British judges have
done with the concept of adventure in the nature of trade 2 Rather,
we are tracing the factors that influenced the Canadian concept of
adventure. Of all of the British decisions on the scope of Schedule
D of the Income Tax Act, 1918,43 Livingston and Rutledge were the
only cases that attempted to differentiate ordinary trade and ad-
venture, and for that reason these judgments received serious
consideration when adventure came to be construed in the Cana-
dian context.
2. Development of adventure in Canada
The first permanent income tax legislation in Canada spoke of
the components of income in general terms. Section 3 of the Income
War Tax Act44 defined income as “annual net profit or gain”, in-
cluding “profits from a trade or commercial or financial or other
business or calling” or “from any trade, manufacture or business”.
There was no mention of “adventure or concern in the nature of
trade” in that Act.
(a) Tax Review Board
In interpreting the scope of “trade, manufacture or business”,
the Board has been visibly influenced by the Rutledge and Living-
ston cases. In Gordon v. M.N.R., Mr Monet held that the purchase of
110 airplane fuselages which the taxpayer crushed and then sold as
scrap aluminum was a “trade venture, the profit of which consti-
tutes taxable income” 4 5 Mr Monet relied on an analogy with
Rutledge in reaching this decision, although the operation was a
42 See “Taxation”, 33 Halsbury’s Statutes (3d) 155-56 for cases collected on
the point.
43 8-9 Geo. V, c. 40 (U.K.).
44 S.C. 1917, c. 28.
45 (1951) 4 Tax A.B.C. 231, 232; 51 D.T.C. 230, 231. [References infra are
cited to Tax A.B.C.]
19801
THE TAXATION OF SECURITIES TRANSACTIONS
manufacturing operation in the sense described by Lord Sands in
Livingston. Mr Monet did buttress his result with the alternative
ratio that the purchase, crushing, and sale of the metal was “the
operation of a business in carrying out a scheme for profit-
making”.”6
Encouraged by Mr Monet’s characterization of the transaction as
a “trade venture”, the Minister attempted to include gains on the
purchase and resale of timber limits in income, on the ground that
they were adventures in the nature of trade, in two subsequent
cases. Mr Fisher held in Johnson v. M.N.R. that section 3 of the
Income War Tax Act did not contain an “expansion of the meaning
of the word ‘trade’ … which would include an adventure in the
nature of trade”.47 In reaching this conclusion, he alluded to a body
of English decisions upon which counsel had relied, but he presented
no direct authority to support his conclusion. Factually, however,
the case presents facts which have become characteristic of Cana-
dian adventures. The taxpayer in question had been active in the
lumber industry for a considerable time through the instrumentality
of a controlled corporation, and he had formed a syndicate with
other members of the local industry to purchase the limits, since
his corporation could not afford it. Strict observance of the separate
legal personality of the corporation led Mr Fisher to view the trans-
action as being an isolated one. On Lord Clyde’s analysis, an isolated
transaction does not come into “trade or business” unless aided
by a statutory formula such as “adventure or concern in the nature
of trade”.
In Whiteside v. M.N.R., 8 the other timber limit case, the Minister
also relied on Gordon. Mr Fordham distinguished that decision on
the basis that the taxpayer was already in the wrecking business
and that the recycling of the airplane fuselage in that case was
simply an exercise of his trade skills, novel only as to subject
matter. 9 Mr Fordham thought that the transactions in Gordon and
Livingston could have constituted businesses even without the addi-
tion of “adventure”, but he did not think that “trade or business”
alone was broad enough to include the timber limit transactions. He
also thought that the addition of “adventure” to the definition of
“business” would expand the scope of business.
46 Ibid., 234.
47 (1951) 5 Tax A.B.C. 71, 72-73; 51 D.T.C. 355, 356-57.
48 (1951) 5 Tax A.B.C. 165, 51 D.T.C. 401.
49 Mr Fordham also distinguished C.I.R. v. Livingston, supra, note 37.
McGILL LAW JOURNAL
[Vol. 25
Mr Fordham confirmed his view of the relationship between
investment, adventure and business in No. 412 v. M.N.R.5 0 The
taxpayer had entered into three significant real estate transactions
during the years 1948 through 1952. Effective in 1949, the statutory
definition of “business” in the Act was modified to include “an
adventure or concern in the nature of trade” 1 an obvious attempt
to supersede the Board’s conception of “business”. Mr Fordham
accordingly concluded that each of the three transactions was an ad-
venture, but that the 1948 gains were exempt from taxation because
the amendment was not then applicable.
(b) Court decisions
The leading Canadian court decision on adventure is M.N.R. v.
Taylor,52 in which President Thorson not only adopted, without
modification, Lord Clyde’s view of business and adventure, but also
ignored the warning in Lord Sands’ opinion. The taxpayer was an
employee of a corporation that used lead in its manufacturing pro-
cesses; as a hedge against impending shortages, he bought twenty-
two carloads of lead which he immediately resold to his employer.
The company’s policy had precluded it from making the purchase
directly, and the taxpayer made a profit on the transaction. It was
argued for the Ministera that the gain was income from an ad-
venture in the nature of trade, or alternatively that it was income
from an office or employment. Thorson P. chose to resolve the
case on the first ground. He took the view that adventure and
business are distinguishable categories because, first, it was plain
from the wording that they are not synonymous expressions;”
second, Lord Clyde had taken the view that trade and adventure
were distinguishable in Livingston and Rutledge;” and third, Lord
Normand had approved Lord Clyde’s position in C.LR. v. Fraser.”
Although he himself had noted the dangers of importing British
tax jurisprudence without regard to statutory differences,” Thorson
P. did not consider that the relationship between business and ad-
60 (1957) 17 Tax A.B.C. 52, 57 D.T.C. 203.
151 Income Tax Act, S.C. 1948, c. 52, s. 127(1) (e), defining “business” for the
purposes of the Act.
152 Supra, note 35.
52a By Mr Jackett (as he then was).
53 Supra, note 35, 13.
’54 Ibid., 14.
“G (1942) 24 T.C. 498 (Ct Sess., Scot.).
‘6 Supra, note 35, 14. Thorson P. was there considering the nature of an
appeal from the British commissioners’ rulings.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
venture in the nature of trade might be different from the relation-
ship between trade and adventure. Even if an isolated transaction
does not constitute a trade (which has been defined as requiring
repetition, organization and frequency of transactions57), “business”
is a term of wider import that suggests risk of loss along with
potential for profitmaking, control of the enterprise and participa-
tion in the proceeds.es Such a concept of business does include an
adventure in the nature of trade, at least as the term was defined
by Lord Clyde. It would have been more appropriate in the Taylor
case for the Minister’s counsel to have argued for judicial recog-
nition of the proper scope of business instead of rigidly insisting
that adventure play the same role in Canada that it has in England,
where it operates to broaden the meaning of “trade”.
Having decided that adventure expands the natural meaning of
business, however, Thorson P. was forced to adopt the components
of adventure from the United Kingdom jurisprudence. The result-
ing “tests” are largely negative propositions and restatements of
Lord Clyde’s reasons in Livingston and Rutledge. Thorson P.’s
negative propositions are:
(1) a transaction may be an isolated transaction and still be classed
as an adventure;
(2) the lack of business organization does not preclude it from
being an adventure;
(3) a transaction may constitute an adventure even if no manufac-
turing operation was performed on the commodity;
(4) the inexperience of the taxpayer or the lack of connection with
his or her regular undertaking does not preclude the trans-
action from being classified as an adventure; and
(5) lack of intent to sell the property at a profit does not negative
categorization of the transaction as an adventure 9
To this set of negative propositions, Mr Justice Martland later
added three others:
(1) the use of borrowed money to finance the acquisition of shares
is not indicative of the character of the transaction;
(2) the fact. that the acquisition does not promise an immediate
return on invested capital is not dispositive; and
Thorson in the Taylor case.
57 Grainger & Son v. Gough [1896] A.C. 325 (H.L.), relied upon by President
58 See Cary, Cases and Materials on Corporations 4th ed. (1969), 1177.
59 Supra, note 35, 24-26.
McGILL LAW JOURNAL
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(3) an intention to dispose of the commodity at a profit “as soon
as reasonably possible” itself is an adequate basis for finding
that a transaction is an adventure.l
President Thorson’s positive tests are just as elusive: the tax-
payer is engaged in an adventure if the transaction is conducted
in the same manner as a dealer or trader in that commodity would
employ, or if the “nature and quantity” of the subject matter of
the transaction precludes the possibility that the purpose of the
transaction was investment.”” Despite innumerable applications of
these two positive tests, the courts have yet to articulate a meaning-
ful description of adventure that can be applied to varying fact
patterns.
(c) Tara Exploration and beyond
The next significant development came in the Exchequer Court
decision in Tara Exploration & Development Co. v. M.N.R.6 The
taxpayer corporation, formed in Ontario by Ontario shareholders,
carried on the business of prospecting for minerals in Ireland. All
of the corporate directors and officers resided in Ireland and all
board meetings were held there. In 1965 and 1966, the corporation
realized gains on the disposition in Canada of mining shares which
it had held for two years, and the Minister took the position that
the gains were taxable as business income and that the taxpayer
was resident in Canada because it was carrying on business by
virtue of the share transactions. In an unorthodox tactic, Jackett P.
assumed that the transactions amounted to an adventure in the
nature of trade, and disposed of the appeal on the basis that an
adventure alone did not constitute “carrying on business” for the
In an obiter dictum,
purpose of the statutory jurisdictional test.
Mr Justice Abbott agreed with the assumption that the facts depict-
ed an adventure, but decided the case under the Canada-Ireland tax
convention on the lack of a permanent establishment in Canada.04
This ground of decision made it unnecessary to deal with the issue
of the taxability of the gains.
6o rrigation Industries Ltd v. M.N.R. [1962] S.C.R. 346, 350.
61 Supra, note 35, 29; approved in Irrigation Industries, supra, note 60, 351-
52 per Martland J.
62 [19703 C.T.C. 557, 70 D.T.C. 6370 (Ex.) per Iackett P., aft’d on other
grounds [1972] C.T.C. 328, 72 D.T.C. 6288 (S.C.C.) per Abbott J. [References
infra are cited to C.T.C.]
6 Now S.C, 1970-71-72, c. 63, s. 2(3).
64 [19723 C.T.C. 328, 331 (S.C.C.).
19801
THE TAXATION OF SECURITIES TRANSACTIONS
There are two problems raised by Tara Exploration. One is
whether Jackett P.’s view (that “carrying on business” and “ad-
is correct. The other is
venture” are two separate categories)
whether the assumption that the share transactions were ad-
ventures is consistent with the decision in Irrigation Industries Ltd
v. M.N.R., in which the Supreme Court of Canada held that a
similar share transaction by a corporation was not an adventure.s
There are several technical ways of reconciling the obvious con-
flict between Tara Exploration and Irrigation Industries. First,
Jackett P. and Abbott J. assumed that the transaction constituted
an adventure, but they resolved the dispute by relying on other
grounds; thus, the conclusion that the transactions amounted to an
adventure can be classed as obiter dicta in both judgments. A
second approach is to assume that there was some evidence (such
as the employment of insider information or special industry
knowledge) that made a finding of adventure inevitable.” This
approach is preferable, for it bypasses the weaknesses of technical
arguments and confronts the fact that the decisions demonstrate
a belief that the transactions were adventures. 7
The other point – whether an adventure constitutes the conduct
is dealt with by Tara consonantly with the decisions
of business –
in Livingston, Rutledge and Taylor, for all these cases take the
position that adventure and trade or business are distinguishable
concepts 8 However, not all cases in which adventure is invoked
65Supra, note 60. In this case, the taxpayer corporation was formed in
order to operate a mill, but six years passed before it took any steps to
accomplish its purpose. It then borrowed money to finance the purchase
of mining shares. When the overdraft became payable, the corporation sold
some of the shares. The rest of the shares were sold a few months later to
pay off a loan relating to another transaction. Reviewing the Exchequer
Court’s conclusion that the share transactions amounted to an adventure in
the nature of trade, Mr Justice Martland stated that even if the shares were
of a speculative nature, the mere intention “to dispose of the shares at a profit
so soon as there was a reasonable opportunity of so doing” did not constitute
an adventure. The overriding reason for Mr Justice Martland’s conclusion
seems to be that he regarded capital investment in business corporation
shares to be so thoroughly stamped with an investment character and so
different from “articles of commerce” that the mere intention to sell at a
profit – usually sufficient to establish an adventure – was discounted: 352-55.
‘O Supra, note 64, 329-30.
07 The conflict can also be resolved by reading Mr Justice Abbott’s decision
as refraining from commenting on the correctness of President Jackett’s
conclusions on adventure because the case could be decided on other grounds.
08 See also Stekl v. M.N.R. [1956-60] Ex. C.R. 376 per Thorson P.
McGILL LAW JOURNAL
[Vol. 25
support the proposition that adventure and business are mutually
exclusive,”9 and recently doubt has been cast on the authority of
Tara Exploration by Birmount Holdings Ltd v. The Queen30
The facts in Birmount Holdings were similar to those in Tara
Exploration. A nonresident bought a tract of undeveloped land near
metropolitan Toronto through an Ontario corporation formed for
the occasion; eleven years later the corporation sold the land for a
profit of about one million dollars. Sweet D.J. treated the corpora-
tion as a nonresident 1 and framed the same issues as arose in
Tara Exploration: (1) was this an isolated transaction? (2) was it
a taxable transaction even if isolated? and (3) did the transaction
constitute carrying on business in Canada, rendering the corpora-
tion subject to Canada’s taxing jurisdiction? In reasoning that is not
particularly clear, Sweet D.J. ruled that the gain was taxable
because it arose from a “transaction … in the nature of trade”.72
(The elliptical phrase probably refers to an “adventure in the nature
of trade”.) In ruling on the residence issue, Sweet D.J. held that
the taxpayer “carried on business in and with the land”7 3 because
the corporation “performed the very business function anticipated
by the wording of its letters patent”1 4
Sweet D.J. noted that the share trading gains in Tara Explora-
tion were not taxable income because the transactions were periphe-
ral and unrelated to the business purpose for which the corporation
was formed, whereas the transaction in Birmount Holdings was
09 See, e.g., M.N.R. v. Rosenberg [1962] C.T.C. 372, 62 D.T.C. 1216 (Ex.);
M.N.R. v. Mandelbauin [1962] CT.C. 165, 62 D.T.C. 1093 (Ex.); M.N.R. v. Minden
[1962] C.T.C. 79, 62 D.T.C. 1044 (Ex.), decisions in which President Thorson
held that gains on the realization of discounted mortgages were business
income because the taxpayers’ operations constituted both a business in the
ordinary sense and adventures in the nature of trade. President Thorson gave
no explanation for the two-pronged ratio: most likely he was simply dis.
couraging the possibility of appeal that may have been taken had he selected
one or the other basis.
70 [1977] C.T.C. 34, 77 D.T.C. 5031 (F.C.T.D.) per Sweet D.., aff’d on other
grounds [1978] C.T.C. 358, 78 D.T.C. 6254 (F.C.A.) per Heald 3. [References
infra are cited to C.T.C.]
71 On accepted United Kingdom authority, the corporation was not managed
in Canada because it was in reality controlled by a nonresident. See Unit
Construction Co. v. Bullock [1960] A.C. 351 (H.L.), which looked to the “real”
geographic location from which corporate policy emanated, though in con-
travention of the constitutional powers of the directors.
72Supra, note 70, 44 (F.C.T.D.).
73 Ibid., 46.
4Ibid. [emphasis added].
19801
THE TAXATION OF SECURITIES TRANSACTIONS
the business of the corporation and was its only business15 Realizing
that he was implicitly relying on the effect of incorporation to get
him over the fact that Canadian tax law does not treat the purchase
and sale of one piece of real estate as the conduct of a business,
Sweet D.J. attempted to rationalize the anomaly:
In my opinion, it is not open to a person to have a corporation controlled
by him acquire only one parcel of land, and no other asset, have that
corporation perform no function other than something associated with
that land, and then, that land having been sold by the corporation in one
piece, claim that the corporation having had only one purchase and sale,
is entitled to a tax advantage merely because there was a single trans-
action. I do not think that the cases wherein a single transaction has
been held not to be carrying on business are necessarily in conflict with
that view.j 6
While Birmount Holdings and Tara Exploration can be distinguished
on the differences in their corporate constitutions, Sweet DJ. did
not give any substantive reason for refusing to treat the real estate
transaction as an investment. The Supreme Court has rejected the
“charter powers” doctrine in order to treat de facto businesses
as businesses, and this imposes a requirement on the courts to
classify a transaction on its merits alone.
Historically, Canadian courts have classified real estate trans-
actions entered into by experienced business people as business
operations while treating securities transactions by experienced
business people as investment transactions. 8 This is an uneasy
reconciliation, similar to that required by the conflict between
Tara Exploration and Irrigation Industries. The tension is reduced
somewhat by the fact that entirely different grounds were substi-
tuted by the appellate court in Birmount Holdings in reaching its
conclusion that the corporation was subject to Canadian taxation on
the gain, which both courts agreed derived from at least an ad-
venture.79 In ruling that the transaction was an adventure and a
7 Ibid.
710Ibid. Sweet D. J. also distinguished M.N.R. v. Valclair Investment Co.
[1964] C.T.C. 22, 64 D.T.C. 5014 (Ex.) on the basis that the real estate trans-
action in that case augmented share transactions which clearly were of an
investment nature, since they were held for the revenue that they produced.
77 See Sutton Lumber & Trading Co. v. M.N.R. [1953] 2 S.C.R. 77, 83.
78 E.g., Glaspie v. M.N.R. (1963) 33 Tax A.B.C. 274, 63 D.T.C. 828.
79 Heald J. distinguished Unit Construction Co. on the facts, and applied
Bedford Overseas Freighters Ltd v. M.N.R. [1970] C.T.C. 69, 70 D.T.C. 6072
(Ex.) to conclude that the legal power and duty to manage the corporation
lay with the Canadian directors and to dismiss the actual power of the con-
trolling shareholder. Thus the corporation was a resident on the common law
test and the “carrying on business” test did not have to be met.
McGILL LAW JOURNAL
[Vol. 25
business transaction, Heald J. rejected the view that Lord Clyde
and Thorson P. had so carefully constructed:
The fact that, as distinguished from an investment, certain activities have
been found to constitute an adventure in the nature of trade, does not,
of itself, preclude a finding that those activities amount to carrying on
business. The activities of this appellant are carefully considered and
analyzed [by the trial judge]. Were it necessary for me to decide this
question, I would see no basis for interfering with that finding since,
in my view, such a conclusion was reasonably open to him on the
evidence.80
(d) Conclusions
The impact of Birmount Holdings has not yet been measured
but the implications are clear. An adventure in the nature of trade
is not a trade, but both adventures and ordinary trades are con-
templated by the term “business”. It is not easy to impose this
framework on the various components of business after nearly
fifteen years of adjudication which has taken as a starting point
Thorson P.’s negative and positive tests of adventure. Usage has
generated acceptance of the view that the introduction of adventure
expanded business beyond its natural borders, whereas in fact Can-
ada had been developing an unnaturally narrow concept of business.
However, Birmount Holdings threatens to displace the adventure/
business dichotomy only in cases in which the scope or nature of
the taxpayer’s business is in question. Birmount Holdings, No. 412,
Gordon, Livingston, and Rutledge all dealt with the same fact
pattern:
the taxpayer, whether incorporated or unincorporated,
directly engaged in a business as well as in a “sideline”, 81 and because
of differences between the subject matters of the business and the
sideline, adventure was used to bring the gain into income. The
better approach in such cases is the approach suggested in Birmount
Holdings –
adventure is within the scope of business.
Other decisions disclose a second fact pattern in which adventure
remains distinguishable from business. The unifying characteristic
of Johnson, Whiteside, Taylor, and Tara Exploration is that neither
the business in which the taxpayer is involved nor the adventure
are directly owned by the taxpayer; they are separated by legal
fictions that have been created for purposes other than those of tax
law. For example, the taxpayers in Johnson and Whiteside owned
lumber businesses indirectly through corporations, and thus they did
80 Supra, note 70, 372 (F.CA.).
81 The term is taken from McDonald, Capital Gains and Losses in Canada,
supra, note 39.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
not “have” a business in the ordinary sense, although as con-
trolling shareholders they did “have” a business in a real sense. As
sidelines isolated from the taxpayers’ businesses by a legal fiction,
Canadian law treated these transactions as adventures.
Taylor offers another version of the same theme. As early as
1948, the Supreme Court of Canada had established that a person
who had the status of an employee under the Income War Tax Act8″
was not carrying on business even though his responsibilities in-
cluded the conduct of his employer’s business.8 The taxpayer in
Taylor, then, was engaged in a business which required lead, and
the purchase and sale of the twenty-two carloads of lead would have
fallen into the scope of that business –
if it had been “his”.
Instead, the purchase was considered to be a sideline to employ-
ment, and was classified as an adventure. Tara Exploration presents
the converse situation: the underlying business of the corporate
shares the taxpayer purchased was mineral exploration, but that
undertaking was separated from its own by the legal fiction of the
separate legal personality of corporation and shareholder, and hence
the share transaction was a sideline, an adventure.
Where legal fictions operate to separate a taxpayer’s ordinary
business from a sideline that employs many of the same types of
human wealth, Canadian judges have used adventure to justify
bringing sideline gains into ordinary income. This was a natural
development in light of the artificially narrow scope of business
before adventure was added in 1948, and ih light of the separation
of business and employment sources. Where the subject matter of
the sideline transaction is the same commodity that forms the sub-
ject matter of the taxpayer’s ordinary business, then it is not
difficult to conclude that the sideline is in its “true nature” a
business undertaking. Where the subject matter of the outside
transaction is shares, it is harder, to accept as a business under-
taking. A corporate share represents an investment interest in the
underlying business, and unless a gain in the value of the shares is
expected, any gain arising would be a capital gain. It may be said
generally that expected gains are gains which are the end product
of personal effort or of the application of human wealth. Thus,
when human wealth takes the form of special knowledge about
that underlying business or about market behaviour, Canadian courts
have employed the concept of adventure to bring these speculative
investments into ordinary income.
82 S.C. 1917, c. 28.
83Argue v. M.N.R. [1948] S.C.R. 467.
McGILL LAW JOURNAL
[Vol. 25
The Canadian judiciary has had little success in dealing with
isolated and speculative transactions. Unworkable concepts, such as
intention and similarity to ordinary business undertakings, have
generated unworkable precedents. The judges who have participated
in the process of applying the legislation are not entirely to blame;
when adventure was introduced into Canada, it was already apparent
that adventure did not constitute a clear test for exempt trans-
actions.
The concepts of business and adventure as applied by the case
law are inadequate as alternatives to the full inclusion of capital
gains and losses. The gains that are caught by adventure do resemble
income more than do gains that are exempted, but case by case
litigation achieves justice at the expense of certainty. Thirty years
after its introduction, the meaning of “adventure” is still in a state
of flux, and still cannot be developed into a workable standard.
C. An economic realities analysis
Lawyers use the term “capital” to include a wide array of assets.
Capital encompasses assets which are held for personal and non-
personal use; it contemplates such things as paintings, a home,
investmeht obligations and assets used in an enterprise. Economists
define capital by reference to the stream of receipts which can be
attributed to it.81 The future income stream can take the form of
actual receipts (in cash or kind) or imputed income.”
Classical economists categorize capital gains according to causa-
tion, as unexpected or expected gains. Unexpected gains are some-
times referred to as pure or windfall gains, and are not motivated
by gainful activity. Expected gains are motivated by the desire for
remuneration, however unrealistic the expectation may be. The
difference between expected and unexpected gains is the degree
to which the gain can be attributed to activities that can also
generate ordinary income.
Seltzer subdivides expected capital gains into real capital gains
and capitalized ordinary income (also referred to as pseudo or
false capital gains).86 The difference between real gains and capitaliz-
ed income in many cases is the difference between future and
84Reynolds, Economics: A General Introduction 4th ed. (1973), 247-48.
8 5 Imputed income is frequently valued at the opportunity cost of the
86 Seltzer, supra, note 9, 71. The discussion in this section draws heavily
wealth invested in the asset: ibid., 242.
upon Seltzer’s analysis of causation.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
present rights. Real gains are valued by capitalizing the future
stream of receipts associated with the asset; the capitalization
factor is usually the present rate of interest applied to estimated
receipts. Pseudo gains are valued by aggregating the value of present
rights to receipts to obtain the value of the so-called capital.
1. Unexpected gains
Seltzer describes windfall gains as falling outside the con-
templation of organized exploitation:
A pure capital gain is functionless. It serves neither to overcome the
reluctance of investors to take risks nor to allocate this scarce and
valuable disposition, and the other resources associated with it, among
the fields competing for them.87
In the context of securities transactions, a windfall gain or loss
results from unforeseeable changes in the rates of capitalization
applied to an asset or unexpected changes in disposition toward
risk-taking. 8
(a) Changes in the rate of capitalization
The process of valuing assets which have the potential
to
produce a stream of receipts is highly speculative. Simple capitaliz-
ation formulas discount expected future receipts by the present
rate of interest. Even a small shift in the interest rate can effect a
noticeable change in the present value of an asset. 9 Generally,
87 Ibid.
88 Ibid., 54. Seltzer also lists unexpected changes in interest rates, but
capitalization formulas take this cause into account.
89 The formula for present value (PV) is
Y
Y
+ x)n
+…+
+
Y
+
1+ x
PV _____ Y
where Y is the amount in dollars of the future receipt, x is the present rate
of interest expressed as a decimal and n is the number of productive years
of the asset.
(1+ x)3
(1 + x) 2
On day 1 assume future receipts of $10 annually, a present interest rate
of 8% and a productive life of 5 years. The present value of the future re-
ceipts is $39.93:
10
1.08
+
10
(1.08) 2
+
10
(1.08)3
+
10
(1.08) 4
+
10
(1.08)r,
$39.93.
On day 2, assume an unexpected shift in the interest rate to 7%. If the
taxpayer disposed of the asset on day 2, the taxpayer would receive proceeds
of disposition equal to its new present value of $41.00.
+
+
10
10
1.07
The rate of interest is not the only variable; if the present rate of interest
remained at 8% but the amount of income expected each year were to rise
10 = $41.00.
10
(1.07)3
(1.07)4
(1.07)2
(1.07)5
10
+
+
McGILL LAW JOURNAL
[Vol. 25
capitalization formulas simplify the elements that interact in making
the projection of an asset’s future production. This simplification
creates an aura of certainty around the calculation of present value
a certainty that is not realistic. In fact, future receipts depend on
–
demand for the product of the asset as well as on general price
levels, two items which can be forecast on a short term basis but
which are matters of mere conjecture on a long term basis.
Estimates as to the productive life of an asset are stable only for
fixed term obligations. Fluctuations of interest rates compound
the uncertainties. Thus, it is possible to treat gains in present values
as “expected” and “unexpected”, depending on their foreseeability,
the general level of knowledge and expertise possessed by the tax-
payer and other factors which are familiar to Canadian tax spe-
cialists. In the economists’ view, the existence of windfall gains
is subjective, being based on the content of the taxpayer’s mind
when selecting or timing an acquisition.
(b) Changes in disposilion toward risk taking
All of the factors in the capitalization formula are subject to
change, except for incomes or terms fixed by contract or other legal
device. Where the rate of return on an asset is uncertain,- the range
of possible future yields may well include possibilities that are
unacceptably low to some taxpayers. While possibilities of low
returns are frequently coupled with the possibility of an extremely
high rate of return, some individuals will not knowingly expose
themselves to certain levels of risk. The inclination to take on
certain levels of risk manifests itself in mass behaviour as well as
on an individual basis, and a mass repugnance or predisposition to
risk is an important component of market conditions. Where there
is a mass repugnance to risk, securities with modest income possi-
bilities but little risk of unacceptably low returns or even of loss
will become more desirable. The increase in demand will drive
present values up and the holders of such securities will experience
windfall gains. When attitudes become more favourably inclined
toward risk of low return or loss, then the premium awarded to
to $12, then the present value of the asset would climb from $39.93 on day 1
to $47.92 on day 2:
12
(1.08)3
+
12
(1.08)4
+
12
(1.08)5
$47.92.
If the expected life of the asset were extended by a year, a similar gain
12
1.08
+
12
(1.08)2
+
would be experienced.
+
10
10 _ +
1.08
(1.08)2
l0
(1.08)s
+
10
(1.08)4
+
10
(1.08) 5
+
0
(1.08)6
-$46.93.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
taxpayers disposed to take on risk can be reduced without impairing
the supply of investment capital.
2. Expected gains
Putting aside the problematic fact that expectation is a matter
of subjective response to widely divergent fact situations, “real”
gains are based on the taxpayer’s expectations concerning the stream
of receipts to be derived from an asset. In an economic as well
as a legal sense, there is a vast difference between a receipt that
is equal to an amount already earned on account of personal ser-
vices, use of property or risk taking, and a receipt that is equal to
the present value of a stream of receipts which the transferee of
the property expects to receive. The first type of payment is ordinary
income and it must be included in taxable income when it is re-
ceived or receivable. The second type of payment is measured by
the present value of the future receipt of ordinary income, but the
amount of the receipt is calculated in a manner that reflects the
contingent nature of that stream of future income. The reason-
ableness of the expectation varies from security to security. One
security might have a solid record of producing income at a certain
rate, while another may have no record of income production and
uncertain prospects for the future.
The amount of the capital receipt for disposition of such
securities is derived from the application of a capitalization formula,
and capital gains or losses arise when some factor in the capital-
ization formula changes. These factors are the present rate of
interest, the income yield of the security and the risk associated
with the transaction 0
In short, the difference between expected and unexpected gain
can be traced to the relationship between the cause of the gain
(change in interest rates, income yield or risk factors) and the
efforts and accomplishments of the taxpayer in question. These
efforts and accomplishments encompass the entire range of human
activity.91
(a) Inflation
Inflation and recession can drive general price levels up or
down without effecting any change in the value of the security
relative to other securities. Gains attributed to inflation are some-
00 See Seltzer, supra, note 9, 55 for an illustration of this process.
91 For a comprehensive discussion of all factors of causation, see Seltzer,
ibid., 69.
McGILL LAW JOURNAL
[Vol. 25
times called illusory gains because they do not represent a real
accretion to wealth or economic power. However, not all securities
rise or fall in value at the same rate. By careful effort, a taxpayer
can generate a real gain relative to other holdings by nullifying in
part or in whole the effect of general price level movements. The
effort employed in such manoeuvres consists of researching, select-
ing and timing investments which will perform better than the
majority of securities. This kind of effort is the same as that em-
ployed to generate real gains caused by an increase in demand, but
it is distinguished from those real gains because it usually takes
the form of a reduction of inflationary loss rather than an arith-
metic gain.
(b) Demand
Increased demand is the other force which can affect the price
levels taken into account in capitalization formulas, and the tax-
payer can manipulate or create demand in order to produce a gain
on the disposition of securities. Personal effort in manipulating
the demand factor would manifest itself much as trading on in-
flation does: the study of demand patterns and cycles, product
development, demographic investigation and cultural trends yields
the information needed to select and time securities transactions.
Where such personal effort is employed in generating gain, it is
difficult to ascertain and quantify that part of the gain attributable
to personal efforts and risk taking. From the legal perspective,
it is difficult to see how evidence of intended and unintended
causes is to be weighed. This problem is further complicated by the
fact that not all expectations are fulfilled, and “dumb luck” can
cause a gain in a situation where the taxpayer had intended to cause
the gain through personal efforts.
Personal effort need not take the form of trading on demand;
effort can be devoted to creating demand. Seltzer gives several
typical illustrations: the taxpayer who induces others to build on
contiguous land so that the taxpayer’s land becomes more valuable;
the taxpayer who assembles a block of land which has a greater
value in the aggregate than do its component parts; the taxpayer
who negotiates “a profitable long-term contract for a corporation
in which he [or she] owns a large stock interest”; and the taxpayer
who through delaying tactics drives up the takeover bid price and
thus the value of the shares 2 To this list may be added other
92 Ibid., 70.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
examples that reflect the peculiar nature of securities. Demand for
corporate shares will increase when the corporation’s goodwill in-
creases in value, and goodwill is created by the conduct of the
corporation’s business. Other kinds of corporate assets, such as
patents, copyrights and know-how, are essentially memorials of
personal efforts and their creation within the corporate entity in-
creases its earnings potential and thus the demand for its shares.
The same can be said of corporate profits, whether reinvested in
additional assets or held by the corporation, and of the assembly
of the corporation itself.
Control over a corporation or other issuer is not crucial to the
identification of personal effort as the source of increased demand
for the securities. Shareholders of corporations whose shares are
widely dispersed still enjoy changes in price levels which are caused
by some of the situations described. Where there is a measure of
control on the part of the shareholder, however, the personal efforts
of the shareholder can directly cause the increase in value. Control
of an allied supplier or channel of distribution by the shareholder
of the corporation in question can reduce operating expenses, in-
crease profits and thus increase the demand for shares. A controller
who also acts as a promoter for the remainder of the shares will be
increasing the value of all shares. A controller who has acquired
business acumen and expertise in a parallel enterprise may place
that talent at the disposal of a corporation for less than fair return.
In all of these cases, the demand for shares will increase as the
result of personal effort.
The difficulty in applying an economic realities analysis to the
taxation of securities transactions is that the separate strands of
causation are hard to isolate, and once isolated, they are even
harder to quantifyY3 Canadian courts have attempted to improve
the business and adventure tests by injecting a type of economic
realities analysis, and in some cases they may have come closer to
distributional justice with this approach. However, this approach
is still unpredictable, and the alternative approach to the taxation
of securities transactions which is finally adopted should be more
certain and predictable in its result.
93 For a description of the U.S. treatment of the causation problem, see
Surrey, Definitional Problems in Capital Gains Taxation (1959) 2 Tax Revision
Compendium 1203, 1205-6.
McGILL LAW JOURNAL
[Vol. 25
D. The distributional model
By its use of progressive rates of taxation, the Income Tax
Ac 9 4 adopts redistribution of income as one of its policy objectives.
Redistribution is incompatible with a simplistic notion of equity;
equity demands similar tax burdens for all taxpayers, while redistri-
bution requires higher tax burdens for taxpayers with higher in-
comes. The notions of horizontal and vertical equity resolve this
conflict; equity is achieved if persons in similar positions pay appro-
priately similar taxes, and if persons in dissimilar positions pay
appropriately dissimilar taxes. Equity also requires a comprehensive
tax base so that taxpayers cannot nullify redistribution by manipu-
lating the form their gains take.
A distributive model of income would disregard the form of
receipts and would focus on the timing of receipts. Short-term
gains could be brought into income through the use of an arbitrary
period such as the taxation year. This approach can be refined by
the addition of a diminishing scale of inclusion that reflects the
probable effect of inflation on a long-term holding. For example,
a gain on a security that is held for more than one year and less
than two years would receive a ten per cent exemption, with a
further ten per cent exemption for each year of holding. The
existing fifty per cent floor would avoid severe lock-in problems,
and the taxpayer would have a substantial degree of certainty as
to the tax result. Since holding periods of more than a year are
inconsistent with blatant speculation, the one-year holding period
would end litigation in those types of cases. As the taxpayer’s
holding period increases, the likelihood of a predominantly specu-
lative motive decreases; by the fifth year, when the capital gains
preference reaches its maximum, the transaction would be unlikely
to attract litigation. The common law business test would still
serve to bring blatantly speculative long term gains into ordinary
income.
While in each particular case there would be a trade-off between
absolute justice and ease of compliance, an approach which manages
rough justice with virtually no uncertainty might be welcomed by
both administrators and taxpayers. The holding period concept
has been used successfully in the United States: securities which
are held for a period which exceeds a designated holding period
are deemed to be capital property held for investment, while
securities which are disposed of within the holding period are
94S.C. 1970-71-72, c. 63 as am.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
deemed to be sales in the course of business and give rise to
ordinary income.95
Canada already uses a limited version of the holding period
approach which permits certain employees to acquire shares under
options and obtain capital gains treatment of the benefit if the
shares are held for at least two years 6 In this type of provision,
there is no need to use terms like “investment”, “dealer”, “trader”,
“carrying on business” or other language that is designed to separate
the investors and the business people. The holding period is two
years, which will work no real hardship on employees of controlled
Canadian private corporations. One year might be more appro-
priate as a holding period for most securities, since taxpayers who
acquire and dispose of securities within the taxation year will be
in the same economic position as those who receive traditional
income. The fact that one taxpayer is an investor and another is
a securities professional does not alter the economic realities of
their positions. However, if a shorter holding period is thought to be
conducive to investor flexibility, then six months or less could
be used.
A holding period approach raises collateral issues. Should a
holding period rule form the only basis for separating capital and
business transactions, or should it be used in conjunction with a
presumption that all taxpayers except securities professionals are
engaged in investment? Should transactions which are caught within
the holding period be treated as ordinary gains or losses, or should
a class of short term gains and losses be created with special rules
governing inclusion of gain and application of losses? What pro-
vision should be made for cases of hardship, where the taxpayer’s
investment intent is obvious yet supervening forces necessitate an
accelerated disposition within the holding period?
With a short holding period, it becomes possible for a securities
professional to qualify for long term treatment by happenstance.
If a short period were selected, it would then be wise to augment
the holding period scheme with a detailed exclusion for “securities
dealers who hold securities for sale to customers”. In addition,
there would be no reason to exclude highly active “traders” who
the character of the taxpayer is
trade on their own account:
irrelevant so long as the character of the transaction can be de-
95 I.R.C. 1223, as am.
96 Income Tax Act, s. 7(1.1), added by S.C. 1977-78, c. 1, s. 3, applicable to
agreements entered into after March 31, 1977.
McGILL LAW JOURNAL
[Vol. 25
termined with accuracy, and a simple holding period rule makes
accuracy possible. If a longer holding period is employed, then the
need for an exclusion for professionals diminishes. If frequent
adjustment of the holding period is anticipated, however, it would
be desirable to establish a simple prohibited category and alleviate
the harshness of the prohibition by registration rules such as those
employed in the United States.97
The precise treatment to be accorded short term gains and
losses is another facet of the scheme which can be adjusted from
time to time. These gains are economically indistinguishable from
the ordinary income of professionals, so full inclusion of gains and
full application of losses is indicated. The chief advantage of treat-
ing holding period gains and losses as capital gains and losses in
the United States is that such losses have limited application in
practice. Short term losses can be set off only against capital
gains; if there is any excess of loss over gain, a small amount may
be applied to other income while the balance may be used only
on a carry-over basisY8 Thus taxpayers who receive short term
gains have to include them fully in income, but unless short term
losses nearly balance gains, they are as ineffective to reduce tax
liability as long term capital losses. This treatment is arguably
appropriate where large losses can be used to shelter income from
other sources from taxation and disproportionately reduce revenue.
Where the distribution of capital gains and losses correlates
with income class and occupation, as in Canada, the fear that
revenue will be lost is not as compelling as the inequities that result
from the limited application of losses 9 Those taxpayers who are
the first to incur losses –
are
the least likely to have gains against which the losses can be offset.
In effect, these taxpayers receive less loss relief than taxpayers who
those in the lower income classes –
97 See I.R.C. 1236.
98 See I.R.C. 1211(b), 1212.
99 The record of gains and losses on share transactions over the period
1972-1975 provides an illustration. In 1972 and 1973, years in which share
prices were generally rising, virtually all income classes reported net gain on
share transactions. In 1974 and 1975, years reflecting weakened share values,
the
all but the highest income classes reported net losses. Taxpayers in
$40-50,000 and over-S100,000 income classes reported the only total gain in
1973, and in 1974 that gain was restricted to the over-S50,000 income class.
To restate the proposition, 7% of all taxpayers who engaged in share trans-
actions in 1974 (9% in 1975) reported 100% of the gain. At the other end of
the income scale, 9% of the taxpayers reported 18% of the loss realized on
share transactions. See App. 4.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
have gain as well, and to give holding period losses capital treatment
would have a harsher effect on low income taxpayers.
The business investment loss provisions indicate a willingness
on the part of the government to go beyond the narrow application
of capital losses which has characterized the North American
approach to the taxation of capital gains. If a holding period scheme
for separating capital and business transactions were to be em-
ployed, it would be appropriate to grant taxpayers the right to
apply the full amount of any loss to income from other sources.
Full application of losses would also encourage greater investor
response to loss, for taxpayers would have more reason to cut
losses short and let profits run.
Whether the holding period rules can be suspended for hard-
ship is a delicate question. Although arbitrary rules are becoming
increasingly acceptable as the tax base takes account of diverse
situations, a hardship rule, especially if based on intention, would
be as difficult to administer as the present system. On the other
hand, to refuse a hardship exception would bring about unintended
results in some cases. Cases of sudden loss or financial em-
barrassment are within the realm of foreseeability and should not
be granted relief. Sudden illness, unique financial emergency or
demands for ransom come closer to qualifying for real hardship,
and here an administrative tribunal might usefully exercise some
discretion. The only clear cut case of hardship is death, which
could easily be excepted.100
III. Canadian treatment of speculative transactions
A. Judicial trends
An important feature of a security is that its value to its holder
depends on the success of the underlying enterprise. 1″ The type of
involvement that an investor may choose in attempting to maximize
gain can range from reading the financial columns in the newspaper
or taking the advice of a broker to purchasing shares in a cor-
poration of which the taxpayer is shareholder and manager, supplier
and customer. This section takes a closer look at the kinds of in-
100E.g., Income Tax Act, s. 7(1.1) sets up a two year holding period for
shares acquired under employee options, but it sanctions a shorter holding
period if it ends on the taxpayer’s death.
11DThe concept of “security” used throughout this paper derives from
Coffey, The Economic Realities of a “Security”: Is There a More Meaningful
Formula? (1967) 18 Case W. Res. L. Rev. 367, 377.
McGILL LAW JOURNAL
[Vol. 25
volvement which render the purchase of investment securities a
business via adventure in the nature of trade –
even though the
transactions do not constitute trading. This class of cases is im-
portant because it marks the leading edge of tax liability for non-
trading securities transactions.
Those adventures which are referred to as speculative trans-
actions in shares can be categorized according to the form taken
by the personal services element of the transaction. In one category,
the taxpayer exercises his or her ordinary business skills in a trans-
action concerning the same subject matter; in a second, the tax-
payer exercises business acumen in an area related by knowledge
or subject matter; in a third, shares are sold as a substitute for the
underlying subject matter; in a fourth, the sale of shares is ac-
companied by promotion activities. A fifth category uses the tax-
payer’s interest in one enterprise to foster the value of his or her
other shares; a sixth employs an agent’s skills as a substitute for
the taxpayer’s personal expertise. In a seventh, the taxpayer expends
energy to ascertain primary trends in the absence of sophisticated
information or ability.
1. Subject matter the same as in ordinary business
In cases where the taxpayer turns pre-existing business skills
to his or her own account in transactions concerning the same
subject matter, gains from the sideline will be treated as income
from business or income from an adventure. Even where the subject
matter of the transaction is “property”, the existence of a business
or adventure will preclude capital gains treatment. Because of the
strong relationship between the business and sideline in this
category, “business”
is a more appropriate categorization than
“adventure”, but the courts’ reluctance to ignore the legal fictions
of employment and incorporation has aggravated the tendency to
use adventure as the basis for tax liability unless the sideline itself
clearly constitutes the conduct of a business.
For example, in Whittall v. M.N.R., Gibson J. held that a stock-
broker’s share transactions on his own account were adventures. 1 2
However, Mr Justice Martland affirmed the result on the ground
that the taxpayer’s activities constituted a business and that the
stockbroker was in a fiduciary relation at all times, availing him-
self of the opportunity to make trading profits as a result.103 Access
102 [1964] C.T.C. 417, 64 D.T.C. 5266 (Ex.).
103 [1968] S.C.R. 413.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
to insider information sets Whittall apart from similar decisions,
is
although the dividing line between business and adventure
blurred. The taxpayer in Falconer v. M.N.R. 14 was a geological
engineer and an officer of a petroleum company which extended
share options to him. He and some associates exercised the option
and disposed of the shares shortly thereafter. Without expressly
designating ordinary business or adventure as the basis for liability,
this transaction was described in the Tax Appeal Board decision
as “an undertaking closely related to his particular calling”. 1
5
0
Although it is unnecessary to employ adventure to bring sidelines
into the scope of unincorporated businesses, several cases have done
so. In Lansdell v. M.N.R.,04 a financial consultant participated in
underwriting a block of speculative shares. After the underwriting
was completed, he disposed of his allotment of shares from that
issue and took the position that the resulting gain was capital. He
was held to have engaged in an adventure in the nature of trade
because of the similarity between his business operations and the
so-called investment.1 7 The taxpayer in No. 924 v. M.N.R. 18 was a
scrap metal dealer and the special industry knowledge that he
possessed was the reason that his transactions in shares of a scrap
metal company were held to be adventures.
Cases that fall into this category are not difficult to analyze, as
the elements of business in the ordinary sense are so clearly present.
The only question is whether these cases are appropriately classed
as adventures when the facts closely reflect the attributes of
business.
2. Subject matter loosely related to ordinary business
An elderly lawyer who acquired mortgages at discount and then
held them to maturity in order to realize the discount was held to
be engaged in adventures in Scott [No. 2] v. M.N.R.'” The same
conclusion was reached in respect of an elderly businessman who
acquired discounted mortgages and later turned the management
104 [1961] Ex. C.R. 353; affd [1962] S.C.R. 664.
105 (1959) 23 Tax A.B.C. 114, 118; 59 D.T.C. 622, 626. See also Ladin v. M.N.R.
[1977) C.T.C. 2604, 78 D.T.C. 1007 (T.R.B.) (taxpayer who was employed to
purchase cattle earned business income on cattle futures transactions).
106 [1972] C.T.C. 74, 72 D.T.C. 6057 (F.C.T.D.).
10l See also Nasso v. M.N.R. (1960) 26 Tax A.B.C. 111, 61 D.T.C. 127.
108 (1958) 18 Tax A.B.C. 412, 58 D.T.C. 124.
109 [1963] S.C.R. 223, affg [1961] C.T.C. 451, 61 D.T.C. 1285
(Ex.) per
Thorson P.
McGILL LAW JOURNAL
[Vol. 25
of the obligations over to an agent.”” Each taxpayer relied on
general business contacts in the real estate industry, built up over
years of conducting business, to aid in selecting sound mortgages.
A large number of transactions was involved in each case.
The loose relationship between the taxpayer’s ordinary business
and the sideline increases the tendency for the courts to treat the
sideline as isolated from the ordinary business, and to class the
sideline as a business per se or an investment; the sole basis for
making the distinction seems to be the volume and frequency of the
transactions.'”
3. Promotion of property
“Promotion” is a broad concept which encompasses not only
the traditional concept of a promoter of a corporation and its shares
but also more subtle arrangements
in which the taxpayer has
control of an enterprise which directly or indirectly increases the
value of other property owned by the taxpayer. Shares disposed of
by a promoter in the first sense will almost inevitably be regarded
as income from business; adventure need not be invoked.” 2 In the
case of indirect promotions, however, it is likely that the courts
will give capital treatment to property whose value is affected by
the success of a related enterprise. This is the result reached in
Chaffey v. M.N.R., 3 where the taxpayer had an interest in real
estate and in the corporation formed to operate a tourist attraction
on the land. The shares produced a loss, and the taxpayer argued
that the attraction was designed to spark the value of the land.
LeDain J. concluded that the shares had been acquired on their own
110M.N.R. v. MacInnes [1963] S.C.R. 299 per Judson I., rev’g [1962] Ex. C.R.
385 per Thurlow J.
” Volume and frequency of transactions is an unsatisfactory basis for
determining tax consequences. There is no way to make rules on this basis
which are both easy to administer and logical. In M.N.R. v. Spencer [1961]
C.T.C. 109, 61 D.T.C. 1079 (Ex.), the taxpayer had entered into more than 140
mortgage transactions over the years, which led President Thorson to con-
clude that he was engaged in the operation of a scheme for profit making.
In Wood v. M.N.R. [1969] S.C.R. 330, however, similar transactions were held
to be investments. The taxpayer in Wood had entered into a total of eleven
transactions over the years, with an average of 1.5 mortgages maturing each
year.
112 See, e.g., McAdam v. M.N.R. [1973] C.T.C. 215, 73 D.T.C. 5189 (F.C.A.);
Angle v. M.N.R. [1969] C.T.C. 624, 69 D.T.C. 5423 (Ex.); Morgan Securities Ltd v.
M.N.R. [1967] C.T.C. 1, 67 D.T.C. 5015 (Ex.); Davidson v. M.N.R. [1964] Ex.
C.R. 48.
113 Supra, note 11, per LeDain I.
19801
THE TAXATION OF SECURITIES TRANSACTIONS
merits, on the balance of the evidence, and that the loss was not
from an adventure. LeDain J. did observe that on the evidence
before him the decision could have gone the other way at trial. A
similar issue arose in Cooper v. M.N.R.,” 4 in which LeDain J. held
that “promotion” is simply the “carrying on of a campaign to sell
shares to the public”:
A “campaign” to sell shares is a course of action that involves not only
juridical acts but non-juridical activity of an organizational and promo-
tional 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.11a
4. Securities sold as a substitute for the underlying property
Where a taxpayer with established ability in a particular line of
endeavour, such as real estate development, tries to obtain capital
gains treatment for the transaction by incorporating the property
and selling the shares instead of the developed property itself, the
courts have attributed the commercial intent of the taxpayer to
the share transactions as well, and have frequently invoked “ad-
venture” in order to explain the result. The anti-avoidance impli-
cations of this treatment are obvious, and it is possible that the
inclusion of capital gains in the tax base renders this response
unnecessary today.
Sears v. M.N.R.”0′ illustrates
this reasoning. The taxpayer had
engaged in a real estate transaction which evidently would have
been an adventure in the nature of trade if a corporation had not
been interposed. Instead of selling the real estate at a profit, the
shares of the company that owned it were sold instead; this also
was held to constitute an adventure because selling the shares was
simply another way of turning the real estate to account. 17
114 [19773 C.T.C. 107, 77 D.T.C. 5099 (F.CA.) per LeDain J. [References infra
are cited to C.T.C.]
LeDain $. in Cooper, 115-17.
15Ibid., 117. See also Appleby v. M.N.R. [1975] 2 S.C.R. 805, discussed by
116 [1970] Tax A.B.C. 388, 70 D.T.C. 1272.
117 See also Siebens v. M.N.R. [1971] C.T.C. 557, 71 D.T.C. 5310 (F.C.T.D.);
Slater v. M.N.R. [1966] C.T.C. 53, 66 D.T.C. 5047 (Ex.); Ellis v. M.N.R. (1965)
37 Tax A.B.C. 337, 65 D.T.C. 107; Majerle v. M.N.R. [19703 Tax A.B.C. 781;
Greer v. M.N.R. [1967] Tax A.B.C. 297, 67 D.T.C. 227. Greer presents an in-
teresting set of facts. The taxpayer formed two corporations – a vegetable oil
manufacturing company and a brokerage firm. The broker corporation un-
dertook to sell the taxpayer’s shares in the other company for him, which the
taxpayer had received for transferring some land to the company, and the
Minister assessed the gain as income because it resulted from an adventure.
McGILL LAW JOURNAL
[Vol. 25
5. Employment of an agent; acting on primary trends
Where none of the features discussed above appear in securities
transactions, it is unlikely that the transaction will be classed as a
business or an adventure. The personal efforts of an agent are
capable of bringing the principal’s securities gains into income,118
but ordinarily the employment of an agent will not have this effect.
Energetic study of the market appears insufficient to transform
securities transactions into an adventure or a series of adventures;
the cases disclose that the courts have required some evidence of
special knowledge and effort before classifying such a transaction
as an adventure. Where the evidence merely demonstrates vigour,
the transaction is classed as business if there is enough activity,
otherwise as an investment.
The securities industry is the beneficiary of a broader concept
of investment than that applied to most industries. It is difficult
to retain the characterization of investment for real estate if even
the slightest step is taken to increase its value while keeping the
possibility of sale open.”19 Only recently has it begun to appear that
the courts will give credence to the intention to hold developed real
estate for income production. 12 Securities have different stature.
For some time the courts have taken the position that in the
absence of other factors, the purchase of shares in the hope and
expectation that they will rise in value and be sold at a gain even
shortly after purchase is not enough evidence to support the finding
of an adventure. 12 1
This proposition was given cogent expression in Geddes v.
M.N.R., 112 a recent administrative ruling which considered the treat-
ment of gains on grain futures by an individual who was engaged
in the grain elevator business. Mr Frost refused to treat the tax-
payer’s gains as ordinary income, and drew attention to the vast
difference between professional trading and acting on primary
trends:
118 E.g., M.N.R. v. Minden, supra, note 69.
119 Regal Heights Ltd v. M.N.R. [1960] S.C.R. 902.
12O Hiwako Investments Ltd v. The Queen, supra, note 11. Chief Justice
Jackett ruled that the acquisition of profit-producing real estate as a hedge
against inflation was not an adventure in the nature of trade, presumably
because there is no presumption that developed real estate is speculative
property. He did not discuss whether raw land could constitute such a non-
speculative hedge against inflation.
121 See, e.g., Irrigation Industries Ltd v. M.N.R., supra, note 60. Cf. Rutledge
v. C.I.R., supra, note 41; Gordon v. M.N.R., supra, note 45.
122 [1976] C.T.C. 2449, 76 D.T.C. 1338 (T.R.B.). [References infra are cited to
C.T.C.]
19801
THE TAXATION OF SECURITIES TRANSACTIONS
To say that a taxpayer can trade successfully on fundamentals is to deny
the realities of trading and the principles which traders use. … [Niothing
that the appellant did resembled a genuine trading operation. Such sub-
missions as “scheme of profit making” or “whole course of conduct” do
not apply in any real sense to trading in futures on an organized exchange.
I do not mean that a non-professional cannot trade. He certainly can, but
he must trade in a technical sense, watch the market, cut his losses and
not merely rely on a primary trend to bail him out… . [Although he
is far removed from being a mere dabbler, his gains are not profit from
a business ….123
This decision is consistent with authority which takes the view that
mere frequency of transaction does not render securities trans-
actions a business if the operator is only an energetic amateur.1 4
6. Summary
“Adventure”, as it has been developed in Canada, has certain
recognizable features which distinguish it from trading, though not
from business in the general sense. The components of adventure
drawn from the cases in which adventure has been in issue can be
restated in terms of the economic elements of investment and
business. An adventure is a transaction which meets all of the
(1) it is a speculative investment; (2) there is
following criteria:
some risk of loss of initial value which is associated with the
acquisition of the subject matter of the transaction;
(3) the em-
ployment of human wealth in the motivation or timing of the
transaction operates to reduce that risk of loss relative to other
taxpayers; and (4) the transaction does not constitute a “trade”
as that term is used to describe a type of business enterprise. Even
though these generalizations can be extracted from reported cases,
they are of little use in predicting the ultimate disposition of a
given case. By injecting an economic analysis into their approach,
the courts have achieved a measure of justice in recent years, but
the cost of that justice in terms of litigation expenses and un-
certainty is probably too high.
B. Legislative response
It
is impossible to state that all adventures, as described by
Canadian courts, fall neatly into the category of either business
:123 Ibid., 2451.
124 See, e.g., Glaspie v. M.N.R., supra, note 78, per Fisher (corporation with
$1.5 million portfolio managed by a professionally trained financial specialist
was not carrying on business); but see Graham v. M.N.R. [1970] Tax A.B.C.
1185, 70 D.T.C. 1747 per Fordham (investment of $250,000 in mortgages was an
active business).
McGILL LAW JOURNAL
[Vol. 25
or investment. Securities are consistently thought of as investment
vehicles, and where security transactions are in question, it is
appropriate to think of adventure as connoting speculative invest-
ment. 12′ When securities adventures are thought of as speculative
investments instead of as business undertakings, the proposition
that all securities transactions should enjoy capital treatment has
some merit. 20 In the United States, this attitude toward securities
has crystallized
into specific rules which guarantee securities
holders capital gains treatment under every circumstance, unless
the taxpayer is a dealer in securities. 2 7
Recent legislation permits unincorporated taxpayers to treat all
gains or losses arising on the disposition of certain Canadian se-
curities as capital gains and losses, regardless of the circumstances
surrounding the disposition.1 28 The main limitation on the right to
elect this treatment is that dealers and traders in securities may
not make the election. The purpose of the election is to confer some
certainty on nonbusiness transactions.
The earlier discussion in this paper established criteria for
legislation in the difficult area of speculative securities trans-
actions. An ideal model which disregards the distinction between
capital and income transactions is politically unfeasible because
there are numerous policy arguments for a preference, and those
arguments have widespread popular support. Case by case litigation
applying the concept of adventure in the nature of trade is a costly
device for implementing policy, since the standard is too subjective
and too easily manipulated. An economic realities approach leads
us closer to distributive justice but again the cost in terms of un-
125 Andrews, A Consumption-Type or Cash Flow Personal Income Tax (1974)
87 Harv. L. Rev. 1113 describes “speculative investments” as the acquisition of
property which has no established pattern of earnings. “Speculation” exists
when future yield is “highly conjectural” and the “concept of what a willing
buyer would pay a willing seller may be highly abstract and quite hypo-
thetical”: ibid., 1145. Mere speculation is generally inadequate to transform an
acquisition into a business venture; hence it is by default characterized as an
investment, even though it is not an investment which is productive of income.
’12 Tresilian, The Capital Gains Scare (1955) 3 Can. Tax J. 396; Gordon,
Capital Gains are Sometimes Taxed (1955) 3 Can. Tax J. 399.
127I.R.C. 1221(1) restricts the scope of noncapital assets for securities
holders to stock in trade, inventory and property held for sale to customers.
Thus, all securities transactions are treated as capital transactions unless
reported by a “dealer”. Mere trading in securities will not affect the capital
asset treatment of the property. Even dealers may segregate
investment
securities from inventory, permitting dealers some enjoyment of the capital
treatment. See I.R.C. 1236.
128Income Tax Act, s. 39(4), (5), (6), added by 1977-78, c. 1, s. 16(2).
19801
THE TAXATION OF SECURITIES TRANSACTIONS
certainty and litigation is too high. A distributive model that seeks
to give to gains that approximate income the same treatment as
ordinary income would remove most of the uncertainty while
achieving a rough measure of justice.
In seeking certainty, the guaranteed capital gains election has
managed to combine the worst features of the common law business
and the economic realities models. It substitutes unworkable con-
cepts like “dealer”, “trader”, and “carrying on business” for the-
unworkable concepts of “adventure”, “capital”, and “investment”,
and has merely shifted the focus of litigation. It narrows the range
in which the courts can employ their newly devised
of cases
economic analysis. This will increase the number of cases in which
taxpayers who generate gains that resemble income flows will be
treated as if the gain was unexpected and therefore deserving of
a tax preference. It also defeats distributive objectives by expanding
the scope of the capital gains preference. It is likely that many
taxpayers who will generate gains that resemble income flows will
be entitled to take advantage of the election if a narrow concept
of dealer or trader is developed by the courts.
*t *
*
APPENDIX 1
Percentage of Income Derived from Capital Gains, by Income Class (1972-1976)
1972
1973
1974
1975
1976
Loss and nil
$1-1000
$1000 -2000
$2000 -3000
$3000-4000
$4000 -5000
$5000 – 10,000
$10-15,000
$15 -20,000
$20 -25,000
$25 -50,000
$50- 100,000
$100 -200,000
over $200,000
overall
–
.04
.05
.008
.08
.05
.05
.09
.28
.50
.97
1.90
3.50
8.90
.22
–
–
.09
.13
.13
.10
.09
.15
.32
.60
1.00
1.80
3.90
9.60
.32
–
–
.10
.03
.11
.13
.11
.13
.25
.45
.80
1A0
2.60
5.70
2.80
–
.26
.10
.17
.20
.20
.15
.14
.22
.40
.86
1.60
2.60
6.50
3.65
–
.20
.12
1.40
.20
.27
.23
.19
.25
.39
1.00
2.40
4.30
8.90
5.00
Source: Revenue Canada, Taxation, Taxation Statistics (1974-1978), Table 2.
18
McGILL LAW JOURNAL
[Vol. 25
APPENDIX 2
Number of Individuals Reporting Gain or Loss by
a Percentage of All Individuals Reporting Ga
Asset Type, Expressed as
in or Loss
(1972-1976).
1972
1973
1974
1975
1976
No.
Reporting %
No.
Reporting %
No.
Reporting %
No.
Reporting %
No.
Reporting %
200,121 65
9
27,425
9
27,604
208,027 50
8
34,423
69,809
17
187,021 48
9
37,709
92,198 24
171,092 50
41,076 12
94,655 28
188,918 48
48,699 12
103,419 26
78,534 26
145,696 35
114,605 29
61,448
18
95,767 24
230,862 75
302,584 72
238,773 61
201,608 59
272,264 68
75,098 25
115,075 28
152,724 39
131,858 41
126,634 32
305,960
417,659
391,497
339,466
398,898
Shares
Bonds
Real Estate
Other
Capital
Property
Total
Reporting
Gain
Total
Reporting
Loss
Total
Reporting
Source: Revenue Canada, Taxation, Taxation Statistics (1974-1978), Table 18.
APPENDIX 3
n 80
0
.5 70
0
r. 60
to
0
P.
50
~,40
30
0
? 20
i
Taxpayers reporting
*— gain
*—Shares
ff
* . “‘
.
.
.
.
..
RealEstate
“….ZOther
Property”
–
_ – –
–
–
-4 Bonds
I
1972
1973
I
1974
I
1975
I
1976
I
I
Source: Revenue Canada, Taxation, Taxation Statistics (1974-1978), Table 18.
1980]
THE TAXATION OF SECURITIES TRANSACTIONS
0
104
xa
r110
.0
0
o Z
,j tw
0
