Date: 20050617
Dockets: A-463-03
A-462-03 & A-465-03
A-464-03
A-466-03
Citation: 2005 FCA 227
CORAM: ROTHSTEIN J.A.
Docket A-463-03
BETWEEN:
GORDON REZEK
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Dockets: A-462-03 and A-465-03
BETWEEN:
PHIL HAYES and PAT HAYES
Appellants
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Docket A-464-03
BETWEEN:
STEPHEN STEPHENS
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Docket A-466-03
BETWEEN:
MURIEL SCOTT
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Heard at Toronto, Ontario, on April 25, 2005.
Judgment delivered at Ottawa, Ontario, on June 17, 2005.
REASONS FOR JUDGMENT BY: ROTHSTEIN J.A.
CONCURRED IN BY: NADON J.A.
SHARLOW J.A.
Date: 20050617
Dockets: A-463-03
A-462-03 & A-465-03
A-464-03
A-466-03
Citation: 2005 FCA 227
CORAM: ROTHSTEIN J.A.
Docket A-463-03
BETWEEN:
GORDON REZEK
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Dockets: A-462-03 and A-465-03
BETWEEN:
PHIL HAYES and PAT HAYES
Appellants
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Docket A-464-03
BETWEEN:
STEPHEN STEPHENS
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
Docket A-466-03
BETWEEN:
MURIEL SCOTT
Appellant
and
HER MAJESTY THE QUEEN
Respondent
and
CANADIAN BANKERS ASSOCIATION
Intervener
REASONS FOR JUDGMENT
[1] These are five appeals from the Tax Court affecting a number of taxation years of each appellant. The Minister of National Revenue is also cross-appealing.
[2] The Minister's reassessments that precipitated the appellants' appeals to the Tax Court arose from an investment approach undertaken by the appellants known as convertible hedging. The convertible hedge strategy engaged in by the appellants was promoted by J.K. Maguire and Associates of Toronto, who held themselves out as financial and tax strategists. For income tax purposes, the appellants deducted losses and expenses that they incurred arising from transactions made in the course of engaging in this strategy. The Minister's reassessments disallowed a number of these deductions. The issues cannot be simply stated before providing a description of the convertible hedge strategy.
CONVERTIBLE HEDGE STRATEGY
Introduction
[3] Under the convertible hedge strategy, common shares of publicly traded companies are "sold short" and at approximately the same time, another security carrying the right to acquire approximately the same number of common shares is purchased. The purchased securities may be preferred shares or debentures, both convertible to common shares, or a warrant to acquire common shares.
Selling Short
[4] A short sale of shares is a sale of shares that the seller does not own. The shares are said to be "borrowed." That means that the sale is facilitated by entering into an agreement with a broker who will permit the sale of shares belonging to another person (who may be the broker or a customer of the broker). The proceeds of the sale, net of broker's fees, are credited to the account of the short seller. On the record here, when shares were sold short by the appellants, they paid a fee called a "rental fee" to the brokers. In addition, they paid an amount equal to the dividends paid on the shares between the time they were borrowed and the time they were returned. Such payments are referred to as "compensatory dividends."
[5] The profit or loss on a short sale is determined when the short sale is "closed out". That occurs when the short seller replaces the borrowed shares. That is done by having the broker purchase an equivalent number of identical shares for the person who lent them to the short seller. The cost of the purchase, including broker's fees, is debited to the account of the short seller.
[6] If the cost of acquiring the replacement shares is less than the proceeds of the short sale (because the value of the shares has declined), the short seller realizes a profit on the short sale. If the cost of acquiring the replacement shares is more than the proceeds of the short sale (because the value of the shares has increased), the customer will realize a loss on the short sale. Any broker's fees, rental fees and compensatory dividends paid by the short seller between the short sale and the close out will reduce the profit or increase the loss.
[7] A short sale of shares is different from a normal sale of shares in two ways. First, the seller receives the proceeds of sale before incurring the cost of acquiring the shares. Second, a short sale results in a profit only if the value of the shares declines, while a normal sale results in a profit if the value of the shares increases.
Hedging
[8] A "hedge" is a technique for mitigating the risk of loss. The main risk of loss on a short sale is the risk that the value of the shares may increase. To mitigate that risk, a short seller of common shares may acquire a security carrying the right to acquire the same number and kind of common shares. That right may be found in a right of conversion attached to a convertible share or a convertible debenture, or in a warrant to acquire common shares.
[9] The value of a convertible share or a convertible debenture includes the value of the common shares into which the security may be converted, plus the value of the security without the conversion feature (the stated capital if it is a preferred share or the principal amount if it is a debenture) plus, in certain circumstances, a premium representing the value of the right to make the conversion. The cost of acquiring a convertible security necessarily includes the cost of all of those components.
[10] A warrant confers the right to acquire common shares for a limited period of time at a specified price. If the market price of the common shares is below the specified price that entitles the warrant holder to acquire the common shares (sometimes referred to as the "strike" or "exercise" price), the warrant would have no value. If the market price of the common shares exceeds the specified price at which the warrant holder is entitled to acquire the common shares, the market price of the warrant should be the difference between the specified price and the market price of the common shares plus a premium for the right to acquire the common shares. For example, if the warrant entitles the holder to acquire common shares at ten dollars per share and the market price of the common shares is twelve dollars, the market price of the warrant should be about two dollars plus a small premium.
[11] To the extent that the value of a convertible security includes the value of the common shares into which it may be converted, its value necessarily increases as the value of the common shares increases. Similarly, the value of a warrant will increase as the value of the common shares increases. Therefore, a short seller of common shares who is at risk of loss on the short sale (because of an increase in the value of the common shares) may mitigate that risk by holding convertible securities or warrants carrying the right to acquire the same number and kind of common shares.
[12] Holding a convertible security or warrant entails a risk of loss resulting from a decline in the value of the common shares. Such a decline will automatically reduce the value of the convertible security or warrant. However, if the holder of a convertible security or warrant has also made a short sale of the common shares, a decline in the value of those common shares will result in a profit on the short sale. Thus, a short sale will mitigate the risk of loss on the convertible security or warrant.
[13] Holding a convertible security or warrant to hedge a loss on a short sale of common shares was referred to in the record as a "convertible hedge" or a "convertible hedge strategy". A person who has made a short sale of common shares and who also holds a convertible security or warrant representing the same number of identical common shares is hedging two potential losses. The potential loss on the short sale resulting from an increase in the value of the common shares is hedged by holding the convertible security or warrant. The potential loss on the convertible security or warrant resulting from a decline in the value of the common shares is hedged by the short sale.
Profit or Loss on the Spread
[14] On the record here, there was generally a small premium between the amount paid for the convertible securities, or the amount paid for the warrants and income earning investments on the one hand, and the proceeds from the short sale of common shares on the other. If the market value of the common shares were to increase, the value of the convertible security or warrant would also go up generally in tandem with the common shares. Upon the conversion to common shares or the exercise of the warrant, the investor would simply not recover the premium.
[15] However, if the value of the common shares were to decline, at some point the investor may make a profit. That is because at some lower value of the common shares, the market will place little or no value on the conversion feature of the convertible security or warrant and the value of the convertible security or warrant will not fall further. For example, if a warrant entitles an investor to acquire common shares for ten dollars per share and if the market value of the shares is below ten dollars, the warrants should have no value. However, the investor's profit on the short sale will continue to increase as the value of the common shares continues to decline below ten dollars. The spread between the value of the common shares sold short and the value of the warrants will increase in favour of the investor.
[16] Using the same example, assume that the investor sold common shares short at twelve dollars and at the same time purchased warrants to acquire common shares for the exercise price of ten dollars. The market price of the warrants should be two dollars plus a small premium reflecting the right to acquire the common shares in the future, say ten cents. If the price of the common shares falls to five dollars per share, the warrant will have no value because no one would pay for the right to acquire the common shares at ten dollars when the market value was five dollars. The investor will lose two dollars and ten cents in respect of the warrant. However, the investor will be able to make a cover purchase for the short sale of the common shares for five dollars. In that case, the investor will gain seven dollars on the short sale and lose two dollars and ten cents on the warrant for a net gain of four dollars and ninety cents.
[17] Thus, in the example, while the investor will lose the ten cent premium if the value of the common shares does not decline below the exercise price, the investor will earn a profit of four dollars and ninety cents if the value of the common shares declines below the ten dollar exercise price to five dollars.
[18] For convenience, hereafter I will refer to convertible preferred shares, convertible debentures and warrants as "convertible securities" or as a "convertible security".
Income Opportunity
[19] In addition to the potential for profit on the spread under the convertible hedge, there is also an opportunity to earn income during the period of the hedge. Generally, convertible preferred shares or debentures will yield greater dividends or interest than the common shares. While convertible hedge investors will have to pay compensatory dividends to the broker, these investors expect to receive greater dividends or interest on the convertible preferred shares or debentures they hold. Even when the convertible security is a warrant that pays no dividend or interest, investors will be able to acquire treasury bills or other low risk, interest-bearing securities with that portion of the proceeds from the short sale of the common shares that exceeds the amount required to pay for the warrants. That interest is expected to exceed the compensatory dividends payable on the common shares sold short.
[20] In summary, there are two sources of income from a convertible hedge strategy - profit on the spread and net income from dividends or interest during the period of the hedge.
The Potential Tax Benefits
[21] In addition to the profit potential from the convertible hedge strategy, Maguire's promotional material advised of potential tax benefits from the strategy "regardless of whether the market rises or falls." The promotional material dated November 1, 1986, was entitled "Hedging, Canadian Style A Win/Win Proposition". The material states, in part, at page 5:
It is hopefully apparent that there are countless permutations of potential tax games to be played with a hedge of this nature, REGARDLESS OF WHETHER THE MARKET RISES OR FALLS. It is not the purpose of this article to delve into the myriad of potentialities. However, it cannot be overemphasized that this is a game only suitable for taxpayers with the best of professional assistance.
[22] In accordance with representations from the Maguire firm, the appellants claimed tax deductions as a result of coordinated transactions between spouses or, in the appellant Muriel Scott's case, coordinated transactions with her daughter. The following example, taken from the broker's statements, will illustrate how this was done:
On April 27, 1988, the appellant Gordon Rezek bought 10,100 Laidlaw convertible preferred shares for a total cost of $615,506.12. These 10,100 preferred shares were convertible into 30,704 common shares of Laidlaw. On the same day, Mr. Rezek sold short 30,704 Laidlaw common shares for proceeds of $612,925.52. The spread was $2,580.60. He was only required to put up $2,580.60 with the broker as it was only this spread that was considered to be at risk.
On May 20, 1988, Mr. Rezek sold the 10,100 Laidlaw convertible preferred shares for $477,075, incurring a loss of $138,431.12 which he claimed as a deduction in his 1988 taxation year. On the same day, his girlfriend and future wife, Gloria Fahrngruber, purchased 10,100 Laidlaw convertible preferred shares for $477,375.
The brokers held guarantees from each of Mr. Rezek and Ms. Fahrngruber guaranteeing the other's indebtedness to the broker. Therefore, even though the short sale of common shares and the acquisition of convertible preferred shares were in separate accounts, the hedge was maintained.
In August 1988, Ms. Fahrngruber converted her 10,100 preferred shares into 30,709 common shares of Laidlaw (five shares were sold within a few days). At this point, Mr. Rezek had sold short 30,704 common shares of Laidlaw and Ms. Fahrngruber owned 30,704 common shares of Laidlaw. This was referred to as a common-common position in which there was no possibility of profit for either of them but also no risk. In 1995, this common-common hedge was closed out with Ms. Fahrngruber disposing of her Laidlaw common shares by transferring them to Mr. Rezek to cover his short sale of the common shares.
THE REASSESSMENTS
[23] The Minister reassessed the appellants on the basis that, when they engaged in the convertible hedge strategy with their spouses or, in Mrs. Scott's case, her daughter, they were doing so in a partnership relationship or alternatively, in a principal/agent relationship. In either case, the Minister said that the appellants could not isolate the transactions that created the losses that the appellants had deducted from their income.
[24] The Minister relied on the decision of this Court in Schultz v. Canada (C.A.), [1996] 1 F.C. 423. In that case, Stone J.A. found a partnership to exist between the two spouses engaged in a convertible hedge strategy promoted by Maguire. When one spouse incurred a loss, the other had a compensating gain. Therefore, the partnership had no net loss. The Minister's disallowance of the deductions claimed was upheld by the Tax Court and the appeals to this Court were dismissed.
SUMMARY OF THE CONCLUSIONS OF THE TAX COURT JUDGE
[25] In these cases, the Tax Court judge agreed with the appellants that there was no partnership relationship between spouses in respect of the convertible hedge strategy. He found that the convertible hedging in which the appellants had engaged were adventures in the nature of trade and that the spouses were co-adventurers. He then determined that each convertible hedge constituted a separate identifiable property, which consisted of both the acquired convertible securities and the short sale of the common shares, what he referred to as the long position and the short position. Because the convertible hedge was a single property, any loss on one position could not be isolated and could not be a deduction for tax purposes. The only amounts that were deductible were losses on the premium and expenses incurred during the period of the hedge. He also determined that the appellant Muriel Scott could not avail herself of subsection 10(1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) as amended, to write down the securities she held to the lower of cost or market value and that Mrs. Scott and the appellant Pat Hayes could not invoke subsection 39(4) of the Act to elect to treat their security transactions on capital account.
MATTERS NOT IN DISPUTE
[26] 1. The parties agree that all profits or losses are on income account (subject to elections under subsection 39(4) filed by Mrs. Scott and Mrs. Hayes).
2. The applicable provisions of the Act to the main issues in the appeal are subsections 3(1), 9(1), 9(2), paragraphs 18(1)(a), 20(1)(c) and section 82.
3. The relationship between Mrs. Scott and her daughter Patricia Scott was that of principal/agent. The issues in her appeal involve her write down of inventory under subsection 10(1) of the Act and her election under subsection 39(4) of the Act.
POSITION OF THE PARTIES AND INTERVENER
Appellants
[27] The appellants say that the Tax Court judge erred in finding that the convertible hedge was a separate identifiable property. They also submit that they were not partners with their spouses and that Schultz is distinguishable. Other than Mrs. Scott, they also say they were not in a principal/agent relationship with their spouses. They say their transactions should be treated individually, without regard to the involvement of their spouses in the convertible hedge strategy.
Intervener
[28] The Canadian Bankers Association only intervenes to argue that the Tax Court judge erred in finding that a convertible hedge was a separate identifiable property. Otherwise, the Association takes no position with respect to the outcome of the appeals.
Minister
[29] While he does not defend the position, the Minister accepts the finding of the Tax Court judge that a convertible hedge is a separate identifiable property. In the alternative, he cross-appeals on the basis that the Tax Court judge erred in finding that the appellants were not in a partnership or principal/agent relationship with their respective spouses.
ISSUES
[30] The issues in this appeal are:
1. whether the Tax Court judge erred in finding that a convertible hedge was a separate identifiable property;
2. if so, whether he erred in finding that the appellants were engaged in adventures in the nature of trade and in failing to find that the appellants were in a partnership or principal/agent relationship with their respective spouses in carrying out the convertible hedge transactions;
3. whether Mrs. Scott is entitled to invoke subsection 10(1) of the Act; and
4. whether Mrs. Scott and Mrs. Hayes made valid elections under subsection 39(4) of the Act.
CONVERTIBLE HEDGE AS A SEPARATE IDENTIFIABLE PROPERTY
The Approach to the Interpretation and Application of the
Income Tax Act
[31] In determining that the convertible hedge was a separate identifiable property, the Tax Court judge relied upon the following definition of "property" in subsection 248(1) of the Act:
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"property" means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes (a) a right of any kind whatever, a share or a chose in action, (b) unless a contrary intention is evident, money, (c) a timber resource property, and (d) the work in progress of a business that is a profession;
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« _biens_ » Biens de toute nature, meubles ou immeubles, corporels ou incorporels, y compris, sans préjudice de la portée générale de ce qui précède: a) les droits de quelque nature qu'ils soient, les actions ou parts; b) à moins d'une intention contraire évidente, l'argent; c) les avoirs forestiers; d) les travaux en cours d'une entreprise qui est une profession libérale.
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[32] The judge observed that "this is not only the broadest of definitions, it invites a non-restrictive approach... ." In his opinion, the justification for characterizing the convertible hedge as a separate identifiable property was "the rights implicit in the convertible hedge." The right that was implicit in the convertible hedge itself, he found "is the right to rely on one component of the convertible hedge to satisfy the margin requirements of the other component."
[33] After referring to the evidence of the appellants, he concluded at paragraph 127:
I conclude it was a common view that the investment was the convertible hedge itself. This is consistent with the finding that the convertible hedge is a property, and it is that property which is the subject of the Appellant's adventure, the Appellant's business.
[34] It would appear that the learned judge recognized that this was not an easy conclusion to reach. Indeed, in the introduction to his lengthy decision, he provided a preview of his expansive approach to the interpretation and application of tax laws at paragraph 2:
At the outset, I should mention that the conundrum in applying tax principles to the financially innovative strategy of convertible hedging is that tax laws have not necessarily kept apace with the ingenuity of the financial community. It is therefore appropriate, when viewing the transactions through the tax looking glass, that the focus not be so finely adjusted as to preclude a broad, common sense, but equally innovative, approach to the application of our tax laws. A square peg does fit in a round hole if the round hole is big enough.
[35] In justifying the convertible hedge as a separate identifiable property theory, he reiterated the "round hole - square peg" analogy at paragraph 118:
This is where the round hole of taxation principles must expand to accommodate the square peg of financial innovation: where what is real in law is not so restrictively interpreted as to deny a result that meshes economic and legal reality. ...
[36] In his conclusion at paragraph 219, he expressed the view that tax laws must exhibit "elasticity":
As is clear from comments throughout this judgment, I am of the view our taxation laws must exhibit sufficient elasticity to accommodate novel financial arrangements without having to resort either to relying entirely on economic realities, or to deeming legal relationships that in fact do not exist. So I have approached questions such as what is property and what is a source with both an eye to the true legal nature and an eye to adaptability of tax laws to the moving target of financial innovation.
[37] With respect, I am of the opinion that the judge was in error in his approach to the interpretation and application of the Act.
[38] The customary role of the Court is to find the facts, to interpret the law and to apply the law to the facts. The interpretation of legislation is to be guided by the often-quoted excerpt from E.A. Driedger, Construction of Statutes, 2nd ed. 1983, at page 87:
Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.
See, for example, Will-Kare Paving & Contracting Ltd. v. Canada, [2000] 1 S.C.R. 915 at paragraph 32.
[39] The Tax Court judge's approach implies that the role of the Court is to interpret the Act so as to restrict innovative tax avoidance measures. I think that approach is wrong in law. In Canada, it is not the role of the Court to act as the protector of the public revenue. It is for Parliament to enact measures for doing so.
[40] In Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622 at paragraph 46, the Supreme Court reiterated that, in the absence of a specific statutory bar to the contrary, taxpayers are entitled to structure their affairs in a manner that reduces the tax payable. If "tax laws have not necessarily kept pace with the ingenuity of the financial community", as found by the Tax Court judge, that is a matter for Parliament, not the courts.
[41] The Tax Court judge's elastic approach is inconsistent with Supreme Court jurisprudence. The role of the Court is not to expand taxation principles depending upon the innovation of taxpayers or the view of a judge as to the merits of a particular case. As stated by McLachlin J. in Shell at paragraph 45:
... [t]his Court has made it clear in more recent decisions that, absent a specific provision to the contrary, it is not the courts' role to prevent taxpayers from relying on the sophisticated structure of their transactions, arranged in such a way that the particular provisions of the Act are met. ...
Analysis of the Convertible Hedge as a Separate Identifiable Property
Theory
[42] Hedging is a normal aspect of many businesses, including financial businesses and businesses that deal in commodities. There may be businesses that deal exclusively in hedge transactions. It is also fair to say that there is an investment approach that is termed "convertible hedging". But it is an error to synthesize the components of the hedge into a single identifiable property. The term "convertible hedging" is just a shorthand way of describing certain types of individual transactions that take place at approximately the same time. Each transaction is concerned with a certain identifiable property. But just because the transactions take place at the same time and involve the same investor or investors in related security transactions, does not justify collapsing the results of the separate transactions into a single property.
[43] The basis of the Tax Court judge's theory was the financing of the convertible hedge. At paragraph 120 of his reasons, he stated:
The right or rights must derive from the convertible hedge itself and not just from the accumulation of independent rights of components of the convertible hedge. ... [t]he right which only arises from the convertible hedge itself, and consequently satisfies me that the convertible hedge is property, is the right to rely on one component of the convertible hedge to satisfy the margin requirements of the other component. ...
[44] To address the reasoning of the judge, it is necessary to explain the margin arrangements to which he referred. The risk of a change in the value of the shares is assumed by the customer. When the customer does not pay for the transaction outright, the broker will require the customer to maintain margin (cash or other securities) in his account. The margin requirement will initially be met from the acquired security or the proceeds of the short sale of shares. But the broker will normally require an additional amount to be placed in the customer's account to cover the risk of loss. On the record here, in the case of non-hedged transactions, the additional amount would be fifty percent of the price at which convertible securities were acquired or common shares were sold short and thereafter maintained at fifty percent of the market value calculated at the end of each day. (Adjusting the market value of shares to reflect current market value is referred to as "mark to market.")
[45] However, under the convertible hedge strategy promoted by J.K. Maguire in these cases, brokers were willing to waive the additional fifty percent margin requirement because, in their view, the convertible security purchased and the proceeds from the short sale of common shares each hedged the loss that might be incurred from the other. The only amount at risk was the premium between the amount paid for the convertible securities and the proceeds received on the short sale of the common shares. According to the evidence, the brokers only required the appellants to put up, in cash, the amount of the premium. Therefore, the financing required to engage in the convertible hedge strategy was relatively minimal, e.g. in Mr. Rezek's Laidlaw hedge, $2,580.60 in respect of convertible securities costing $615,506.12 and proceeds of the short sale of common shares of $612,925.52. It was the brokers' willingness to forego the usual additional fifty percent margin requirement and instead treat each component of a convertible hedge as largely satisfying the additional margin required that caused the judge to reach his conclusion that a convertible hedge was a separate identifiable property.
[46] I am unable to agree with the judge's reasoning. In Principles of Property Law, 3rd ed. Scarborough, Carswell, 2000, Professor Ziff provides an introduction to the concept of property at page 2:
Property is sometimes referred to as a bundle of rights. This simple metaphor provides one helpful way to explore the core concept. It reveals that property is not a thing, but a right, or better, a collection of rights (over things) enforceable against others. Explained another way, the term property signifies a set of relationships among people that concern claims to tangible and intangible items.
[47] The learned Tax Court judge was correct to consider property in terms of rights. He was also correct to observe that the independent rights associated with the components of a convertible hedge could not be accumulated to constitute the convertible hedge as a separate property. However, he was incorrect to say that the right to rely on one component of the convertible hedge to satisfy the margin requirements of the other component was a right that gave the convertible hedge the status of a separate identifiable property.
[48] Application of the Income Tax Act relies on the general law respecting property. The Income Tax Act itself is not a commercial code. These principles were succinctly stated by Major J. in Will-Kare at paragraph 31:
To apply a "plain meaning" interpretation of the concept of a sale in the case at bar would assume that the Act operates in a vacuum, oblivious to the legal characterization of the broader commercial relationships it affects. It is not a commercial code in addition to a taxation statute. Previous jurisprudence of this Court has assumed that reference must be given to the broader commercial law to give meaning to words that, outside of the Act, are well defined. See Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298. See also P.W. Hogg, J.E. Magee and T. Cook, Principles of Canadian Income Tax Law, 3rd ed. 1999, at p.2 where the authors note:
The Income Tax Act relies implicitly on the general law, especially the law of contract and property ...
The independent enforceable rights associated with securities held in a brokerage account and the equally independent rights, if any, associated with the short sale of shares are evidence of the broader commercial environment in which transactions resulting in those positions take place.
[49] The satisfaction of margin requirements originates from and relies upon the individual components of the convertible hedge. The convertible security that is used to satisfy margin requirements is itself a separate identifiable property. It belongs to the investor. It carries with it the rights of ownership that would include the right to dividends or interest, the right to convert to common shares and whatever other rights are conferred on the investor according to the terms of the security. These rights are incidents of the ownership of the convertible security. They do not change because the convertible security is part of a convertible hedge. The rights, and therefore, the property in the convertible security are independent of any convertible hedge involving the convertible security. The nature of rights in respect of the short sale of common shares is harder to identify; the completion of a short sale entails mostly obligations. Perhaps there are rights associated with the proceeds from the short sale. Such rights as may exist in respect of a short sale are independent of a convertible hedge involving the short sale.
[50] The rights associated with the holding of convertible securities and the rights, if any, associated with the short sale of common shares are "independent rights of components of the convertible hedge" and by the judge's own reasoning, do not support the theory that a convertible hedge is a separate identifiable property.
[51] It is true that in the case of a convertible hedge, the brokers were satisfied with less margin than would otherwise be required. That is because each component of the convertible hedge acted as a hedge against the risk of loss in respect of the other component. But a strategy of minimizing risk does not transform separate properties, each with their own rights, into a single property. Put another way, at its highest, the margin arrangements were a contractual overlay on each component of the convertible hedge. They reflected the way in which the appellants and the brokers dealt with their property. But the margin arrangements did not change those separate properties into a new property.
[52] The definition of "property" in the Income Tax Act is indeed wide. That is to ensure that the Act will apply to all property recognized by the general law of property. However, the breadth of the definition is not a licence to the courts to create, for income tax purposes, a new type of property that is not recognized outside the Act.
[53] There is another reason why, on the facts of this case, the judge's reasoning does not stand up to scrutiny. At paragraph 120, the Tax Court judge drew a critical inference from his assessment of the evidence:
... The experts' description of the convertible hedge, combined with the evidence of Mr. Sildva and Mr. McCrodon confirmed that the brokerage houses' agreement with those engaged in convertible hedges included a provision to waive the usual strict requirements for margin, and accept that a convertible long position was in and of itself sufficient margin for the short position. This was critical to the operation of the convertible hedge, and it was something the investor was able to rely upon in the arrangement with the broker. It was, I would suggest, a legally enforceable claim that the broker would provide margin on this basis. [Emphasis added.]
[54] Although he suggested the waiver by the brokers of the usual margin requirements was a "legally enforceable claim", I see nothing in the record to support this view. The fact that a broker waived the usual requirements for margin or that the appellants relied on this arrangement with the broker does not create a legally enforceable right by the appellants.
[55] The waiver of the usual margin requirements reflects nothing more than an accommodation provided by the broker that could be cancelled at the option of the broker. The convertible hedge margin arrangements were subject to the brokers' customer agreements and cross-guarantees signed by the appellants and their spouses. Under the customer agreements, it was the brokers who had the discretion as to the margin required from their customers. For example, the Customer Margin Lending Agreement between Nesbitt Thompson Bonguard and the appellant Stephen Stephens (the "Undersigned") provided:
The Undersigned will at all times maintain such margin as you may from time to time require upon or in the account(s) of the Undersigned and promptly meet all margin calls.
[56] Accordingly, the customer agreements and cross-guarantees gave the brokers the right to require additional margin at any time and to seek recovery from the account holder or the guarantor for any liability arising in the account. The brokers did not limit that right in these cases. Therefore, the limited convertible hedge margin arrangements were not enforceable against the brokers and were not rights accruing to the appellants. As they were not rights of the appellants, even under the Tax Court judge's theory, they did not establish that a convertible hedge was a separate identifiable property.
[57] There are two other reasons why the judge's separate identifiable property theory cannot stand. Synthesizing the acquisition of convertible securities with the short sale of common shares constitutes a re-characterization of the effect of transactions. The Supreme Court has made it clear that re-characterization is only permissible if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect (see Shell at paragraph 39). There is no doubt here that the transactions acquiring convertible securities resulted in the convertible securities being held in the account of the investor; similarly, the transactions selling short common shares resulted in obligations imposed on the investor. It may be that the separate transactions were part of the convertible hedge strategy with its risks and benefits, but that does not permit the re-characterization of ordinary market transactions for tax purposes.
[58] Finally, the convertible hedge as a separate identifiable property constituted a new basis of assessment created by the judge in 2003. The Minister's limitation period for assessing had expired at the latest in 1998. The judge rejected the Minister's partnership basis of assessment and did not make a determination on the Minister's principal/agent basis of assessment, except in the case of Mrs. Scott. Absent the convertible hedge as a separate property finding, the appeals of the spouses would have been allowed. Therefore, the convertible hedge as a separate identifiable property constituted an impermissible new basis of assessment after the limitation period for assessing had expired (see Pedwell v. Canada (C.A.), [2000] 4 F.C. 616 at paragraphs 13 to 16).
PARTNERSHIP
Application
[59] The discussion of partnership applies only to the appeals involving Gordon Rezek, Phil and Pat Hayes and Stephen Stephens. In the case of Muriel Scott, the parties agreed and the Tax Court judge accepted that she was in a principal/agent relationship with her daughter.
Reasons of the Tax Court Judge
[60] Even though partnership was the primary basis of the Minister's reassessments, the Tax Court judge did not initially determine whether the appellants and their spouses were in a partnership relationship in their convertible hedging activities. Although the parties had agreed that the profits and losses from their transactions were on income account, he thought it necessary to satisfy himself of that conclusion. He did so by considering the definition of "business" in the Income Tax Act, which includes an adventure in the nature of trade. He concluded that the appellants' profits and losses arose from adventures in the nature of trade and were on income account.
[61] It was only after he had concluded that the appellants and their spouses were co-adventurers in the nature of trade that he considered whether they might be in a partnership relationship and determined that they were not.
The approach to determining the applicable form of business
organization at issue
[62] An adventure in the nature of trade is an Income Tax Act concept designed to determine which purchase and sale transactions are of a business nature and which are of a capital nature. However, as already noted, the Act is not a commercial code operating in a vacuum. In determining the nature of transactions or forms of business organization, it is necessary to have regard first to the general law of contract and property or the law pertaining to the form of business organization. It is only after that analysis is carried out that it is appropriate to apply provisions of the Act to determine liability for income tax. I think the Tax Court judge was in error in applying Income Tax Act concepts before determining the form of business organization according to applicable law pertaining to the business organization alleged by the Minister. I proceed to do that below.
Partnership Analysis
[63] To determine if a partnership exists, the starting point is the definition of "partnership" in section 2 of the Partnerships Act, R.S.O. 1990 c. P-5. Section 2 provides in relevant part:
Partnership is the relation that subsists between persons carrying on a business in common with a view to profit. ...
A partnership exists only if the three conditions of the definition are met:
(1) a business;
(2) carried on in common; and
(3) with a view to profit
(see Continental Bank v. Canada, [1998] 2 S.C.R. 298 at paragraph 22). In this case, it will be convenient to combine the issue of "in common" with "view to profit."
Is there a business?
[64] The definition of "business" in subsection 1(1) of the Partnerships Act includes "every trade, occupation and profession." Having regard to the breadth of the definition of business in the Partnerships Act, for the purpose of determining whether a partnership existed, the trading transactions here in issue constitute a business as defined. That was the express finding of Stone J.A. in Schultz (at pages 439-440) in respect of the same kind of convertible hedging transactions as have occurred in these appeals.
Is the business being carried on?
[65] The Tax Court judge found that while a business existed, it was not being carried on. The determination by the Tax Court judge that engaging in the convertible hedge strategy did not constitute the carrying on of a business was made in the context of his finding that the appellants' activities were adventures in the nature of trade. Because he was of the opinion that an adventurer in the nature of trade is not carrying on a business and because carrying on a business is an essential ingredient of a partnership, he concluded that no partnerships existed in the cases before him. Once again, I must disagree with the judge.
[66] It is true that it has been held that an adventure in the nature of trade is an isolated happening as opposed to a business being carried on (see Tara Exploration and Development Co. Ltd. v. M.N.R., 70 D.T.C. 6370 at 6376). The Tax Court judge relied on Tara. However, the distinction between the existence of a business and a business being carried on in Tara is indeed narrow. In Tara, Jackett P. stated at page 6376:
With considerable hesitation, I have concluded that the better view is that the words "carried on" are not words that can aptly be used with the word "adventure". [Emphasis added]
The issue in Tara was whether a non-resident corporation could be deemed to have "carried on business in Canada" pursuant to what was then subsection 2(2) of the Income Tax Act by reason of having embarked upon an adventure in the nature of trade. The question of partnership was not an issue and no authorities respecting partnerships were referred to in Tara. Further, I am not aware of any authority for the proposition that an adventure in the nature of trade cannot be a business for purposes of the Partnerships Act.
[67] In Continental Bank at paragraph 48, Bastarache J. found that "[t]he fact that the partnership was created for a single transaction is of no consequence." Therefore, the fact that only a single transaction is involved does not mean that a business is not being carried on in common with a view to profit. R.C. I'Anson Banks, Lindley & Banks on Partnership, 18th ed. (London: Sweet & Maxwell, 2002), at paragraph 2-02 states that "virtually any activity or venture of a commercial nature, including a 'one off' trading venture, will be regarded as business for this purpose [determination of the existence of partnership]." This statement is directly applicable to the convertible hedging transactions in these appeals. These, rather than Tara, are the relevant authorities when considering whether a business is being carried on for purposes of a partnership determination.
[68] To try to demonstrate that no business was being carried on, the Tax Court judge observed that on the evidence here, there were no business cards, premises, telephone lines or advertisements. However, I doubt that where a partnership is formed for a single transaction, there will be business cards, separate premises, telephone lines or advertising. Indeed, in Schultz, there was no finding of a business plan, financial statements, business cards and the like. Yet a business of convertible hedging was found to have been carried on.
[69] Further, in Friesen v. Canada, [1995] 3 S.C.R. 103 at paragraphs 13 and 15, Major J. observed that the concept of "an adventure in the nature of trade" is not defined in the Income Tax Act and is "a judicial creation designed to determine which purchase and sale transactions are of a business nature and which are of a capital nature." He noted that it is a term that was particularly important prior to 1972, when capital transactions were completely exempt from taxation. An adventure in the nature of trade is an Income Tax Act concept with a specific purpose unrelated to the partnership question before the judge. The parties agreed that the profits and losses were on income account. It was incorrect for the judge to try to adapt an Income Tax Act concept used to distinguish business and capital transactions to the separate issue of partnership.
[70] The Minister alleged that the appellants were in a partnership relationship with their spouses. The appellants took the opposite position. The judge's obligation was to decide the issue having regard to the definition of partnership in the Partnerships Act. I think that in embarking upon his analysis by mistakenly having regard to the definition of business in the Income Tax Act, rather than focussing on the Partnerships Act, and in introducing the concept of adventure in the nature of trade when it had not been the basis of assessment and had not been put in issue by the parties, the judge's analysis was in error.
[71] Having regard to the findings in Continental Bank and Schultz, the relevant statement in Lindley & Banks on Partnership and to the facts here, I am of the opinion that the appellants were carrying on businesses in convertible hedging.
Is the business being carried on in common with a view to profit?
[72] The Minister's reassessments all pertain to deductions claimed in circumstances in which, at some point, the spouses of each of the appellants executed a transaction involved in the convertible hedge strategy. There is no doubt therefore that at some point the convertible hedging involved both spouses.
[73] The Tax Court judge was of the opinion that no partnership could exist until the spouse took a component of the convertible hedge. He found that in the majority of hedges, the involvement of the spouse would make a loss inevitable. In a number of cases, the spouse's transaction had the effect of placing the parties in a common-common position with no possibility of profit. At that point, the dividend income would be equal to the compensatory dividends to be paid in respect of the common shares that had been sold short. There was no possibility of net dividend or interest income. If there had been a loss realized on the premium at the point the spouses were in a common-common position, there was no possibility of a gain. Because the partnership could not commence before the execution of a transaction by the spouse and because, at that point, there was no possibility of profit, the judge was of the view that the spouses were not carrying on business in common with a view to profit and therefore could not be in a partnership relationship.
[74] The Tax Court judge rejected the Minister's argument that the partnership commenced at the time the brokerage accounts were opened and the cross-guarantees were signed by the spouses. In rejecting the Minister's argument, he observed that the Minister only assessed the appellants on those convertible hedges in which the spouse was involved. Because the Minister did not assess the appellants on their hedging activity in which the spouse was not involved, the judge concluded that a partnership could not have commenced until the spouse became a participant in the convertible hedge.
[75] The question of if and when parties commence carrying on business in common with a view to profit is an objective test to be determined having regard to the conduct of the parties. It does not require that there be trading activity (see Lindley & Banks paragraph 2-03) and it is certainly not affected by which transactions the Minister chooses to reassess.
[76] The appellants and their spouses opened their accounts and signed cross-guarantees at approximately the same time. Thereafter, they engaged in transactions usually initiated in one account. In that account, an appellant held a convertible security of a publicly-traded company and also had sold short the common shares of the same company. When there was an accrued loss on either the convertible security or the short sale, the loss would be realized with the sale of the convertible security or the cover purchase of the common shares. At about the same time, if the convertible security was sold, the spouse would buy the convertible security or the common shares in her account. If there was a cover purchase of the common shares, the spouse would sell the common shares in her account. In this way, the hedge was maintained, although now in two accounts rather than one. The setting up of accounts by each spouse and the execution of cross-guarantees made it possible to maintain the hedges, while at the same time triggering a loss in one account.
[77] In separating the profit element applicable to the period prior to the transaction by the spouse from the tax deduction element after the transaction involving the spouse, the Tax Court judge ignored the evidence of the marketing of the win-win strategy and the motivation that the appellants and their spouses had to engage in the convertible hedge strategy promoted by Maguire. The anticipated profit and tax deductions were part of the same strategy and therefore part of the same business. It was the setting up of the accounts and the cross-guarantees enabled that business to carry on and achieve both results. It was the setting up of the accounts and the cross-guarantees that indicate when the spouses began to carry on that business in common with a view to profit.
[78] One further point about the judge's consideration of the evidence should be made. Even on the judge's theory that a partnership could only be considered to commence when the spouse engaged in a transaction, and that the spouse's transaction occurred when there was no possibility of profit, he seems to have ignored two of the eight transactions entered into by Mr. and Mrs. Hayes. Two of their convertible hedges were commenced by the acquisition of convertible securities in one account and the short sale of common shares in the other account. It is obvious that in the case of these two coordinated transactions, Mr. and Mrs. Hayes were carrying on business in common with a view to profit from the outset.
Objective View of Partnership
[79] The Tax Court judge gave other reasons for not finding the spouses to be in a partnership relationship. Because there were no partnership agreements and because the spouses denied they were in a partnership relationship, the judge determined that to find a partnership "would require conduct of the parties overwhelmingly pointing to that finding" (paragraph 153). The Tax Court judge cited no authority for this standard of proof.
[80] A declared intention of the parties that there is no partnership relationship will carry little or no weight. Lindley & Banks at paragraph 5-05 quote Cozens-Hardy M.R.'s more forceful statement in Weiner v. Harris, [1910] 1 K.B. 285:
Two parties enter into a transaction and say "It is hereby declared there is no partnership between us." The Court pays no regard to that. The Court looks at the transaction and says, "Is this, in point of law, really a partnership?". It is not in the least conclusive that the parties have used a term or language intended to indicate that the transaction is not that which in law it is.
[81] Nor will the existence or non-existence of a partnership agreement be sufficient to decide the issue. In Backman v. The Queen, [2001] 1 S.C.R. 367 at paragraph 27, Iacobucci and Bastarache JJ. determined that, even in the face of a partnership agreement and other formal documentation, there was no partnership because the fundamental criteria for a valid partnership were not met.
[82] Sophisticated parties may have elaborate documentation. Unsophisticated parties may not and may also not be aware of the law of partnership. The question is always whether there is a business carried on in common with a view to profit. If there is, a partnership subsists at law, irrespective of the parties' stated intention, the existence or non-existence of a partnership agreement or the parties' understanding of the law.
[83] Apparently relying upon the declarations in the brokerage documents that the spouses were not partners, the Tax Court judge found that the conduct of the spouses as guarantors was consistent with the position that they were establishing independent accounts supported by the guarantees for their respective spouses or that the parties simply signed what was necessary, not for establishing a partnership but for providing the required margin support to assist their spouse with their investments.
[84] The suggestion that the parties were establishing independent accounts ignores the evidence. The convertible hedge strategy was marketed as a win-win strategy - profit from the spread, dividends and interest income and deductible business losses for tax purposes. Without the involvement of the spouses, the tax deductions the appellants sought would not be possible.
[85] It would be to ignore the convertible hedge strategy in which the appellants were all engaged to say that their spouses were establishing independent accounts. There was no need for guarantee support from a spouse because the brokers were content with a single investor putting up margin to the extent of the premium. It may be that the documents signed by the parties were not signed with the parties' knowingly entering into a partnership with their spouses. But if the essential ingredients of partnership are present, as they were here, such declarations are of no consequence.
[86] The Tax Court judge said that the evidence in respect of profit sharing in these appeals was too vague to infer partnership. Nevertheless, he was able to determine how the spouses had agreed that profits were to be shared. In his view, the implied agreement between the spouses was that the gains or losses on the wind-up of a convertible hedge were to be shared equally between them (paragraph 186). The income, on the other hand, was not to be shared. Here, he found that each spouse "regarded the income or expense from the component of the convertible hedge held by him or her as particular to him or her." However, in the case of Mr. Rezek and Ms. Farhngruber, he inferred that they had intended that only Mr. Rezek was to earn the income and incur the expenses (paragraph 187).
[87] I cannot say that the judge made a palpable and overriding error in drawing the inferences he did as to the division of the income and expenses and the sharing of gains or losses on the spread as between the spouses and I accept his findings. While the division of the income and expenses are not equal, the Tax Court judge was able to infer what the arrangements were between the spouses. The finding of partnership is not dependent on equal sharing. He was able to ascertain the spouses' profit sharing agreement in all the cases before him. As long as the profit-sharing agreement can be ascertained, that is sufficient. It was in the case of all the appellants.
Comparing the Schultz Case to these Appeals
[88] The Tax Court judge acknowledged that in Schultz, this Court had found that a business was being carried on with a view to profit in respect of the spouses in that case. However, he distinguished Schultz on the basis that, in Schultz, the Court considered the separate transactions as the trading transactions and did not consider that a convertible hedge was a separate identifiable property. This, in his view, made it unnecessary for the Court in Schultz to distinguish between "carrying on of a business" and "engaging in an adventure in the nature of trade." In his view, the facts supported the latter. He then proceeded to find differences in the facts between Schultz and the cases before him. His conclusion was that Schultz was distinguishable and did not require a finding of partnership in these cases.
[89] The judge's reliance on the convertible hedge property theory and his finding of adventures in the nature of trade were misplaced and constituted errors of law. These errors caused him to ignore the overwhelming similarities between these appeals and Schultz and to rely upon minimal differences to distinguish Schultz.
[90] It is always possible to identify factual differences between cases. It would be rare that facts in one case would be identical to those in a prior case. Accepting that there will virtually always be some factual differences, the question is whether those differences justify departure from an otherwise binding precedent. Here, the similarities between Schultz and these appeals are overwhelming and the differences minor.
[91] As in the present appeals, Schultz involved the convertible hedge strategy promoted by J.K. Maguire and Associates. Dr. and Mrs. Schultz each opened accounts with brokers. Similarly, in these appeals, each spouse opened an account with a broker. In Schultz, as here, each spouse guaranteed the indebtedness of the other.
[92] In Schultz and in these appeals, the sale of convertible securities or the cover purchase of common shares in one account, which gave rise to the apparent loss in that account, was coordinated with a purchase or sale in the spouse's account so that, as between the spouses, the hedge was maintained.
[93] In Schultz and here, the evidence was that the appellants' intent was to earn a profit from the hedging activity, both in the form of gains from the spread between the convertible securities purchased and the common shares sold short, and in the form of net income from dividends and interest during the period of the hedge.
[94] The Tax Court judge found some differences between Schultz and these appeals. I am of the respectful opinion that they were insignificant in relation to the overwhelming similarities.
[95] In Schultz, one of the purposes of the hedging arrangements was income splitting between the relatively high earning Dr. Schultz and the lower earning Mrs. Schultz. Here, the judge found that "there was no evidence that such discussion [with the Maguire firm] included meeting any income splitting objective." Income splitting is not a requirement of partnership. Indeed, in Schultz, Stone J.A. referred to income splitting in the section of his reasons entitled "BACKGROUND". Income splitting does not appear in his partnership analysis. Income splitting might be evidence of how the profits of a partnership are to be shared, but if there is other evidence of the way in which profits are to be shared, as there was here, the absence of income splitting evidence will not detract from a finding of partnership.
[96] In Schultz, all transactions were hedges. Here, some of these appellants engaged in other non-hedging transactions or hedges with no spousal involvement. The Minister is not seeking to reassess the appellants in respect of these other transactions. The appellants do not argue in the alternative that if partnership is to be found, it should apply to all the convertible hedging activity in which they engaged. Whether the entire series of convertible hedges engaged in by each of the appellants was carried on in partnership between the spouses is an open question and need not be decided to dispose of these appeals. In any event, as I have earlier stated, how the Minister chooses to assess will not determine whether, at law, a partnership exists.
[97] The contributions to satisfy margin requirements came from a joint account in Schultz. Here, the Tax Court judge found that the margin requirements for Mr. and Mrs. Hayes came from a joint account. However, for Mr. Stephens it came largely from borrowed funds. Mr. Rezek provided the funding himself. Nonetheless, the margin requirements were very small. Of far more significance to the issue of whether the spouses were partners were the cross-guarantees signed by the spouses in which each agreed to guarantee the indebtedness in the other's account.
[98] The similarities between Schultz and these appeals are overwhelming. The differences identified by the Tax Court judge are insignificant. These differences did not justify his attempt to distinguish Shultz. In my respectful view, he erred in not following Schultz, which was binding on him.
Re-characterization of relationships
[99] The appellants say that a finding of partnership would re-characterize their relationships with their brokers and would ignore the legal transactions between the appellants and third parties. The appellants submit that their account agreements were individual agreements and that to make a finding of partnership would be to ignore these agreements and the legal rights and obligations flowing from them.
[100] It is quite true that the appellants' account opening documents represented that they were not in partnership relationships. As I have already found, that cannot be conclusive as to the actual legal effect of their conduct. If the appellants were carrying on business in common with their spouses with a view to profit, they were, at law, in a partnership relationship with their spouses. The declarations they made to the brokers or the fact that the brokers received and accepted the declarations at face value did not detract from the legal effect of their conduct.
[101] The appellants' representations to the brokers did not accurately reflect the legal partnership relationship they had entered into with their spouses. In such circumstances, it is not impermissible for the Court to make a finding that accurately reflects the legal relationships.
Partnership - Conclusion
[102] I have no hesitation in concluding that the respective spouses in these appeals were in partnership relationships with respect to the convertible hedges that are the subject of the Minister's reassessments.
TIMING OF TAXABLE EVENTS
[103] In the convertible hedge strategy, taxable events included the receipt of dividends and interest and the payment of compensatory dividends, rental charges, commissions and other fees. They also include the profit or loss on the spread.
[104] Assuming the parties were not computing their income on an accrual basis, dividends and interest income should be taxed in the year received and compensatory dividends, rental charges, commissions and other fees should be deductible in the year paid.
[105] Because the business of the partnerships was convertible hedging, the individual transactions creating losses on the disposition of convertible securities or the covering of short sold shares in one account are not, in isolation, taxable events. The maximum gains or losses sustained by the partnerships are the gains or losses on the spreads.
[106] In respect of the gain or loss on the spread, the gain or loss was realized by the partnership for taxation purposes when the accounts of each spouse entirely offset each other, that is, when the securities in one account exactly matched the securities sold short in the other account. This would be when one spouse held the same number of common shares that the other spouse had sold short. It will be in the taxation year in which the common-common position was reached that the gain or loss on the spread should be recognized for taxation purposes.
SHARING OF PROFITS OR LOSSES
[107] The Tax Court judge found that the gains or losses on the spreads were to be split equally between the spouses. Except for Mr. Rezek, the income and expenses were taxable to the spouse in whose account they were received or incurred. In the case of Mr. Rezek, the learned judge found that all income and expenses were agreed to be for his account alone. I have no reason to interfere with these findings.
INVENTORY WRITE DOWN
[108] Muriel Scott claimed a write down of inventory pursuant to subsection 10(1) of the Act for her 1988, 1990 and 1991 taxation years. At the relevant time, subsection 10(1) read:
|
10. (1) For the purpose of computing income from a business, the property described in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation. |
10. (1) Aux fins du calcul du revenu tiré d'une entreprise, les biens figurant dans un inventaire sont évalués au coût supporté par le contribuable ou à leur juste valeur marchande, le moins élevé de ces deux éléments étant à retenir, ou de toute autre façon permise par les règlements. |
[109] The Minister's argument on this point appears to rely on the convertible hedge as a separate identifiable property. As I have found no merit to that proposition, it cannot avail to the benefit of the Minister on the inventory write down issue.
[110] In oral argument, the Minister suggested that Mrs. Scott was not entitled to an inventory write down to fair market value on the basis of a retroactive amendment to the Income Tax Act by chapter 19, S.C. 1988 s. 70(1), which required that inventory of an adventure in the nature of trade be valued at cost. The Minister has not explained why that provision applied to Mrs. Scott and without the argument being more fully developed, I am not prepared to speculate on why it might apply.
ELECTIONS
[111] Mrs. Scott and Mrs. Hayes each claimed to make a valid election under subsection 39(4) of the Act. Subsection 39(4) provides:
|
(4) Except as provided in subsection (5), where a Canadian security has been disposed of by a taxpayer in a taxation year and the taxpayer so elects in prescribed form in his return of income under this Part for that year, (a) every Canadian security owned by him in that year or any subsequent taxation year shall be deemed to have been a capital property owned by him in those years; and (b) every disposition by the taxpayer of any such Canadian security shall be deemed to be a disposition by him of a capital property. |
(4) Sauf dans les cas prévus au paragraphe (5), lorsqu'un contribuable dispose d'un titre canadien dans un année d'imposition et qu'il exerce un choix, selon le formulaire prescrit, dans sa déclaration de revenu pour l'année en vertu de la présente Partie: a) chacun des titres canadiens qu'il possède dans ladite année ou dans toute année d'imposition subséquent est réputé avoir été une bien en immobilisation qu'il possédait dans ces années; et b) chaque disposition par le contribuable d'un tel titre canadien est réputée être une disposition par lui d'un bien en immobilisation. |
For Mrs. Scott, the election would apply to her 1990, 1991, 1992 and 1993 taxation years. For Mrs. Hayes, the election would apply to her 1992 taxation year.
[112] The Tax Court judge dismissed the claim for election because he held that the convertible hedge was a separate identifiable property and that a convertible hedge was not included in the definition of "Canadian security" in subsection 39(6) which applied to subsection 39(4). As I have determined that there can be no convertible hedge property, that basis for refusing the subsection 39(4) election is not applicable.
[113] Although originally arguing that the elections were not filed with their respective returns and were invalid for that reason, in oral argument counsel for the Minister conceded that the elections were filed with the returns. The only argument now made by the Minister is that although the elections were filed with the returns, the returns were filed late. The Minister says this invalidates the elections. Nothing in subsection 39(4) supports the Minister's position. However, the Minister says that subsection 39(4) must be read with subsection 150(1) and, when read together, these provisions require that the returns with which the elections were filed must be filed by their due dates.
[114] I am unable to agree. It is correct that paragraph 150(1)(d) provides that returns are to be filed on or before April 30 of the year following the taxation year. If they are not, penalties may apply. However, returns are not invalid if they are filed late. Neither subsections 39(4) nor paragraph 150(1)(d) provide that if a return in which an election is included is filed late, that the election is invalid. Where the Act prescribes sanctions for late filing, those sanctions will apply. Where it does not, the Court will not read into the Act sanctions that do not appear. That is the case here.
[115] I would reject the Minister's timing argument and conclude that the elections filed by Mrs. Scott and Mrs. Hayes were valid.
CONCLUSION
[116] The appeals should be allowed only in respect of the subsection 10(1) issue for Mrs. Scott and the subsection 39(4) issue for Mrs. Scott and Mrs. Hayes. The cross-appeals should be allowed only to provide, where appropriate, for an increase in reassessments over and above those resulting from the decision of the Tax Court but not to exceed the last reassessments appealed to the Tax Court. To the extent the decision of the Tax Court is inconsistent with this decision, it should be quashed. The Minister should reassess the appellants in accordance with these reasons.
[117] On or before July 8, 2005, the Minister shall submit, with the consent of counsel for the appellants as to form, a draft judgment giving effect to these reasons. Should directions for preparation of the judgment be required, the parties or either of them shall forthwith inform the Judicial Administrator and on or before July 8, 2005, file succinct submissions not exceeding five pages double-spaced, setting forth the directions sought and the reasons they are required.
[118] If the parties cannot agree as to costs, the Minister shall, on or before filing the draft judgment, serve and file a succinct submission not exceeding three pages double-spaced. Within
seven days thereafter, the appellants shall serve and file a succinct submission in response not exceeding three pages double-spaced.
"Marshall Rothstein"
J.A.
"I agree
M. Nadon J.A."
"I agree
K. Sharlow J.A.
FEDERAL COURT OF APPEAL
Names of Counsel and Solicitors of Record
DOCKETS &
STYLES OF CAUSE:
A-463-03 GORDON REZEK v. HER MAJESTY THE QUEEN and
CANADIAN BANKERS ASSOCIATION;
A-462-03 and A-465-03 PHIL HAYES and PAT HAYES v. HER MAJESTY THE QUEEN
and CANADIAN BANKERS ASSOCIATION;
A-464-03 STEPHEN STEPHENS v. HER MAJESTY THE QUEEN and CANADIAN BANKERS ASSOCIATION;
A-466-03 MURIEL SCOTT v. HER MAJESTY THE QUEEN and CANADIAN BANKERS ASSOCIATION
PLACE OF HEARING: TORONTO, ONTARIO
DATE OF HEARING: APRIL 25, 2005
REASONS FOR JUDGMENT BY: ROTHSTEIN J.A.
CONCURRED IN BY: NADON J.A.
SHARLOW J.A.
DATED: JUNE 17, 2005
APPEARANCES BY:
Mr. Geoffrey B. Shaw
Mr. Stevan Novoselac For the Appellant
Mr. Henry A. Gluch
Mr. James Rhodes
Mr. John Grant For the Respondent
Mr. Al Meghji
Mr. Mahmud Jamal For the Intervener
SOLICITORS OF RECORD:
Cassels Brock & Blackwell LLP
Toronto, Ontario For the Appellant
John H. Sims, Q.C.
Deputy Attorney General of Canada For the Respondent
Osler Hoskin & Harcourt LLP
Toronto, Ontario For the Intervener