Judgments

[1994] 3 .F.C. 83

A-205-93

Henry Loewen (Appellant) (Defendant)

v.

Her Majesty the Queen (Respondent) (Plaintiff)

Indexed as: Canada v. Loewen (C.A.)

Court of Appeal, Pratte, Hugessen and McDonald JJ.A.—Vancouver, March 22; Ottawa, April 14, 1994.

Income tax — Income calculation — Income or capital gain — Appeal from trial judgment holding gain realized on redemption of Scientific Research Tax Credit (SRTC) debenture income from adventure in nature of trade — Appellant buying SRTC for $200,000 in July 1984 — Redeeming debenture for $140,000 in January 1985 — Sole purpose of transaction to obtain tax credit — As debenture redeemable by either company or holder, redemption could never result in profit to holder — As s. 127.3(6) deeming cost of acquisition of debenture actual cost reduced by 50% of designated amount ($200,000), notional gain of $40,000 although actual loss of $60,000 — Appeal allowed — $40,000 capital gain — Adventure in nature of trade if dealing with commodity in same way as ordinary trader or dealer — Must be possibility of profit in commercial sense to be adventure in nature of trade — Notional profit created by Income Tax Act not to be treated as real for purpose of applying objective standard of “ordinary trader” — Notional profit not inducing trader to enter into transaction — Tax credit only inducement herein — Not converting transaction into adventure in nature of trade.

This was an appeal from the trial judgment holding that the gain realized on the redemption of a scientific research tax credit (SRTC) debenture was income from an adventure in the nature of trade, not a capital gain. The litigation arose out of a short-lived statutory scheme to encourage investment in companies doing scientific research. The appellant purchased a debenture for $200,000 in July 1984. It was redeemable by either the holder or the company issuing it for $140,000, and was redeemed in January 1985 at the appellant’s request. The sole purpose of the transaction was to obtain a tax credit. Since the debenture was redeemable by either the company or the holder, it could never have a value in excess of $140,000 and it was impossible that redemption could ever result in a profit to the holder. Income Tax Act, subsection 127.3(6) deemed an investor’s cost of acquisition to be reduced by 50% of the amount designated under subsection 194(4). The vendor designated the entire $200,000 under subsection 194(4). Although the appellant suffered an actual loss of $60,000 (cost of acquisition less redemption price), he had a notional gain of $40,000 (redemption price less deemed cost of acquisition or $100,000 [actual cost reduced by 50%]). The appellant claimed this notional gain as capital gain in his 1985 return. The Minister reassessed on the basis that it was a profit from an adventure in the nature of trade and taxable as business income. The Tax Court held that the $40,000 gain was a capital gain. It could not be a trading transaction because it could not generate a profit. The Trial Judge came to the opposite conclusion because the appellant had disposed of the debenture, once it had served its tax credit purpose, as quickly as possible and in the same manner as a trader. The issues were: (1) whether a transaction which is structured so that it cannot possibly produce a trading profit may be an adventure in the nature of trade; (2) whether a notional profit resulting from such a transaction as a consequence of the law deeming the purchaser’s cost of acquisition to be less than his proceeds of disposition is to be taxed as income or capital gain.

Held, the appeal should be allowed.

Per Hugessen J.A. (McDonald J.A. concurring): The purchase and redemption of the SRTC debenture was not an adventure in the nature of trade and the deemed gain therefrom should be treated as a capital gain, not as income.

The appellant was not assessed on the basis that he was a trader or engaged in a business, but on the basis that the profits from this transaction were to be treated as business profits because the transaction was “an adventure in the nature of trade” within the meaning of section 248. The notion of an adventure in the nature of trade extends the reach of the charging sections to transactions which, although not carried out by a trader, are of the same kind as trading transactions. A trader may in the course of his business enter into transactions which cannot possibly generate a profit by themselves, but whose purpose is to benefit the business as a whole.

While a positive finding that a transaction was for speculation or for investment may be decisive as to whether it was a trading transaction, an equivalent negative finding, i.e. that it was not one or the other of those things, cannot be so. The appellant’s purchase and redemption of the debenture were not to be characterized as an investment.

An intention to make a profit from a transaction is not a prerequisite to finding that such a transaction is an adventure in the nature of trade. If a person deals with the commodity purchased by him in the same way as a dealer in it would ordinarily do, such dealing is a trading adventure.

Tax considerations, more particularly an anticipated tax advantage, cannot be determinative of whether a transaction is a trading operation. A transaction whose sole purpose is to reduce the tax otherwise payable is not, for that reason alone, an adventure in the nature of trade.

For a transaction to be characterized as an adventure in the nature of trade, it must be one from which it is possible to derive a profit in a commercial sense. A purely notional profit cannot turn an otherwise unprofitable transaction into an adventure in the nature of trade. No trader who expected to stay in business would enter into transactions which were capable of producing only fictitious profits. The fictionally reduced cost of acquisition cannot be used to attribute to the transaction itself a profit-making capability which it does not have in reality. If the Income Tax Act is to deem a transaction to produce a notional profit, that profit must not be treated as real for the purposes of applying the test. The question must be whether such a purely notional profit would induce a trader to enter into the transaction. It clearly would not. The real and only inducement herein was the tax credit, which cannot turn the transaction into an adventure in the nature of trade.

Per Pratte J.A. (dissenting): The $40,000 gain was income from an adventure in the nature of trade. The gain was a fiction created by Income Tax Act, subsection 127.3(6). The deeming provision contained therein must be applied for all purposes relevant to the Income Tax Act, including the characterization of a transaction as an investment or an adventure in the nature of trade. In determining the real nature of the transaction it had to be assumed that the appellant acquired the debenture for $100,000 and the fact that he paid twice that amount ignored. As the appellant acquired the debenture with the intention that it be redeemed for $140,000 shortly afterwards, it follows that he was in the same situation as if he had bought for $100,000 a painting that he intended to sell a few days later for $140,000. His profit of $40,000 resulted from an adventure in the nature of trade.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

Income Tax Act, S.C. 1970-71-72, c. 63, ss. 127.3 (as enacted by S.C. 1984, c. 1, s. 73; as am. idem, c. 45, s. 46), 194(4) (as enacted by S.C. 1984, c. 1, s. 95), 248 (as am. by S.C. 1979, c. 5, s. 66).

CASES JUDICIALLY CONSIDERED

APPLIED:

Edwards (Inspector of Taxes) v. Bairstow, [1956] A.C. 14 (H.L.); M.N.R. v. J. A. Taylor, [1956] C.T.C. 189; (1956), 56 DTC 1125 (Ex. Ct.); Moloney (M.) v. Canada, [1992] 2 C.T.C. 227; (1992), 92 DTC 6570; 145 N.R. 258 (F.C.A.); Bishop (Inspector of Taxes) v. Finsbury Securities, Ltd., [1966] 3 All E.R. 105 (H.L.); FA & AB Ltd v. Lupton (Inspector of Taxes), [1971] 3 All E.R. 948 (H.L.); Californian Copper Syndicate v. Harris (1904), 5 T.C. 159; Grainger & Son v. Gough, [1896] A.C. 325 (H.L.); Erichsen v. Last (1881), 8 Q.B.D. 414 (C.A.).

APPEAL from trial judgment ([1993] 1 C.T.C. 212 (F.C.T.D.); revg [1990] 1 C.T.C. 2133; (1989), 90 DTC 1009 (T.C.C.)) holding that the gain realized on the redemption of a scientific and research tax credit debenture was income from an adventure in the nature of trade. Appeal allowed.

COUNSEL:

Craig C. Sturrock for appellant.

O. Brent Paris for respondent.

SOLICITORS:

Thorsteinssons, Vancouver, for appellant.

Deputy Attorney General of Canada for respondent.

The following are the reasons for judgment rendered in English by

Pratte J.A. (dissenting): The facts which gave rise to this appeal as well as the relevant statutory provisions are set out in the reasons for judgment of my brother Hugessen.

In my view, the Trial Division [[1993] 1 C.T.C. 212] was right in holding that the gain of $40,000 realized by the appellant on the redemption of the $140,000 debenture issued by Dynaflex Industries Inc. was income from an adventure in the nature of trade rather than a capital gain.

That gain of $40,000, of course, was not real. In fact, the appellant sustained a loss of $60,000 on the redemption of the debenture since he had paid $200,000 for it. However, pursuant to subsection 127.3(6) of the Income Tax Act [S.C. 1970-71-72, c. 63 (as enacted by S.C. 1984, c. 1, s. 73; as am. idem, c. 45, s. 46)], he was deemed to have acquired that debenture at a cost of $100,000. Hence, the $40,000 gain.

The appellant does not challenge that, for the purposes of the Income Tax Act, his acquisition and the subsequent redemption of the Dynaflex debenture resulted in a gain of $40,000. He agrees that the deeming provision of subsection 127.3(6) must be applied in order to determine whether the transaction resulted in a gain or a loss. However, his argument that the $40,000 was not a profit resulting from an adventure in the nature of trade is based on the assumption that section 127.3 [as enacted idem] has no role to play in the characterization of the transaction as an investment or an adventure in the nature of trade. In my view, that assumption is wrong.

As the deeming provision contained in subsection 127.3(6) was not enacted for special or limited purposes, it must be applied for all purposes relevant to the Income Tax Act including the characterization of a transaction as an investment or an adventure in the nature of trade. It follows that in determining the real nature of the transaction here in question one must assume that the appellant acquired the Dynaflex debenture for $100,000 and ignore the fact that he actually paid twice that amount for it.

As it is common ground that the appellant acquired the debenture with the intention that it be redeemed for $140,000 shortly afterwards, it also follows that he is in the same situation as if he had bought for $100,000 a painting that he intended to sell a few days later for $140,000. His profit of $40,000 clearly results from an adventure in the nature of trade. If the appellant could make a persuasive argument to the contrary, it is only by referring to the fact that he actually paid $200,000 for the debenture (and could not, as a consequence, hope to make a profit on its redemption). But, as I have said, that fact must be ignored.

I would dismiss the appeal with costs.

* * *

The following are the reasons for judgment rendered in English by

Hugessen J.A.: The question raised by this appeal is whether a transaction which is structured in such a way that it cannot possibly produce a trading profit may nonetheless be an adventure in the nature of trade. More particularly, the question is to know whether a notional profit resulting from such a transaction as a consequence of the law deeming the purchaser’s cost of acquisition to be less than his proceeds of disposition is to be taxed as income or as a capital gain.

The matter arises in this way. In July, 1984, the appellant purchased from a company called Dynaflex Industries Inc. a “scientific research tax credit” debenture for a price of $200,000 payable partly in cash and partly by promissory note, the balance of which was due no later than December 31, 1984. The issuer of the debenture, Dynaflex, undertook to “designate” the full amount of $200,000 pursuant to subsection 194(4) of the Income Tax Act.[1] The debenture was redeemable by either party at a redemption price of $140,000 and was in fact redeemed on January 2, 1985 at appellant’s request.

The whole purpose of the transaction, from the appellant’s point of view, was to allow him to benefit from a scientific research tax credit (SRTC) in his 1984 taxation year. The transaction, known in the vernacular of tax advisors as a “quick flip”, achieved its purpose and the appellant obtained a credit against 1984 federal tax of $68,000. Since the reduction in the appellant’s federal tax payable also had the effect of reducing his provincial tax payable by $34,000, he obtained a total tax advantage of $102,000 from the transaction.

The relevant provisions of the Income Tax Act at the time were as follows:

127.3 (1) There may be deducted from the tax otherwise payable under this Part by a taxpayer for a taxation year an amount not exceeding the aggregate of

(a) his scientific research tax credit for the year; and

(b) his unused scientific research tax credit for the taxation year immediately following the year.

(2) For the purposes of this Act,

(a) “scientific research tax credit” of a taxpayer for a taxation year means the aggregate of all amounts each of which is an amount equal to

(i) where the taxpayer is a corporation, 50%, or

(ii) where the taxpayer is an individual other than a trust, 34%

of an amount designated by a corporation under subsection 194(4) in respect of

(iii) a share acquired by the taxpayer in the year where the taxpayer is the first person, other than a broker or dealer in securities, to be a registered holder thereof,

(iv) a bond, debenture, bill, note, mortgage, hypothec or similar obligation (in this section and in Part VIII referred to as a “debt obligation”) acquired by the taxpayer in the year where the taxpayer is the first person, other than a broker or dealer in securities, to be a registered holder thereof, or

(v) a right acquired by the taxpayer in the year where the taxpayer is the first person, other than a broker or dealer in securities, to have acquired that right,

less any amount required by subsection (5) to be deducted in computing the taxpayer’s scientific research tax credit for the year; and

…

(6) For the purposes of this Act, where at any time in a taxation year a taxpayer has acquired a share, debt obligation or right and is the first registered holder of the share or debt obligation or the first person to have acquired the right, as the case may be, other than a broker or dealer in securities, and an amount is, at any time, designated by a corporation under subsection 194(4), in respect of the share, debt obligation or right, the following rules apply:

(a) he shall be deemed to have acquired the share, debt obligation or right at a cost to him equal to the amount by which

(i) its cost to him as otherwise determined

exceeds

(ii) 50% of the amount so designated in respect thereof; and

(b) where the amount determined under subparagraph (a)(ii) exceeds the amount determined under subparagraph (a)(i), the excess shall

(i) where the share, debt obligation or right, as the case may be, is a capital property to him, be deemed to be a capital gain of the taxpayer for the year from the disposition of that property; and

(ii) in any other case, be included in computing the income of the taxpayer for the year,

and the cost to him of the share, debt obligation or right, as the case may be, shall be deemed to be nil.

…

194. …

(4) Every taxable Canadian corporation may, by filing a prescribed form with the Minister at any time on or before the last day of the month immediately following a month in which it issued a share or debt obligation or granted a right under a scientific research financing contract (other than a share or debt obligation issued or a right granted before October 1983, or a share in respect of which the corporation has, on or before that day, designated an amount under subsection 192(4)), designate, for the purposes of this Part and Part I, an amount in respect of that share, debt obligation or right not exceeding the amount by which

(a) the amount of the consideration for which it was issued or granted, as the case may be,

exceeds

(b) in the case of a share, the amount of any assistance (other than an amount included in computing the scientific research tax credit of a taxpayer in respect of that share) provided, or to be provided by a government, municipality or any other public authority in respect of, or for the acquisition of, that share.

Briefly stated, the purpose of the statutory scheme (which was short-lived) was to encourage investment in companies doing scientific research. This was done by providing a federal tax credit of 34% of any amount invested in such a company and “designated” by the latter. Since most provincial income tax is calculated as a function (about 50%) of federal tax a reduction in the latter produced a corresponding reduction in the former for a total tax advantage to the investor of about 50% of the amount invested. To offset some of the scheme’s “tax cost” to the fisc the investor’s cost of acquisition was deemed to be reduced by 50% of the designated amount, or approximately the same amount as the tax credit he had received.

As previously indicated the appellant did not require redemption of the debenture until January 1985. That redemption was for the stipulated price of $140,000. Since the appellant had paid $200,000 for the debenture, he suffered an actual loss on the redemption in the amount of $60,000. Furthermore, since the debenture was redeemable by either the company or the holder, it is inconceivable that it could ever have a value in excess of $140,000 and it was accordingly impossible that redemption could ever result in a profit to the holder.

In the unreal world of income tax, however, things are seldom what they seem and are frequently deemed to be quite different from what they are. By the terms of subsection 127.3(6), supra, the appellant was deemed to have acquired the debenture at a cost of only $100,000, being his actual cost ($200,000) reduced by 50% of the designated amount, or, since the entire proceeds of the debenture had been designated, $100,000. That being so, the redemption price of $140,000 received by the appellant in 1985 was, for tax purposes, $40,000 greater than his cost of acquisition. It is that notional difference which is at the source of this litigation.

In his income tax return for the 1985 taxation year, the appellant showed this amount as a capital gain. The Minister reassessed on the basis that it was a profit from an adventure in the nature of trade and taxable as business income. The appellant appealed to the Tax Court of Canada [[1990] 1 C.T.C. 2133] which allowed the appeal and directed that the Minister reassess on the basis that the gain of $40,000 was a capital gain. The crux of the Tax Court Judge’s reasons appears from the following passage [at pages 2138-2139]:

In light of all the circumstances of this case, I am of the view that this transaction does not possess the characteristics of a trading operation. In my opinion, the evidence is clear that trading in securities was not in the ordinary course of the Appellant’s business. Moreover, the Appellant did not trade in the subject Debenture. He merely purchased it from its issuer for its inherent income tax attributes and redeemed it from its issuer at virtually no risk to him. He did not deal with the Debenture in the same manner as a person whose ordinary business is the buying and selling of Debentures and other securities. The acquisition of the Debenture was not for the purpose of earning income therefrom as it would normally be understood by persons engaged in buying and selling Debentures because the manner in which the present transaction was structured made this impossible right from the start. Indeed, the only way that the holder of the Debenture could recover some of the original purchase price of the Debenture was to call for its redemption for an amount less than the original purchase price. I agree with counsel for the Appellant that no profit in a trading sense arose from the acquisition and disposition of the Debenture. Indeed, if the benefits of the tax credit are disregarded, a loss according to ordinary commercial principles arose upon the redemption of the Debenture because the acquisition cost to the Appellant of the Debenture ($200,000) exceeded the proceeds of its disposition ($140,000) on redemption by $60,000.

…

In brief general terms, the Appellant did not deal with the property as an ordinary trader in property of that nature in order to realize a profit from its sale.

The Crown appealed from this decision to the Trial Division which allowed the appeal and restored the assessment. The Trial Judge said [at page 218]:

However, he dealt with the SRTC debenture in the same way that a trader in property of the same kind would ordinarily, in the sense that he did not retain the debenture to earn interest income. In fact, as soon as the debenture was paid in full, he requested immediate redemption. A trader in such debentures would also quickly realize on them so as to free-up the funds invested.

The SRTC debenture in question was never designed to be held by the purchaser any longer than was required to enable him to obtain the tax credit. Immediate redemption was the incentive and long time investment was never contemplated. Moreover, only a small portion of the funds paid by Loewen remained with Dynaflex. The final $152,000 payment was held in trust by Loewen’s solicitor to ensure that the funds would be available to him for the redemption. Thus, the final payment which represented the bulk of the purchase price was never in the hands of Dynaflex and could not have been invested in its operations.

In considering which of these two approaches is to be preferred it seems to me that it is important to bear certain fundamentals in mind.

In the first place, it is clear that the basis on which the appellant has been assessed is not that he is a trader or engaged in a business, in a broad sense, but rather that the profits from this transaction are to be treated as business profits because the transaction itself is “an adventure in the nature of trade” within the meaning of section 248 [as am. by S.C. 1979, c. 5, s. 66] of the Act. The profits from a trade or business are, of course, taxable on their own account and without recourse to any extended definition; the notion of an adventure in the nature of trade extends the reach of the charging sections to transactions which, although not carried out by a trader, are of the same kind as trading transactions. As was stated by Lord Radcliffe in Edwards (Inspector of Taxes) v. Bairstow:[2]

The true question in such cases is whether the operations constitute an adventure of that kind, not whether they by themselves or they in conjunction with other operations, constitute the operator a person who carries on a trade.

The point is of importance in the present case because a trader may, in the course of his business, enter into transactions which cannot possibly generate a profit by themselves but whose purpose is to benefit the business as a whole. A simple example would be the purchase by a merchant of goods to be given away as premiums with the purchase of his regular merchandise. That is no doubt a trading transaction but it is difficult to see how the purchase of something for the purpose of giving it away could qualify as an adventure in the nature of trade if it were carried out by a non-trader.

Secondly, a distinction is sometimes drawn in the cases between transactions which are to be treated as “investments” and those which are to be considered as “speculations”. While that is frequently a useful way of looking at an income/capital gains problem, it is not an infallible test since the concepts of investment and speculation are not exhaustive of the universe of transactions by which people acquire things and subsequently dispose of them. In particular, things may also be bought or sold for consumption or for use. Thus, while a positive finding that a transaction was for speculation or for investment may be decisive as to whether it was or was not a trading transaction, an equivalent negative finding, i.e. that it was not one or the other of those things, cannot be so.

Clearly, in the present case, the appellant’s purchase and later redemption of the debenture were not of the character of an investment. He admits as much:

The Appellant’s purpose in purchasing the Debenture was to acquire a scientific research tax credit worth $102,000. His only relationship with Dynaflex was the purchase of the Debenture. He had no interest in Dynaflex’s operation other than receiving the tax credit. He did not know the nature of Dynaflex’s business, and did not determine whether it could actually carry out its business. He did not investigate Dynaflex’s solvency, he had no idea what sort of assets Dynaflex owned, and did not know what the floating charge contained in the Debenture would attach to. The Appellant never considered selling the Debenture to anyone else. From the moment he purchased it, he intended to redeem it. [Appellant’s memorandum of fact and law, at page 6.]

That, however, leaves open the question as to whether there was an adventure in the nature of trade.

Next, it is settled law that an intention to make a profit from a transaction is not a prerequisite to a finding that such transaction is an adventure in the nature of trade. In the leading case of M.N.R. v. J. A. Taylor,[3] Thorson P., after an exhaustive review of the cases, said [at pages 211-212]:

And a transaction may be an adventure in the nature of trade although the person entering upon it did so without any intention to sell its subject matter at a profit. The intention to sell the purchased property at a profit is not of itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one. Such intention may well be an important factor in determining that a transaction was an adventure in the nature of trade but its presence is not an essential prerequisite to such a determination and its absence does not negative the idea of an adventure in the nature of trade. The considerations prompting the transaction may be of such a business nature as to invest it with the character of an adventure in the nature of trade even without any intention of making a profit on the sale of the purchased commodity.

In the same case, Thorson P. laid down a number of specific guidelines for determining when there is an adventure in the nature of trade. The first, and in my view the most important, was stated by him as follows [at page 214]:

But there are some specific guides. One of these is that if the transaction is of the same kind and carried on in the same way as a transaction of an ordinary trader or dealer in property of the same kind as the subject matter of the transaction it may fairly be called an adventure in the nature of trade…. Put more simply, it may be said that if a person deals with the commodity purchased by him in the same way as a dealer in it would ordinarily do such a dealing is a trading adventure.

This brings us back to the conflicting views expressed in the Tax Court and in the Trial Division in the present case and already quoted above. If I understand them correctly, the Tax Court Judge was of the view that this could not be a trading transaction because, apart from its tax consequences, it could not generate a profit. The Trial Judge, on the other hand, came to the opposite conclusion because the appellant had disposed of the debenture, once it had served its tax credit purpose, as quickly as possible and in the same manner as would a trader.

In order to resolve the conflict, it is necessary, in my view, first to ask oneself whether tax considerations, and more particularly an anticipated tax advantage, can properly be determinative of whether or not any given transaction is a trading operation. In my view, they cannot. While the saving of taxes is clearly an important consideration in the conduct of any modern business, I do not think it can properly be said that a transaction whose sole purpose is to reduce the tax otherwise payable by a taxpayer is, for that reason alone, an adventure in the nature of trade. In the recent case of Moloney (M.) v. Canada,[4] this Court was faced with the opposite side of the income/capital gains coin, namely whether a taxpayer could deduct as business expenses the costs incurred in a scheme the whole purpose of which was to obtain refunds of tax. In dismissing the taxpayer’s appeal, we said [at pages 227-228]:

While it is trite law that a taxpayer may so arrange his business as to attract the least possible tax (see Duke of Westminster’s case, [1936] A.C. 1), it is equally clear in our view that the reduction of his own tax cannot by itself be a taxpayer’s business for the purpose of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the “Act”). To put the matter another way, for an activity to qualify as a “business” the expenses of which are deductible under paragraph 18(1)(a), it must not only be one engaged in by the taxpayer with a reasonable expectation of profit, but that profit must be anticipated to flow from the activity itself rather than exclusively from the provisions of the taxing statute. [Emphasis added.]

This conclusion is consistent with authority. In Bishop (Inspector of Taxes) v. Finsbury Securities, Ltd.,[5] the House of Lords had to deal with a forward stripping operation, the success of which was dependent upon the taxpayer being able to treat as a trading loss the sale of shares the value of which had been reduced below their cost to the taxpayer by virtue of the latter having, in the interim, taken from the company, by way of dividend, its large accumulated surplus. While the question is not identical to the one facing us here, the following passage from the speech of Lord Morris is instructive (at page 112):

A consideration of the transactions now under review leads me to the opinion that they were in no way characteristic of, nor did they possess, the ordinary features of the trade of share dealing. The various shares which were acquired ought not to be regarded as having become part of the stock-in-trade of the company. They were not acquired for the purpose of dealing with them. In no ordinary sense were they current assets. For the purposes of carrying out the scheme which was devised the shares were to be and had to be retained. The arguments before your lordships depended mainly on the submission by the Crown that the shares were acquired for a period of five years as part of the capital structure of the company from which an income would be earned and, on the other hand, on the submission of the company that they were acquired as part of their stock-in-trade.

In my opinion neither argument is correct. For the reasons which I have already given this transaction on its particular facts was not, within the definition of s. 526, “an adventure or concern in the nature of trade” at all. It was a wholly artificial device remote from trade to secure a tax advantage. [Emphasis added.]

The same Judge in FA & AB Ltd v. Lupton (Inspector of Taxes),[6] a case involving a very similar transaction, said (at page 952):

Deriving such help as a consideration of other cases may yield—the question for decision will be whether the particular transaction under review can and should be regarded as a trading transaction within the course of the trade of a dealer in shares.

This enquiry may or may not involve or necessitate a consideration of the profitability of a transaction or of the tax results of a transaction. One trading transaction may result in a profit. Another may result in a loss. If each of these, fairly judged, is undoubtedly a trading transaction its nature is not altered according to whether from a financial point of view it works out favourably or unfavourably. Nor is such a transaction altered in its nature according to how the revenue laws determine the tax position which results from the financial position. [Emphasis added.]

This brings me back to the questions posed at the beginning of these reasons. In my view, and while, as indicated, an intention to make a profit is not essential in order for a transaction to be characterized as an adventure in the nature of trade, such transaction must be one from which it is possible to derive a profit in a commercial sense. Trade necessarily implies at least the possibility of profit. Not surprisingly perhaps, there are no cases dealing directly with the question since it is unusual, to say the least, to find an unprofitable transaction attracting tax as an adventure in the nature of trade. That it should do so in the present case results solely as a consequence of the reduction which subsection 127.3(6) deems to take place in the cost of acquisition of an SRTC instrument.

In all the reported cases that I have seen dealing with adventures in the nature of trade the taxpayer had actually made a profit on the transaction and it was that profit which had triggered the interest of the fisc. The nearest parallel to the present case is the decision in Moloney, supra, where there was no profit, but a purported expense incurred in connection with a tax avoidance scheme was disallowed.

In all the other cases on the point, however, the Court, in deciding whether a transaction is an adventure in the nature of trade, has clearly assumed that such transaction must be one which could produce a profit. Thus, by way of example, in the leading and often quoted case of Californian Copper Syndicate v. Harris,[7] the test was said to be “is it a gain made in an operation of business in carrying out a scheme for profit-making?”[8] Likewise, in the earlier case of Grainger & Son v. Gough,[9] Lord Davey said (at pages 345-346):

Trade in its largest sense is the business of selling, with a view to profit, goods which the trader has either manufactured or himself purchased. [Emphasis added.]

Earlier still in Erichsen v. Last,[10] Cotton, L.J. said (at page 420):

 … in my opinion when a person habitually does and contracts to do a thing capable of producing profit, and for the purpose of producing profit, he carries on a trade or business. [Emphasis added.]

The profit must also, in my view, be a commercial one. Or to put the matter another way, a purely notional profit cannot serve to turn an otherwise unprofitable transaction into an adventure in the nature of trade. The test being whether the transaction is of the same kind and carried on in the same way as one which a trader would normally enter into, it seems evident to me that no trader who expected to stay in business would enter into transactions which were capable of producing only fictitious profits.

Accordingly, while the appellant’s cost of acquisition of the debenture is deemed for tax purposes to be reduced to $100,000, that is a fiction: his real cost remains $200,000 and the fictionally reduced cost cannot be used to attribute to the transaction itself a profit-making capability which it does not have in reality.

The test for an adventure in the nature of trade is an objective one based upon the standard of the “ordinary trader or dealer.” If the Income Tax Act is to deem a transaction to produce a notional profit, that profit must not be treated as real for the purposes of applying the test. In the context of the present case that means that the question to be asked must be whether such a purely notional profit would serve to induce a trader to enter into the transaction. In my view, it is clear that it would not. The real and only inducement here was the tax credit but that, as we have seen, cannot serve to turn the transaction into an adventure in the nature of trade.

I conclude, therefore, as did the Tax Court Judge, that the appellant’s purchase and subsequent redemption of the SRTC debenture was not an adventure in the nature of trade and that his deemed gain therefrom should be treated as a capital gain and not as income.

I would allow the appeal, set aside the decision of the Trial Division and restore the judgment of the Tax Court with costs throughout.

McDonald J.A.: I agree.

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