Roland St-Onge:—In 1968 appellant realized a profit of $86,317 on the sale of shares which it held in Fibracan Inc, hereinafter referred to as “Fibracan”. This profit was taxed as income; appellant however contends that it was a tax-exempt capital gain.
Since the facts on which the action is based are clearly set out in the pleadings, we felt it advisable to cite the following:
(TRANSLATION)
NOTICE OF APPEAL
A. STATEMENT OF FACTS.
1. In 1964 a group of six industrialists or businessmen and two engineers, who had personal savings for investment, agreed to form an “investment club”; appellant company was incorporated for that purpose on December 3, 1964, with an authorized capital of $150,000, divided into 20,000 common shares with a par value of $1.00 each and 13,000 preferred shares, having a preferential, non-cumulative dividend of six per cent and a par value of $10.00 each, the said authorized capital being increased by 80,000 additional common shares at a par value of $1.00 each by means of supplementary letters patent dated October 18, 1967.
2. Fernand Lucchesi is the president of appellant and of Fibracan.
3. As indicated by its letters patent, appellant is an investment company.
4. On December 7, 1964, subscriptions were accepted by appellant from the eight shareholders, to whom, on receiving cash payment for the said subscriptions, appellant issued 16,000 common and 6,400 preferred shares in its capital stock, fully paid up, for a total sum of $80,000.
5. Other applications for shares in appellant’s capital stock were subsequently received, the shareholders making monthly advances to appellant, or monthly payments, to pay for shares subscribed or to be subscribed, as in any investment club.
6. On December 10, 1968, there were 33,433 common shares in appellant’s capital stock issued and outstanding, 600 common shares subject to option, and 8,800 preferred shares issued and outstanding, making the total paid-up capital $122,033.
7. On November 30, 1961, Edgar D’Souza, an engineer and an acquaintance of Fernand Lucchesi, incorporated Fibracan as a company manufacturing polystyrene cups, with an authorized capital stock of $575,000, divided into 27,000 preferred shares, with a cumulative dividend of six per cent, redeemable and participating after payment of a dividend of $0.20 per share to the common shares, having a par value of $10.00 each, and 300,000 common shares with a par value of $1.00 each.
8. As large sums were necessary for the establishment of Fibracan, Edgar D’Souza, through Fernand Lucchesi, interested appellant in investing in the capital stock of Fibracan.
9. During 1965 and 1966, appellant subscribed and paid for a total of 57,425 common shares in the capital stock of Fibracan, and 4,250 preferred shares, making a total of $99,925.
10. On September 22, 1967, Fibracan, in recognition of the services rendered to it since its incorporation by its directors and the members of its managing committee, the persona! endorsement by the latter of substantial loans contracted by Fibracan, a number of things done by the said persons and their attendance at regular meetings without remuneration or reimbursement for travel expenses, granted.
(a) to its directors and the members of its managing committee an option to purchase 9,000 common shares, the said option being valid for a period of five years from September 22, 1967, at a price of $1.50 per common share, at the rate of 60 common shares in the capital stock of Fibracan for each attendance at the regular meetings of the Board of Directors or the managing committee, as the case may be, namely in the case of Messrs. Fernand Lucchesi, Lionel Barnabé, Jean Royer and Gilles Barré, all directors. of the appellant, 1,320, 780, 300 and 240 common shares respectively, and
(b) to each of the five members of the managing committee, including Fernand Lucchesi, an option to purchase 4,000 common shares in the capital stock of Fibracan, which said option could be exercised during the five-year period from September 22, 1967, at a price of $1.50 per common share.
11. At July 25, 1968, the capital stock of Fibracan, issued and outstanding, stood at 174,109 common shares and 10,255 preferred shares.
12. Early in 1968 negotiations were commenced between Edgar D’Souza and Fernand Lucchesi, officers of Fibracan and Charterhouse Canada Limited (hereinafter referred to as Charterhouse), the latter being prepared to purchase common shares in the capital stock of Fibracan at $0.85 per share.
13. In May, 1968, the purchase of 65,000 common shares in the capital stock of Fibracan by Charterhouse was renegotiated at a price of $1.75 per share.
14. On May 17, 1968, Edgar D’Souza advised Fernand Lucchesi that the issued and outstanding common shares in the capital stock of Fibracan would undergo an appreciable increase in value such that in the next two years he foresaw that the market value of the common shares would be about $10.00. Edgar D’Souza also spoke of expanding Fibracan’s operations in Toronto and Vancouver; he mentioned the growth in sales volume, from $156,000 in the first year of operations to $669,000 in the third year, and forecast a volume of business amounting to $1,500,000 in the fourth year, which amount would double in the fifth and sixth years.
15. (a) Whereas Fibracan was expanding and would continue to do so for many years to come, so that any profit realized would be immediately reinvested in the business and no part of it distributed to its shareholders in the form of dividends;
(b) whereas the shares in Fibracan were subject to restrictions on transfers of common stock, under its by-law No. 5, so that any shareholder wishing to sell his common stock was first obliged to offer it to the other shareholders, at a price equal to one and one-quarter times the book value
of the common stock established in the last balance sheet of the preceding financial year (June 30);
(c) whereas the book value of a common share in the capital stock of Fibracan was 32.4 cents on June 30, 1966, and 74.8 cents on June 30, 1967;
(d) whereas because of a financing arrangement with Charterhouse, Fibracan could not pay a dividend on its issued and outstanding preferred shares without first meeting certain conditions:
(e) whereas Fibracan had to compete with large companies that are well established in the field of manufacturing cups and other similar products;
and
(f) whereas appellant’s shareholders were beginning to find that appellant was slow in yielding a return on its investments;
(g) Fernand Lucchesi took Edgar D’Souza at his word and suggested to him that he buy all the common shares in the capital stock of Fibracan held by appellant, at $10.00 a share.
16. Finally, after some discussion, appellant consented to give Edgar D’Souza an option on all its 57,425 common shares, at $4.00 a share, and on ail its 4,250 preferred shares, at their par value, which it held in the capital stock of Fibracan, the said option to be valid for a period of 90 days from May 17, 1968.
17. The price offered, $4.00 per share, was so attractive under the circumstances that the appellant’s directors did not hesitate over appellant’s selling Edgar D’Souza ail of its common shares in the capital stock of Fibracan, and appellant thus recovered its investment.
18. On or about June 4, 1968, subject to obtaining an exemption from registration from the Securities Commission, Charterhouse subscribed for 60,000 common shares in the capital stock of Fibracan at the price of $2.00 per share, and the said shares were issued to it on July 26, 1968.
19. At the end of August or beginning of September 1968, Edgar D’Souza, acting through Charterhouse, purchased 30,000 common shares in the capital stock of Fibracan from appellant at $4.00 per share, and 2,250 preferred shares in the capital stock of Fibracan at their par value, namely $1.00 (sic) per share, for a total cost of $142,500, consisting of $71,250 cash, $35,625 payable on September 5, 1969, and $35,625 on September 5, 1970, the balance of the selling price to bear no interest, and a sales commission of $3,552 payable to Edgar D’Souza to be deducted from the selling price.
20. Purchase of the said common stock by Edgar D’Souza at $4.00 a share also enabled the latter to set a value for his own common shares in the capital stock of Fibracan, transferred as collateral security on a loan.
21. The proceeds thus received by appellant from the sale of the said shares in the capital stock of Fibracan were reinvested, for example, in shares quoted on the Stock Exchange — to cite only a few, Industrial Acceptance Corporation, Dupont of Canada, Great Lakes Paper Ltd., Price Co., Abitibi, Alcan, Chemcell, Traders, Westcoast, Bell Canada, American Growth Special, Acklands Ltd., etc. in the same way as an individual makes investments.
22. Appellant subsequently considered various proposals for investment in the capital stock of such companies as Nilus Leclerc Inc., La Buanderie Lévis Ltée, etc.
23. As the option to purchase granted on September 22, 1967, was conferred on Fernand Lucchesi personally and not on the appellant, Fernand Lucchesi wished the appellant’s directors to be informed of this option and wanted appellant to state officially that it was not interested in the said option, so that Fernand Lucchesi could not be charged in due course by any of appellant’s shareholders with having taken advantage of his position as an officer and director of appellant and of Fibracan, and this is why the matter was included in appellant’s book of minutes.
24. Appellant has no office, employees, or telephone, and engages in no public advertising or solicitation to attract funds or secure investments, but remains a strictly private investment company, As it is not in the securities business, it is not registered with the Quebec Securities Commission as a broker.
B. GROUNDS FOR APPEAL.
25. The profit of $86,317 realized on the sale of the shares in the capital stock of Fibracan constitutes a capital gain, as was held, for example, in Canada Permanent Mortgage Corporation v MNR, 1971 DTC 5409, [and Foreign Power Securities Corporation Limited v MNR, 1967 DTC 5084], as appellant is an investment company and not in the business of selling securities.
26. Even if, as respondent claims, the profits were taxable, which is categorically denied by appellant, they were received over a period of three years and section 85B(d)(i) would therefore apply in the circumstances.
27. Respondent appears to be making a distinction between the sale of shares by an investment group and the sale of shares by an investment group with corporate status.
28. Appellant has always sought long-term investments with a good rate of return. Apart from dealings in shares quoted on the Exchange, the sale of the shares in Fibracan was the only other transaction undertaken by appellant.
29. No benefit or advantage can be conferred on appellant by Fibracan, because in the first place the option to purchase 6,640 common shares in the capital stock of Fibracan was not conferred on appellant but on Fernand Lucchesi, Lionel Barnabé, Jean Royer and Gilles Paré, and secondly, the book value of the Fibracan shares at the time the option was exercised was about $0.85, while their market value per share varied between $1.50 (the price paid by the shareholders) and $2.00 (the price paid by third parties such as Charterhouse).
Respondent’s reply to the notice of appeal reads in part as follows:
(TRANSLATION)
15. In assessing appellant for the 1968 taxation year Respondent relied inter alia on the presumptions resulting from the following facts:
(a) appellant was incorporated by letters patent issued on December 3, 1964;
(b) Fibracan Inc. commenced operations on July 15, 1964;
(c) even before Appellant’s incorporation the monies required to pay for the shares purchased by its shareholders had been used for the purchase of shares in Fibracan Inc.;
(d) up to September 1968 all the capital stock subscribed by Appellant’s shareholders was used by Appellant for the purchase of shares in Fibracan
Inc.;
(e) in 1966 Appellant held 57,425 common shares and 4,250 preferred shares issued by Fibracan Inc.;
(f) Fernand Lucchesi, President of the Appellant, is also President of Fibracan Inc.;
(g) between its incorporation on December 3, 1964, and September, 1968, Appellant was engaged in only one activity, namely the launching or promotion of Fibracan Inc.;
(h) as Fibracan Inc. was a newly-formed business, Appellant could not hope to receive any dividends for a good many years;
(k) in August, 1968, Appellant exercised its option to purchase 6,640 common shares in Fibracan Inc. at $1.50 each, whereas this right to purchase had been conferred only on certain shareholders in Fibracan Inc. and the value of the said shares was at least $4.00 each:
(l) Respondent rightly treated as taxable business income the profit of $86,317.00 realized on the sale of shares mentioned in paragraph 15(i) above;
(m) Respondent also rightly treated the transaction mentioned in paragraph 15(k) above as having conferred on Appellant a taxable profit of $16,600.00;
(B) STATUTORY PROVISIONS AND SUPPORTING REASONS
16. Respondent relies inter alia on sections 3, 4, 8(1), 85B(1)(d) and 139(1 )(e) of the Income Tax Act;
17. the profit of $86,317.00 realized by Appellant in 1968 represents income from a business within the meaning of sections 3, 4 and 139(1)(e) of the Act;
18. Appellant cannot claim a reserve for the amounts to be collected in 1968 and 1969 on the sale price of the shares mentioned in paragraph 15(i) above, since section 85B(1)(d) of the Act requires that the payments be spread over a period of more than two years after the date of the sale:
19. The purchase of the 6,640 shares mentioned in paragraph 15(k) above conferred on Appellant a benefit or advantage taxable under section 8(1) of the Act.
At the hearing Edgar D’Souza, who had already enjoyed considerable success in business management, explained that his intention initially was to set up a corporation known as Fibracan which would be an attractive investment for people of Quebec. He had a study made by the Société canadienne d’études techniques et d’investissements Incorporée of the feasibility of setting up a factory to make paper cups in the Lac St-Jean region; the report was then submitted to Mr Lucchesi and his group with a view to interesting them in the new business.
This report, which considered inter alia the situation of the Canadian market, anticipated production costs and the planned financial structure of the business, forecast the following profits:
| Net Profit | Net Profit | |||||
| before | after after | Available for | ||||
| Year | Sales Sales | Tax | Tax | Tax | Tax | Reinvestment^ |
| 1 | $ 549,600 | $ 67,250 | $ 43,900 | $ 89,900 | ||
| 2 | 870,200 | 181,600 | 98,610 | 133,410 | ||
| 3 | 1,059,600 | 254,660 | 135,250 | 165,490 | ||
The factory called for an initial investment of $220,000. The Lucchesi group, interested in making a good long-term investment, took shares in the business, on condition, first, that the directors be chosen from the said group and, second, that the company by-laws restrict share transfers, so as to make the sale of shares by shareholders difficult.
At first it seemed that none of the 50 to 60 shareholders would have control of the company, but it should be noted that, by 1964, the Lucchesi group had already acquired 30% of the controlling shares. The private nature of the company did not facilitate share transfer; there was in fact no purchase of shares except the one by Charterhouse in 1968.
On July 4, 1964 Fibracan, which had obtained permission from the Securities Commission to issue common and preferred stock, passed a resolution that such shares be issued to subscribers mentioned in the resolution, including the witness, Mr D’Souza, who was entitled to 6,300 common shares. On December 14, 1970, in a letter addressed to Jean-Paul Marcoux (Exhibit A-11), Mr G M Alarie, secretary of Fibracan, described the different options provided and the value of Fibracan shares at various times. This letter reads as follows:
Further to our conversation, as requested by you I am providing details regarding share offerings made to shareholders, management committee members and others, as per the recorded company minutes and also the audited statements prepared by Samson, Bélair, Côté, Lacroix et Associés, our auditors.
1. On October 29, 1966, shareholders were given the opportunity to buy common shares of the company at $1.00 per share. Non shareholders were given this opportunity to purchase common shares at $1.50 per share. Also, on May 26, 1967, both Messrs. D’Souza and Alarie were provided options for a 5-year period to purchase common shares at $1.50 per share.
2. Based on the June 30, 1966, financial statement of the company, the book value of the common shares was 32.4 cents each.
3. On September 22, 1967, several members of the management committee, most of whom were directors of the company, were provided options to purchase common shares at $1.50 per share for a 5-year period.
4. According to audited statement of June 30, 1967, the book value of the common shares was 74.8 cents each.
5. In early 1968, the President of Fibracan entered into negotiations with Charterhouse Canada Limited to get the company to invest in Fibracan. In the early stages, Charterhouse Canada Limited, based on book value of June 30, 1967, offered the company 85 cents for each common share. However, in May 1968, agreement was reached between the company and Charterhouse Canada Limited for the sale of 60,000 common shares at $2.00 each, subject to approval of the Quebec Securities Commission.
6. The actual share transaction with regard to Charterhouse Canada Limited took place on July 26, 1968.
According to this letter the Fibracan shares had a low book value. Mr D’Souza maintained that this was due to the company’s lack of capital, the difficulty in training qualified staff, and competition from American companies, which made price cuts of nearly 50%.
This situation obliged Fibracan to resort to an offering of shares in order to obtain the capital needed to run its factory efficiently. In other words, the company would have to face bankruptcy, or sell its assets to another company, unless it could obtain the sum of $150,000 at short notice. Its directors and shareholders, including the Lucchesi group, had no more money to invest in Fibracan. Mr D’Souza said he personally approached Charterhouse, a financial institution which purchased shares in new companies for investment purposes, shares which it later resold at a profit. The latter offered to buy stock at $0.85 per share. As the directors and shareholders had paid $1.50 per share themselves, they could not accept this offer. After considerable negotiation, Charterhouse decided to buy 60,000 common shares at $2 per share, provided that Fibracan shareholders could not sell their shares without first offering them to Charterhouse.
Subsequently, at a meeting with the Lucchesi group at the Queen Elizabeth Hotel, Mr D’Souza told them that Fibracan shares would be worth up to $10 each. This optimistic statement caused some discussion, as a result of which Mr D’Souza agreed to sign an option to purchase from the said group all the shares it held in Fibracan at $4 each. However, he only exercised half his option, since the members of the group decided to retain the other half. An amount of $3,562 was credited to Mr D’Souza from the purchase price as a commission.
Mr D’Souza also testified that Fibracan had offices and warehouses in Toronto, Vancouver, Chicago and Weston (USA), and that it intended to put up a new $600,000 factory in Toronto.
Two of the appellant company’s shareholders testified that they had decided, after examining the feasibility report, to put their savings into appellant company so as to build up a pension fund for themselves. One of them, an engineer, said that all shareholders in the appellant company had the technical skill to carry out their undertaking. He had himself taken steps to acquire shares or equity in other companies not registered on the Exchange, but which could pay attractive dividends, such as Nilus Leclerc, Victoriaville Casket and Buanderie Lévis.
Fernand Lucchesi, president of Fibracan, explained that he had been invited by a friend, a Quebec industrialist, to attend a meeting of big city contractors and engineers for the purpose of setting up a company to deal in structural steel. This first meeting gave him an opportunity to obtain large amounts of capital. Subsequently, through his father, he had occasion to examine the feasibility report prepared at Mr D’Souza’s request. After the report was examined a questionnaire was prepared by the Quintex group for Mr D’Souza, who replied to the satisfaction of the group. Mr D’Souza required $75,000 to start operations, and a lawyer was asked to handle the incorporation. Because of difficulties in the choice of a name, incorporation was delayed ‘or some time.
Mr Lucchesi further explained that the company had had no need to borrow money, and that the subscriptions for shares had been sufficient to provide $100,000—$75,000 of which was to be invested in Fibracan and $25,000 in other industrial companies. His group was in touch with the Quintex group, which included two engineers, two contractors and an accountant named Jean-Paul Marcoux. He explained that appellant company had never been incorporated to deal in stock or to buy control of Fibracan. Each member of his group invested from $5,000 to $10,000 as the initial outlay, and then undertook to pay $25 a month to create additional capital, in order to make investments in other companies. When there was a surplus of unused subscriptions appellant company bought shares in well-known companies quoted on the Stock Exchange. Finally, Mr Lucchesi corroborated the testimony of the other witnesses, stating that the option which he had acquired personally had been referred to in the books of minutes of appellant company, at his request, so that all the shareholders would be aware of this option.
Counsel for appellant explained that neither appellant nor its shareholders had borrowed money to purchase the Fibracan shares; that appellant had purchased them as a long-term investment and had never had any intention of reselling them; that it had never sold shares and that this isolated sale in 1968 was the result of circumstances which made it inevitable and, accordingly, not taxable. According to his submission, the proven facts clearly indicate that appellant was incorporated to make long-term investments; that it never acted as a securities broker; that it never advertised its shares for sale and that the latter were not quoted on the Exchange and were subject to transfer restrictions. Appellant was to buy majority holdings in small corporations, and did in fact take steps to buy stock or equity in Victoriaville Casket, Nilus Leclerc and Buanderie Lévis. Despite the attractive offer to purchase all its shares at $4 a share, appellant sold only half of them, indicating, in counsel’s view, that its intention was to keep its shares as an investment.
Counsel for the respondent maintained that even if this was an isolated transaction it was still an adventure in the nature of trade, since appellant invested all its capital in a single company in order to promote a new industry and sell its shares at a profit at the first opportunity, which constitutes a purely speculative venture.
All the shareholders in the appellant company were astute businessmen, and must have been aware of the highly speculative nature of a new business. They must also have known of the competition which Fibracan was up against in the Canadian market. The purchase of common and preferred stock in such a large quantity could not be a genuine investment like the purchase of shares in well-known Canadian companies, of which appellant, as shown by its balance sheet, had only a token number. This manner of proceeding showed clearly that it would rather tie up its capital in a company of an exceptionally speculative nature.
Appellant alleged that at a certain point Fibracan was short of capital funds and had to sell its shares to obtain working capital, even though Fibracan was forecasting a turnover of one million for its third year of operation and net profits of $135,250, or 13 /2% of the anticipated annual turnover. How could Fibracan have been forced to sell stock when it could easily have got the money from other sources? It sold a sizable number of shares to Charterhouse, which, even according to the witnesses in the case, bought shares in developing companies with the definite intention of selling them at the right time at a profit. Is that not what appellant did itself? And has appellant not, under the guise of investing, purchased land in the Bahamas which cannot of itself produce any income, and even entails administrative expenses? With such assets how can appellant call itself an investment company?
Moreover, appellant company does not have even 8% of its capital in gilt-edged securities, but has invested all its capital in a single company with the same president, which is described as a new industry. It is true that this was an isolated transaction, but this is natural since it was the first one, it did not preclude the possibility of subsequent transactions of the same kind, and it was carried out at the instigation of the promoter of Fibracan, who had every reason to promote his company’s interests.
In the circumstances the Board cannot accept appellant’s claim that it purchased the shares in Fibracan as a long-term investment and never had any intention of selling them.
While the evidence showed that appellant had never sold shares, it also indicated that appellant had never held any before, and that this was its first experiment in the field of new undertakings.
Appellant is a corporation, and if we are to understand its behaviour we must judge from its actions. In the case at bar, it made an investment of $57,000 in Fibracan in 1964, and barely four years later sold half of its shares and realized a profit of over $86,000. For four years appellant, far from diversifying its investments, engaged only in the launching or promotion of Fibracan Inc, a company from which it could not hope to receive dividends for many years. This manner of proceeding by appellant cannot be considered to be that of a taxpayer desirous of putting his money into sound securities.
In such cases, especially in transactions involving real estate, the appellant almost alleges it had to make the sale for a variety of reasons, whereas in this case appellant did not even have a reason to sell, since it was supposed to buy shares as long-term investments and was not in difficulties, as Fibracan, the company in which it held shares, was supposed to be. Appellant is not to be confused with the company in which it held shares and which it was trying to promote. This transaction has all the features of an adventure in the nature of trade.
The Board therefore holds that the profit realized by appellant is taxable income and that appellant cannot claim a reserve for the sums it was to receive in 1968 and 1969 on the sale price of the shares mentioned, since section 85B(1)(d) of the Act provides that payments must be spread over a period of more than two years after the date of the sale.
For all the foregoing reasons, the appeal is dismissed.
Appeal dismissed.