Paragraph 112(2.2)(f) of the Income Tax Act as it read prior to its repeal by 1986, c.6 subsection 61(1)
This is in reply to your memorandum dated November 30, 1990. We apologize for the delay. Our comments, as requested, are of a general nature and do not address any particular case which you may presently have under audit.
All references herein are references to the Income Tax Act and the Income Tax Regulations unless otherwise specified.
You have asked for our opinion as to whether the determination of the favourable application of the exception provided in paragraph 112(2.2)(f) with respect to guaranteed shares impacts on the taxation of future dispositions of such shares. That is to say, where it is established that the guaranteed shares were acquired in the ordinary course of a financial institution's business does it then follow, as a corollary, that a profit or loss generated from a later disposition of such shares will be on income account.
Subsection 112(1) allows a deduction with respect to taxable dividends in computing the taxable income of a corporation. Subsection 112(2.1) prohibits a "specified financial institution's from taking a deduction pursuant to subsection 112(1) in computing its taxable income on "term preferred shares" unless the shares were not acquired in the ordinary course of its business.
Pursuant to section 6201 of the Regulations, as it read with respect to shares issued prior to May 24, 1985, certain shares that would otherwise be "term preferred shares" were excluded from that definition. Essentially these were shares listed on certain stock exchanges in circumstances where the owner, and persons the owner did not deal at arm's length with, held no more than 10% of the issued and outstanding shares. Subsection 112(2.2) as it read generally prohibited a taxpayer from taking a deduction pursuant to subsection 112(1) in respect of dividends paid on guaranteed shares subject to certain exclusions including that provided for in paragraph 112(2.2)(f). While paragraph 112(2.2)(f) was intended to permit the deduction of dividends on such shares to the extent they were acquired in the ordinary course of business it also allowed a deduction in respect of dividends on shares excluded from the application of subsection 112(2.1) by virtue of section 6201 of the Regulations even though such shares were "guaranteed shares".
Apparently this was not intended (i.e. the deduction of dividends in respect of "guaranteed shares" that would be term preferred shares but for section 6201 of the Regulations) and as a consequence paragraph 112(2.2)(f) was repealed applicable to shares issued after May 23, 1985.
The position we have so far advocated with legal support is that due to the nature of a bank's business it would be reasonable to take the general position that gains and looses from the sales of securities would be on income account subject to evidence in respect of any particular transaction to the contrary. The scheme of the Act also appears to support such a position when we consider that a bank is prohibited by subsection 39(5) from making an election under subsection 39(4) to treat its Canadian securities as capital properties.
As indicated in paragraph 14 of Interpretation Bulletin ("IT") 479R when dealing with transactions in securities made by financial institutions the determination of whether they are on income or capital account is a question of fact. Paragraph 11 of IT 479R describes various factors which must be considered in such a determination. These factors were also often considered by the Courts in various leading cases such as Canada Permanent Mortgage Corporation, [1971] CTC 694 (F.C.T.D.), Punjab Co-operative Bank Limited, (1940) A.C. 1055, California Syndicate Ltd. (1904) 5 T.C. 159 and McMahon and Burns Limited [1956] CTC 153 (Ex. Ct.).
In trying to establish whether a corollary exits between the nature of the acquisition of securities by a bank and that of the disposition of such securities, the Department has stated in Paragraphs 10, 16 and 17 of IT479R that:
"10. Where the whole course of conduct indicates that
(a) in security transactions the taxpayer is disposing of securities in a way capable of producing gains and with that object in view, and
(b) the transactions are of the same kind and carried on in the same way as those of a trader or dealer in securities the proceeds of sale will normally be considered to be income from a business and, therefore, on income account
16. As indicated in IT-114, any gain or loss arising from the acquisition and disposition of a debt obligation is on income account where the acquisition of debt obligations, either for the purpose of resale or for holding to maturity, constitutes part or all of the taxpayer's business. Such would be the case where the taxpayer was clearly a money lender or a trader or dealer in debt obligations.
17. The presumption that gains and losses from security transactions are on income account will also be taken by the Department in any situation where it is apparent that the taxpayer has used special information not available to the public to realize a quick profit."
There are inferences in the above comments and in various court cases that the general corollary referred to earlier appears to exist where the transactions are part of a taxpayer's ordinary course of business. In McMahon and surns Limited ([1956] CTC 153 (EX. Ct)) the taxpayer was an investment dealer and stock-broker firm which purchased and dealt in securities while acting as either principal or agent. It had acquired certain securities which it had designated as acquired as investment and reported subsequent gains realized on capital account. The court held that intention wag not a relevant factor whether profits are on income or capital account where the profit derived from a particular transaction fall within the company's normal business operations. In such a case, it would follow that any profit would be on income account since the securities were acquired in the course of the company's business.
In Gairdner Securities Ltd. ([1953] CTC 371) the court held that: "the true nature of the transaction is to be determined from the taxpayer's course of conduct viewed in the light of all the circumstances and it was in fact not an investment but a speculation essentially of the same character as appellant had previously engaged in and one which it was specifically empowered to do, since appellant was authorized to acquire and hold, and to sell and exchange stocks in other companies as principal as well as agent as one of the appointed means by which it would carry on business for a profit and its action was exercise of the very power for which the company was incorporated." This decision was reaffirmed unanimously by the Supreme Court [1954] CTC 24.
In Roynat Ltd. (F.C.T.D.) 81 CTC 93), the taxpayer was in the business of lending money and in the course of its business as a money lender it received from borrower mortgage bonds, shares and options to purchase shares of the borrowers. The profits realized on the dispositions of these securities were held to be an integral part of the profit-making activities of the taxpayer and therefore held to be on income account. A reference was made to the California Copper Syndicate case 5 TC 159 to the effect that:
"It is quite a well settled principle in dealing with questions of assessment of Income Tax that where the owner of an ordinary investment chooses to realise it and obtains a greater price for it than he originally acquired it at the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business."
In a memorandum dated December 20, 1990 dealing with 24(1) and the issue of "in the ordinary course of the business" we made the following comments:
"(Where the phrase is "in the ordinary course of the business", (as opposed to "the ordinary course of business") it is necessary to determine the business(es) of the recipient (BC Telephone Co. v. M.N.R.), [1986] CTC 2410). To determine if a transaction is in the ordinary course of the business, the Courts tend to look at whether the transaction was extraordinary in terms of the usual operations of the corporation, whether the authority, accounting, etc. of the corporation to proceed with the transaction was done using standard procedures or whether special procedures were followed (i.e. approval by the corporate C.E.O.) and whether the transaction(s) was an integral part of the taxpayer's business. See i.e. E.V. Keith Enterprises Ltd., 76 DTC 6018 (F-C.T.D)."
In addition, under section 173 of the Bank Act,
"A bank may engage in and carry on such business generally as appertains to the business of banking and, without limiting the generality of the foregoing, may (a) open branches; (b) borrow money (c) acquire, deal in, discount and lend money and make advances on the security of and take as security for any loan or advance made by the bank or any debt or liability to the bank, bills of exchange, promissory notes and other negotiable instruments, coin, gold and silver bullion and securities;"
On the other hand, a recent court case, Société d'Investissement Desjardins ("SID") [1991] 1 CTC 2214 (Tax Court of Canada) is on point with respect to the making of each a determination.
21(1)(b)
The Court had to decide whether term preferred shares were acquired in the ordinary course of the business carried by SID. The Fédération des caisses populaires et d'économie Desjardins held, as of December 31, 1982, 79% of the ordinary shares of SID. SID was considered to be carrying on a venture capital business that made medium and long-term investments in certain shares in Québec companies. SID was not considered to be a moneylender. The Court considered the circumstances which lead to the acquisition of these shares and also SID's general investment philosophy and practices. It also held that one had to give meaning to the exception in subsection 112(2.1) which recognizes that a financial institution may acquire term preferred shares outside the ordinary course of its business.
21(1)(b)
21(1)(b)
In conclusion, the various court cases appear to follow a general line of thought which infers that where a financial institution acquires securities in the ordinary course of its business and where it continues to hold and to use such securities within the ordinary course of its business until such time as it disposes of such securities, the profits or losses generated at the time of disposition would be on income account. However, this can only be determined following the review of all the relevant facts.
We trust the above comments will be of assistance.
for DirectorFinancial Industries DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch