The Queen v. Roynat Ltd., 81 DTC 5072, [1981] CTC 93 (FCTD)

Addy, J:—The action involves income tax assessed against the defendant for taxation years 1967 to 1970 inclusively, pursuant to reassessments made against it for certain gains realized from share and option transactions as well as interest received by the defendant on certain bonds which, according to the defendant, qualified as income bonds.

The defendant appealed the reasssessment to the Tax Review Board. The appeal was allowed in part in that the Board agreed with the defendant that the bonds in question qualified as income bonds under paragraph 139(1 )(t) of the Income Tax Act, RSC 1952, c 148 (hereinafter referred as “the Act”). The plaintiff in the present action appeals against this finding. The defendant, on the other hand, counterclaims in this action against the dismissal of its appeal by the Tax Review Board with respect to gains realized from the disposition of certain shares, options and mortgage bonds which took place in each of the four taxation years.

There exists no dispute between the parties as to the actual amounts involved in this action but merely as to how the amounts should be considered for taxation purposes.

Dealing first with the plaintiff’s claim regarding the income from what was found by the Tax Review Board to be income bonds, the dispute as to whether the interest received is to be considered as dividends involves the interpretation and application of subsection 8(3) and paragraph 12(1 )(f) of the Act. They read as follows:

8. (3) An annual or other periodic amount paid by a corporation to a taxpayer in respect of an income bond or income debenture shall be deemed to have been received by the taxpayer as a dividend unless the corporation is entitled to deduct the amount so paid in computing its income.

12. (1) in computing income, no deduction shall be made in respect of:

(f) an amount paid by a corporation other than a personal corporation as interest

or otherwise to holders of its income bonds or income debentures . . .

“Income bond” or “income debenture” is defined in paragraph 139(1 )(t) of the Act as follows:

“income bond” or “income debenture” means, a bond or debenture in respect of which interest or dividends are payable only when the debtor company has made a profit before taking into account the interest or dividend obligation;

The key characteristic of the income bond is that interest is payable by the debtor only if a profit has been realized by the debtor in that year.

The bonds to which the action referred were issued pursuant to six different trust deeds, all executed in 1966 in favour of various trust companies by the following firms as borrowers:

1. Crystal Beverages (1963) Ltd; 2. Agristeel Ltd; 3. Speedway Express Ltd; 4. Springdale Mills (Ontario) Limited; 5. North American Plastics Co Ltd; 6. Comeau’s Sea Food Fishmeal Ltd.

In all of these trust deeds the bonds were described as income bonds, but, in addition to the provision normally attached to this type of security, the payment of the interest on the bonds, as well as the payment of principal, was guaranteed by third parties. The loans were made in all cases pursuant to an offer of finance made by the defendant whereby the intervention of third parties to guarantee full payment was made a condition for the granting of the loans.

The position of the plaintiff is that the interest payments received by the defendant in respect of the bonds should be treated as ordinary interest, because the bonds do not qualify as income bonds, while the defendant takes the contrary view and alleges that it should be deemed to have been received only as dividends, pursuant to subsection 8(3) supra, because the bonds truly qualified as income bonds under paragraph 139(1 )(t) notwithstanding the guarantees from third parties whereby the defendant was assured full reimbursement of the loan and of all interest payable thereunder as well as all interest merely stipulated in the trust deed and which would not in fact be payable by the borrower if the latter did not make a profit.

In the case of the first above-mentioned trust deed, ie, Crystal Beverages, the offer to finance the defendant contains the following clause:

The Bonds will be secured by:

(a) a first specific charge on all machinery and equipment (including motor vehicles) now owned and hereafter acquired by you, and more particularly on all machinery used in the canning and bottling of beverages and for the mixing and bottling of chocolate milk;

(b) a second charge on land and building located at Lotus Street and Henri Durant in the Moncton Industrial Park, Moncton, NB. The land consists of approximately 100,000 square feet and the building consists of approximately 52,000 square feet. Both are subject to a first charge by Eastern Canada Savings & Loan Association, not exceeding $367,500;

(c) a first floating charge on all your other assets (not contained in the above specific charges), expressed in such a manner as not to hinder you from dealing with these assets or giving security to your bankers in the ordinary course of business;

(d) the joint and several guarantee for $200,000 of Hugh John Flemming, Frederick G Flemming, David Owen, Stanley Shefler and Reno Castonguay. In addition, the guarantors shall undertake to pay interest quarterly on the debt at the rate of 8 A% in the event the Company’s earnings are not sufficient to pay the interest due on the Income Bond.

The guarantee itself contains the following recital:

AND WHEREAS it was a condition precedent to the financing contained In and secured by the Trust Deed that the Guarantors further agree as hereinafter provided;

and the following undertaking:

NOW THEREFORE WITNESSETH, that in consideration of the sum of $1 and in consideration of the premises, the Guarantors hereby agree and undertake that in the event the Company does not have income available (as defined in the Trust Deed) for the payment of interest on such dates as called for on the repayment Schedule of the First Mortgage Income Bond then the Guarantors shall pay interest thereon at the rate of 8%% per annum.

The offer to finance and the guarantee document of Agristeel contain substantially the same provisions.

In the case of the Speedway loan the offer to finance contains the following provision:

4. SECURITY

The bonds will be secured by:

Guarantee of G GM MacFie for $100,000. In addition Mr G GM MacFie will pay to RoyNat in the event the Company fails to pay interest on the Bonds on the interest payment dates above mentioned, interest at the rate payable thereunder plus additional interest of 2 /4% per annum calculated on a daily basis on the principal amount of Bonds outstanding computed from the last interest payment date on which interest was fully paid to RoyNat under the terms of the Bonds to the date of actual payment by the said G M MacFie;

It will be noted here that additional interest over and above what the borrower would have to pay is also provided for. Instead of a separate guarantee document the trust deed itself contains an intervention by a third party guarantor who undertakes, among other things, as follows:

6. Notwithstanding the foregoing provisions of this section, and in the event that the Company fails to pay interest on the Income Bonds on the interest payment dates hereinabove mentioned, the said Guarantor hereby agrees to pay to the Bondholders interest at the rate payable thereunder plus additional interest of 2 /4% per annum, calculated on a daily basis on the principal amount of Income Bonds outstanding computed from the last interest payment date on which interest was fully paid to the Bondholders, under the terms of the Income Bonds, to the date of actual payment by the said Guarantor.

The next two loans, that is, Springdale Mills and North American Plastics contain substantially similar provisions. As in the case of the Speedway loan they do not specifically mention that the guarantee will take effect if there is insufficient income but no other reasonable interpretation can be put on the text. The guarantee is absolute and the guarantor becomes liable “in the event that the company (debtor) fails to pay . . . ”

I find that in all six cases the respondent is guaranteed payment in full by the guarantor of all interest at the rate stipulated in the bonds notwithstanding that the principal debtor company might not have made any profit and would not itself be obliged to pay interest. I do not accept the contention of counsel for the defendant that Comeau Sea Food and the North American Plastic loans can be distinguished from the other four in this respect.

If the guarantors were merely guaranteeing payment in full of the income bonds in accordance with the terms of same, then, it seems obvious that this would not affect the nature of the bonds nor prevent any interest paid thereon by the principal debtor from being treated as a dividend. Counsel for the plaintiff in fact fully agrees that this would be the case.

However, the guarantors, assuming that under the circumstances they can be called guarantors, undertake to do much more than the principal debtors: as previously stated, the former in effect undertake to pay interest at the rate stipulated even if the debtors are not contractually obliged to pay it and in some cases they also undertake to pay additional interest as a bonus.

In the case of Comeau Sea Foods the offer to purchase also states that the guarantee is a condition precedent to the loan. It seems obvious from the above that the additional obligations by the guarantors in each of the six cases is integral to the whole transaction and it is indeed specifically referred to as such in the Crystal Beverages, Agristeel and Comeau Sea Foods loans.

The provisions regarding the special way in which interest is to be taxed in the case of income bonds constitute an exception to the general manner in which interest is normally taxed. Therefore, those provisions must be strictly interpreted against that taxpayer, the latter being obliged to establish that the case falls squarely within the provisions of the section.

“Interest” is not defined in the Act. In Riches v Westminister Bank Ltd, [1944] 1 All ER 469 Viscount Simon, at 472, quoted with approval the following statement of Evershed, J as to the nature of interest:

. it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had had the use of the money, or, conversely, the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation. From that point of view it would seem immaterial whether the money was due to him under a contract, express or implied, or a statute, or whether the money was due for any other reason in law.

Rand, J In the matter of a reference as to the validity of section 6 of the Farm Security Act, 1944, of the Province of Saskatchewan, [1947] SCR 394 had this to say, at 411 and 412, regarding the nature of interest:

Interest is, in general terms, the return or consideration or compensation for the use or retention by one person of a sum of money, belonging to, in a colloquial sense, or owed to, another. There may be other essential characteristics but they are not material here. The relation of the obligation to pay interest to that of the principal sum has been dealt with in a number of cases including: Economic Life Assur Society v Usborne [1902] AC 147 and of Duff J in Union Investment Co v Wells [1929] 39 Can SCR at 645; from which it is clear that the former, depending on its terms, may be independent of the latter, or that both may be integral parts of a single obligation or that interest may be merely accessory to principal.

But the definition, as well as the obligation, assumes that interest is referrable to a principal in money or an obligation to pay money. Without that relational structure in fact and whatever the basis of calculating or determining the amount, no obligation to pay money or property can be deemed an obligation to pay interest.

The above passage was quoted with approval in England by Megarry, J in Re Euro Hotel (Belgravia) Ltd, [1975] 3 All ER 1075. The learned judge then went on to add at 1084 of the report:

It seems to me that running through the cases there is the concept that as a general rule two requirements must be satisfied for a payment to amount to interest, and a fortiori to amount to “interest of money”. First, there must be a sum of money by reference to which the payment which is said to be interest is to be ascertained. A payment cannot be “interest of money” unless there is the requisite “money” for the payment to be siad to be “interest of”. Plainly, there are sums of “money” in the present case. Second, those sums of money must be sums that are due to the person entitled to the alleged interest; and it is this latter requirement that is mainly in issue before me. I do not, of course, say that in every case these two requirements are exhaustive, or that they are inescapable. Thus I do not see why payments should not be “interest of money” if A lends money to B and stipulates that the interest should be paid not to him but to X: yet for the ordinary case I think that they suffice.

Counsel for the plaintiff on the basis of those definitions of interest argued that the guarantors, in undertaking to pay money calculated as interest for capital sums of money lent the debtor companies, were in fact undertaking to pay interest even though it was not the guarantors who had received or benefited from the capital sums on which the interest is calculated. It is the substance of the transaction which matters and not the form or wording of the documents (see La Société coopérative agricole du Can- ton de Granby v MNR, [1961] SCR 671; [1961] CTC 326; 61 DTC 1205. It would follow, if that argument is accepted, that the bonds would not be income bonds as they contain a firm undertaking to pay interest.

The defendant on the other hand argued that what was payable by the guarantor was neither interest nor dividends but something of an entirely different nature.

There is a fundamental difference in nature between the obligations of a principal debtor and those of a guarantor. The defendant quoted from Hervé Roch in his Traité de Droit civil du Québec, Vol 13 at 591 and 592. The text reads as follows:

(3) Il faut dire aussi, que la caution d’une obligation de faire ne s’oblige pas à exécuter ce que le débiteur principal a promis, mais elle garantit les dommages- intérêts que pourra devoir le débiteur au cas d’inexécution; d’où il suit que la caution d’une obligation de ce genre ne peut repousser l’action en dommages-intérêts du créancier en excipant de ce qu’elle n’a pas été mise en demeure de suppléer au défaut du débiteur principal.

(4) Le cautionnement est, enfin, l’accessoire de l'obligation principale et il est soumis en plus des règles du contrat à certaines règles spéciales tant à l’égard des relations de la caution avec le créancier, que de celles avec le débiter et entre les cautions.

It is to be noted, however, that the learned author, at least in the first part of the citation, is referring to a guarantor of “une obligation de faire” and not “une obligation de payer.” In other words, he is stating that where a third party guarantees an undertaking on the part of a contracting party to execute certain work or to do anything, he is really undertaking to save the obligee harmless from any damages which might follow from nonperformance of the contract by the main contracting party for whom he is acting as guarantor. It is really a contract of indemnity.

The following statement pertaining to the nature of a guarantee is to be found in Halsbury’s Laws of England 3rd ed, Vol 18 at 411 and 412:

767. Guarantee. A guarantee is an accessory contract, whereby the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated.

It is often termed, in cases and text books a “collateral” or “conditional” contract, in order to distinguish it from one that is “original” and “absolute”.

A guarantee is always a contract of an accessory nature, ancillary and subsidiary to some other contract or liability on which it is founded. (See Mountstephen v Lakeman (1871), LR 7 QB 196, affirmed sub nom. Lakeman v Mounstephen (1874), LRHL 17 at 24, 25 per Lord Selborne.) But it does not follow necessarily that no part of any payment made under such contract could ever be considered as interest in the hands of the recipient.

Counsel for the defendant argued in addition that the payment by a guarantor on income bonds cannot, under subsection 8(3), above quoted, be deemed to be a dividend because a guarantor can be a natural person as well as a corporation and subsection 8(3) refers exclusively to an “amount paid by a corporation,” otherwise, the words “taxpayer” or “person” would have been used. He also maintained that, because of the expression “holders of its income bonds” in paragraph 12(1 )(f) previously quoted, that the provisions therein contained could not contemplate third parties. It does not deal with the question of whether an amount paid by a third party is or is not deductible and nowhere else in the Act is the question dealt with in respect of income bonds. He argued that, because of this, the definition of income bonds only contemplated a debtor and a creditor and that, since no payment by a third party can be considered a deemed dividend under subsection 8(3), then any payment by a third party cannot be considered as interest. I consider the last conclusion to be a non sequitur.

There exists jurisprudence to support the proposition that what a guarantor pays is not interest. A leasing case on the matter is Holder and Another v CIR, [1932] AC 624. We find therein the following statements as to the nature of a payment made by a guarantor to indemnify a principal debtor against non-payment of interest by a principal debtor. Per Viscount Dunedin at 627 and 628:

I think that interest payable on an advance from a bank means interest on an advance made to the person paying. The guarantor does not pay on an advance made to him, but pays under his guarantee. It is true that he pays a sum which pays all interest due by the person to whom the advance is made, but his debt is his debt under the guarantee not a debt in respect of the advance made to him.

Per Lord Thankerton at 631:

Interest is the return given for the use of the advances, and is due by the person who obtains the advances; the liability of the guarantor is direct to the creditor, and is an undertaking to indemnify him against loss. The creditor computes his loss by the amount of the failure of the principal debtor to pay him principal and interest. In paying the amount of the indemnity, whether limited or otherwise, I am of opinion that the guarantor cannot be said to be paying interest to the creditor, though he is making good the loss of interest.

Per Lord Macmillan at 634:

The short answer, in my opinion, is that the appellants received no advance from the bank and owed no interest to the bank. Their relationship to the bank was not that of borrower and lender, and their liability to the bank was solely that of guarantors of a third party indebtedness to the bank. When they paid the sum of £64,482 16s. 8d. to the bank they did so in discharge of their liability to pay whatever sum, whether of principal or interest, Blumfield, Ltd, owed to the bank. It cannot, therefore, with legal accuracy be said that the appellants made payment to the bank of interest on an advance from the bank within the meaning of the section.

In the case of Donald Preston McLaws v MNR, [1970] CTC 420; 70 DTC 6289, Kerr, J quoted and followed the Ho/der case, concluding with the following finding:

I think that the same reasoning may be applied to the payments made by the appellant to the bank in this case. He made them pursuant to his guarantee, which included interest due to the bank by the company to which it had advanced the amounts of the loans, but what the appellant paid the bank was his debt under the guarantee, not a debt in respect of money borrowed by him. Consequently, the appellant is not entitled to deduct any part of the payments as “interest” pursuant to paragraph 11 (1 )(c), whatever right, if any, to deduction he may have under other sections.

It is of some interest to note that these cases dealt with the nature of the payment made by the guarantor in so far as its deductibility as interest in the hands of the person disbursing the money is concerned and not as to the nature of the payment for taxation purposes qua the payee or recipient of the monies. The same payment may frequently be considered as income for taxation purposes in the hands of the payee and capital in the hands of the payor and vice versa. Also two sums identical in nature paid for identical purposes may also be treated quite differently for taxation purposes, depending on other circumstances such as the occupation of the taxpayer.

As to sections regarding income bonds not contemplating third parties because of the use of the word “corporation” this seems to be, to some extent, begging the question which in essence resolves itself into determining whether or not the bonds qualify as income bonds. If they do not then, of course, there can be no exemption in any event. If they do, then it matters not whether there are third parties, at least where the payment is not actually made by the third party.

The Holder case dealt with a true guarantee or contract of suretyship. However, where a third party undertakes, as in the case at bar, to pay more than the principal debtor, it is not, strictly speaking, a guarantee or a true contract of suretyship but rather a contract of indemnity, although it does ipso facto protect the lender against the default of the borrower.

As to the essence of a guarantee at civil law, see article 1929 of the Civil Code, Title 15th of Suretyship, c1:

Art. 1929. Suretyship is the act by which a person engages to fulfil the obligation of another in case of its non-fulfilment by the latter.

The person who contracts this engagement is called surety.

and see the Report on the Quebec Civil Code, Title 7th, 14th C, Suretyship Vol 1 (Civil Code Revision Office, 1978):

Chapter XIV — Suretyship:

842. Suretyship is a contract by which one person, called a surety, undertakes towards a creditor to execute the obligation of the debtor if he fails to execute it.

A person who promises that a debtor will execute his obligation is deemed a surety.

Halsbury’s Laws of England, 4th ed, Vol 20, Chapter on Guarantee and Indemnity, p 49, para 101 defines a guarantee according to common law as follows:

101. Guarantee. A guarantee is an accessory contract by which the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person whose primary liability to the promisee must exist or be contemplated. As in the case of another contract its validity depends upon the mutual assent of the parties to it, their capacity to contract; and consideration, actual or implied.

It is also important to note the distinction drawn in Halsbury’s between a contract of indemnity and guarantee at 54, paragraph 108 of the same volume:

108. Guarantee and indemnity. Although a contract of guarantee may be described as a contract of indemnity in the widest sense of the term, yet contracts of guarantee are distinguished from contracts of indemnity ordinarily so called by the fact that a guarantee is a collateral contract to answer for the default of another person, and thus is a contract that is ancillary or subsidiary to another contract, whereas an indemnity is a contract by which the promisor undertakes an original and independent obligation.

The difference between these two types of contract was also dealt with by the Court of Appeal in England in Western Credit Ltd v Alberry, [1964] 2 All ER 938. The Holder case and the McLaws case can therefore be distin-

guished from the case at bar on two grounds: the fact that they dealt with true guarantees as opposed to what is essentially a contract of additional indemnity but mainly, and above all, on the grounds that they dealt with the payments made as compensation for the capital sums lent, from the standpoint of the payor as opposed to the payee. In the McLaws case for instance, the decision turned on whether the payment made by the taxpayer should be charged to income account or capital account.

I could find nothing in the ordinary definitions of interest which would make it essential that the compensation for money lent where it otherwise meets the criteria of interest, be paid by the borrower in order for the payment to qualify as interest. On the contrary, an ordinary person, offering to act as a guarantor would simply say to the proposed lender: “If *X‘ (the borrower) does not pay the interest, I will pay it”. He would think of using no other expression. In the case at bar, should any of the debtors at any time have paid no interest because no profits had been realized and should the third party then have paid pursuant to his contract of indemnity, then I would have had no hesitation in finding that such a receipt would be considered as income in the hands of the defendant and that, since the amount was calculated on a percentage of a capital sum loaned and also proportionately to the length of time that the capital sum remained outstanding, it could only be defined as interest in the hands of the defendant. As previously found by me, the contracts of indemnity or guarantee formed in each case an integral or essential part of and a condition sine qua non of the loan. As the bonds were issued pursuant thereto, the latter cannot be considered independently of the undertaking of the third party. One must consider the true substance of the transaction as opposed to its mere form. The fact that the guarantees in certain cases were contained in seprate documents does not in any way affect the result. I find that, as part and parcel of the whole scheme, the receipt of interest for the money lent is absolutely guaranteed to the lender, the bonds do not qualify as income bonds.

In the circumstances of the present case, interest provided for in the collateral agreement is, as between the parties to the whole transaction, to be considered as interest payable under the whole transaction with the guarantor being considered as included in the transaction. The payment of interest even when provided for only in the collateral agreement, is, in so far as the payee is concerned, to be considered as interest provided for in the bond or in the trust agreement, since the execution of the agreement is a condition sina qua non of the existence of the whole transaction. I can see no difference in the case at bar from a situation where the bond itself would contain the text of the absolute guarantee of payment and name the third party undertaking to pay. Such a bond would not, in my view, qualify as an income bond as defined in paragraph 139(1 )(t). It is true that where the guarantee Is entirely contained in the collateral agreement, which is not referred to in any way in the bonds or in the trust deed, and where the bonds are subsequently sold to a third party, without the absolute guarantee being assigned, then, in the hands of that third party the same bonds would, in all probability, qualify as income bonds since that particular holder or payee could no longer be assured of receiving interest in the event of the principal debtor not realizing sufficient profits. Similarly, if the text of the bonds and of the trust agreement were to conform strictly to the provisions of the Act regarding income bonds and if there were no guarantor but, by separate collateral agreement the principal debtor were to undertake directly with the bond holder and not through the trustee, to pay interest in any event, then surely the bonds could not be considered as income bonds as long as that collateral agreement remained enforceable, notwithstanding the fact that the bonds themselves are expressed to be payable only when the debtor has made a profit.

On this issue the finding of the Tax Review Board will therefore be set aside and the original assessment confirmed.

I turn next to the issues raised by the defendant in its counterclaim as to gains realized from the disposition of certain shares, options and mortgage bonds which were declared to be taxable as ordinary income by both the Minister and the Tax Review Board.

The transactions involved were the following:

The evidence established that RoyNat provided term financing, that is 3 to 10 years, for small and medium sized businesses. The loans averaged approximately $250,000. It was also engaged in the financing of equipment through leasing or rent-purchase agreements. As part and parcel of its various lending transactions in certain cases it acquired bonus shares and options to purchase shares. In one case, that is, Canadian Fiberform Ltd, it claims to have paid fair value for the shares obtained.

Counsel for the defendant readily admits that it has been firmly established by jurisprudence that, where assets other than shares have been acquired as a bonus when loans are made, those assets are treated as ordinary income from every standpoint, since they are considered as gains made in the course of the taxpayer’s business. But he also argues that in none of the cases where the assets shares or other forms of investments and that these should be treated differently because where shares are concerned, taxpayers are fully taxable on the profits made on resale only if trading in shares or if the transaction is found to be an adventure in the nature of trade. His argument is also founded on the allegations that in the case at bar, there was no element of speculation in the enterprise and also that the distinction betwen shares and other assets lies not only in the nature of the assets but also on the fact that, while RoyNat acquired the shares in question in relation with its financing business, the disposition of same had nothing to do with the financing business.

The facts are really uncontested, the plaintiff having called no witnesses at trial and both parties having agreed to rely on certain documentary evidence produced as exhibits at trial and the oral testimony of the Vice- President of Investments of the defendant given before the Tax Review Board as well as the exhibits filed at the hearing. I arrived at the following findings of fact from the evidence adduced:

1. The subject loans in issue were made in the regular course of the taxpayer’s business as a money lender but represented only a small part of its overall activities. Selective equity investments amount to approximately 1% of its total business.

2. The great majority of companies involved were private companies owned and controlled by not more than three individuals.

3. RoyNat did not participate in the actual management of the companies in which it made investments nor did it have representatives on their boards of directors. It also appears that the shares or options were eventually disposed of at the request of the borrowers and not at the insistence of RoyNat.

4. At first the bonuses consisted entirely of shares. Later, options to buy shares were taken and, finally, combinations of both shares and options to purchase shares were requested as bonuses.

5. Bonus shares or options were obtained in addition to interest where the risk was considered as above average. If the bonus had not been granted the interest required on the loans would have been one-quarter percent and one-half percent higher. The defendant never financed by means of equity alone.

6. The bonuses were always requested by the defendant and not offered by the borrowers, and were made a condition sine qua non of the financing.

7. Neither the shares nor the options could have been obtained by the defendant were it not for the financing.

8. RoyNat obviously intended to make a profit from the eventual disposition of shares, generally after a careful analysis of the financial stituation of the company and did not expect any dividends to be paid on the shares nor, in fact, were any dividends received.

9. RoyNat had the required expertise to determine whether there would be a likelihood of a profit before requesting the bonus in shares or options. It also considered the return on the shares as part of the profits. (Refer to internal memo filed as Exhibit P I, Tab F).

10. The evidence as to when the shares or options were eventually disposed of does not appear to support the argument advanced by the defendant to the effect that RoyNat was looking to the investments over a long term period of 5 to 8 years, after which dividends would be obtained. The shares or options were disposed of without any dividends having been paid after the following periods:

On the question of when a particular transaction is an adventure in the nature of trade, counsel for the defendant quoted from the Supreme Court of Canada case of Irrigation Industries Limited v MNR, [1962] SCR 346; [1962] CTC 215; 62 DTC 1131, where Martland, J, after citing cases where it was held that the nature and quantity of property purchased and sold qualified the transaction as an adventure in the nature of trade, distinguished corporate shares from ordinary property in the following terms:

Corporate shares are in a different position because they constitute something the purchase of which is, in itself, an investment. They are not in themselves, articles of commerce, but represent an interest in a corporation which is itself created for the purpose of doing business. Their acquisition is a well-recognized method of investing capital in a business enterprise.

It is perhaps worthy to note here that this case involved one isolated transaction. Counsel also referred to the statement of Noel, J, as he then was, in Foreign Power Securities Corporation Ltd v MNR, [1966] Ex CR 358; [1966] CTC 23; 66 DTC 5012, after quoting the above passage from the Irrigation Industries case, supra, stated:

The short period during which these securities were held by the appellant can be of little assistance to the respondent as their fast disposal was properly explained by Mr Wert in that the directors of the appellant would have been remiss in their duties had they not taken advantage of the surprisingly high rise of the market at the time the securities were sold. The fact that the appellant entered into these transactions for the purpose of making a profit as soon as it could and took advantage of this rise as soon as it occurred, should not either change the nature of its investments if this is what they were and render them taxable as trading receipts and this also would appear from the remarks of Martland J at p 355 of the same decision:

The only test which was applied in the present case was whether the appellant entered into the transaction with the intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so doing. Is that a sufficient test for determining whether or not this transaction constitutes an adventure in the nature of trade? I do not think that, standing alone, it is sufficient.

The decision of Noel J was upheld on appeal before the Supreme Court of Canada in MNR v Foreign Power Securities Corporation Limited, [1967] _ SCR 295; [1967] CTC 116; 67 DTC 5084.

Counsel also cited from Thorson, P’s judgment in the well-known case of MNP v James A Taylor, [1956] CTC 189; 56 DTC 1125, regarding some of the criteria to be taken into consideration when deciding whether a particular transaction constitutes an adventure in the nature of trade. He also pointed out, as a reason for distinguishing it, that the case concerned the purchase of lead, that is, a commodity, as opposed to the purchase of shares.

The defendant also relied on the statement of the Master of the Rolls in Lomas (H M Inspector of Taxes) v Peter Dixon & Son Ltd, 25 TC 353, where the latter stated at 363 of the report:

The position is more complicated when A lends £100 to B at a reasonable commercial rate of interest and stipulated for payment of £120 at the maturity of the loan. In such a case it may well be that A requires payment of the £20 as compensation for the capital risk; or it may merely be deferred interest. If it be proved that the former was the case by evidence of what took place during the negotiations, it is difficult to see on what principle the £20 ought to be treated as income. In the absence of such proof, what inference ought to be drawn? Something may, perhaps, depend on the length of time for which the money is lent. If the period is short it is perhaps easier to treat the £20 as deferred interest.

I refer to these problems, not for the purpose of attempting to solve them, but in order to show that there can be no general rule that any sum which a lender receives over and above the amount which he lends ought to be treated as income. Each case must, in my opinion, depend on its own facts and evidence dehors the contract must always be admissible in order to explain what the contract itself usually disregards, namely, the quality which ought to be attributed to the sum in question.

I cannot say that I agree with the statement if unqualified, as it is much too broad: a bonus is always taxable when it is obtained as part and parcel of the operation of the taxpayer’s regular business or as part of an adventure in the nature of trade.

The judgment of Heald, J, in this Court, in Canada Permanent Mortgage Corporation v MNR, [1971] CTC 694; 71 DTC 5409 was also relied upon by the defendant. In that case, however, as opposed to the case at bar, there was a clear finding of fact on the part of Heald, J to the effect that the taxpayer was interested in the returns on the stocks rather than gains on their re-sale and that the stocks were purchased and held for their dividend income.

Jackett, P, as he then was, in the Exchequer case of Associated Investors of Canada Limited v MNR, [1967] CTC 138; 67 DTC 5096, had this observation to make as to when an operation is to be included in the profits of a business:

It was not argued that a loss could not be taken into account in computing profit unless it arose from an operation or transaction calculated or intended to produce a profit. It is clear that such a contention could not succeed. A profit arising from an operation or transaction that is an integral part of the current profit-making activities must be included in the profits from the business. See MNR v Independence Founders Limited [1953] SCR 389 [53 DTC 1171] and the foreign exchange cases such as Tip Top Tailors Limited v MNR, [1957] SCR 703; [57 DTC 1232].

The case did not relate to shares and the observation is obiter dictum, but it remains nevertheless valid as a general statement of the law. Similarly, Thurlow, J, as he then was, in Stuyvesant-North Limited v MNP, [1958] CTC 154; 58 DTC 1092, had this to say regarding share options acquired by the taxpayer as a bonus:

For, even assuming that the rights were bonuses or premiums and were given and received to compensate for the capital risks involved in making the two loans and could, on that account, be regarded as capital if the loans were mere investments, such bonuses or premiums could not be so regarded if they were obtained in the course of the operation of the appellant’s business. This distinction is clearly expressed in Californian Copper Syndicate v Harris, 5 TC 159, where the Lord Justice Clerk said at p 165:

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 West Coast Parts Co Ltd v MNP, [1964] CTC 519; 64 DTC 5316, my brother Cattanach, J after quoting that approval from the Taylor case, supra had this comment to make:

There can be no dobut that a money lender who advances money in the course of an established business on terms whereby he charges interest as such plus a fixed amount determined by reference to the special risk involved, would count as profits from his “trade” not only the interest collected as such, but the additional amounts charged by reason of special risks. If it be true that such an amount is a profit from a money lender’s trade, it follows, in my view, that, when a person who is not a money lender enters into such a contract and thus embarks on an adventure in the nature of the money lender’s trade and earns a similar profit, he acquired a profit from an adventure in the nature of trade.

In the case at bar it seems obvious that the profits arose from operations or dealings which constituted an integral part of the profit-making activities of the defendant. The bonus shares or options were, in the course of the operation of its business of lending money, required by the defendant as extra compensation for the additional risks involved in these cases; it intended to make a profit from the eventual disposition of the shares and did not expect dividends nor did it indeed receive any. The defendant has, in addition, failed to satisfy me that fair value was paid for the shares or options in any of the transactions in issue.

Under those circumstances and applying the principles outlined in the cases on which I have commented, it seems obvious that the counterclaim must fail and the finding of the Tax Review Board and of the Minister must be confirmed on this issue.

The plaintiff will be entitled to costs throughout.