Tax Court of Canada Judgments

Decision Information

Hayes v. The Queen

Court (s) Database	Tax Court of Canada Judgments
Date	2003-09-09
Neutral citation	2003 TCC 93
File numbers	96-2573(IT)G
Judges and Taxing Officers	Campbell J. Miller
Subjects	Income Tax Act

Decision Content

Docket: 96-2573(IT)G

BETWEEN:

PAT HAYES,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

______________________________________________________________________

Appeals heard on common evidence with the appeals of Philip Hayes (96-2737(IT)G), (99-2414(IT)G), Stephen Stephens (97-653(IT)G), (97-749(IT)G), Gordon Rezek

(98-806(IT)G) and Muriel Scott (98-2507(IT)G) on October 28, 29, 30, 31, and November 4, 5, 6, 7, 18, 19, 20, 21, 25, 26, 27, 2002, at Toronto, Ontario, by

The Honourable Justice Campbell J. Miller
	Appearances:
	Counsel for the Appellant:	Geoffrey B. Shaw and Stevan Novoselac
	Counsel for the Respondent:	Henry Gluch, David Chodikoff and James Rhodes

___________________________________________________________________

JUDGMENT

The appeals from assessments of tax made under the Income Tax Act for the 1992 and 1993 taxation years are allowed, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the Schedules attached hereto.

The appeal from the assessment of tax made under the Act for the 1989 taxation year is dismissed as the application of the conclusions set out in the Reasons for Judgment herein would result in a greater tax liability than that assessed to the Appellant, as outlined on the Schedule attached hereto.

Page: 2

The Respondent is granted 75 per cent of the costs calculated in accordance with the Tariff.

Signed at Ottawa, Canada, this 9th day of September, 2003.

"Campbell J. Miller"

Miller J.

	Last Assessment	Court Decision
	152(7)
Patricia Hayes	Patricia	Patricia
	1989	1989

Employment	20,165.14	20,165.14

Dividend Income:
Abitibi
Alcan
Gulf
Placer
Trilon
Westar
Comp Dividends:
Abitibi
Alcan
Gulf
Hees
Laidlaw		(0.12)
Placer
Trilon
Westcoast
Unknown
Total dividends		-
Gross up @ 1.25		-

Interest Income:
TD Bank		352.27
Mutual Life
State Farm
Merrill Lynch		879.33
Dominion Sec

Other Income		4,528.00

Business Income (Loss):
Consulting
Haylon Inc
Securities:
Westcoast
Alcan

Total Income	20,165.14	25,924.74

	Last Assessment	Court Decision
	152(7)
Patricia Hayes	Patricia	Patricia
	1989	1989
Total Income	20,165.14	25,924.74

Carrying Charges:
Rental Fees:
Hees
Westcoast
Trilon		(600.00)
Dividends Paid:
Abitibi
Alcan
Gulf
Hees
Laidlaw		(0.12)
Placer
Trilon
Management Fee
Accounting Fee		(480.00)

Net Income	20,165.14	24,844.62

Non capital losses

Taxable Income	20,165.14	24,844.62

Non Refundable Tax Credits

Personal	(6,066.00)	(6,066.00)
Married
CPP	(366.77)	(366.77)
UI	(393.22)	(393.22)

	(6,825.99)	(6,825.99)

x 17%	(1,160.42)	(1,160.42)

	Last Assessment	Court
	152(7)	Decision
Pat Hayes	Patricia	Patricia
	1992	1992
Employment	17,405.00	17,405.00

Dividend Income:
Abitibi
Alcan
Gulf
Placer
Trilon
Comp Dividends:
Abitibi
Alcan
Gulf
Dofasco
Laidlaw		(0.16)
Placer
Trilon
Total dividends
Gross up @ 1.25
Interest Income:
TD Bank	1,869.41	2,078.54
Mutual Life
Can Life Ass
T452 Refund Ind	28.59	28.59
Ivaco - WG
Wood Gundy
Dominion Sec
Taxable Capital Gains (Allowable Capital Losses):
Abitibi
Gulf
Business Income (Loss):
Securities:
Walker
Abitibi
Total Income	19,303.00	19,512.13
Carrying Charges:
Rental Fees:
Trilon		(600.00)
Dofasco
Accounting Fee
Accounting Fee- Paid in 1992		(963.00)

Net Income	19,303.00	17,949.13
Non capital losses
Capital gains ded.

Taxable Income	19,303.00	17,949.13

Non Refundable Tax Credits

	Last Assessment	Court
	152(7)	Decision
Pat Hayes	Patricia	Patricia
	1992	1992

Personal	(6,456.00)	(6,456.00)
Married
CPP	(340.76)	(340.76)
UI	(518.25)	(518.25)

	(7,315.01)	(7,315.01)

x 17%	(1,243.55)	(1,243.55)

	Last Assessment	Court Decision
	152(7)
Patricia Hayes	Patricia	Patricia
	1993	1993

Employment	20,662.00	20,662.00

Dividend Income:
Alcan
Placer
Trilon
Comp Dividends:
Alcan
Laidlaw		(0.16)
Placer
Trilon
Total dividends		-
Gross up @ 1.25		-
Interest Income:
TD Bank	1,360.00	1,486.29
Mutual Life
T Bill
First Marathon
Ivaco
Wood Gundy
Dominion Sec

Business Income (Loss):
Securities:
Unknown
Mark to Mkt 10(1)
FMV Adjustment

Total Income	22,022.00	22,148.29

Carrying Charges:
Interest Paid:
Horsham 20(14)
First Marathon		(172.16)
Merrill Lynch
Rental Fees:
Trilon		(600.00)
Dofasco

Net Income	22,022.00	21,376.13

Non capital losses

Taxable Income	22,022.00	21,376.13

Non Refundable Tax Credits

	Last Assessment	Court Decision
	152(7)
Patricia Hayes	Patricia	Patricia
	1993	1993

Personal	(6,456.00)	(6,456.00)
CPP	(432.37)	(432.37)
UI	(619.86)	(619.86)

	(7,508.23)	(7,508.23)

x 17%	(1,276.40)	(1,276.40)

Citation: 2003TCC93

Date: 20030909

Docket: 96-2573(IT)G, 96-2737(IT)G,

97-653(IT)G, 97-749(IT)G, 98-806(IT)G

98-2507(IT)G, 99-2414(IT)G

BETWEEN:

PAT HAYES, PHILIP HAYES, STEPHEN STEPHENS, GORDON REZEK, AND MURIEL SCOTT

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Miller J.

[1] In the early-1980s to the mid-1990s, a number of people in southern Ontario became involved in a form of investment known as convertible hedging. A common fact in their involvement was that they received advice from Maguire & Associates, a business engaged in financial and tax consulting. The Appellants, who had varying degrees of understanding of this complex investment strategy, were led to believe the strategy was a win-win situation. They understood this meant they would win from the cash flow generated by the strategy and from an increase in the value of their investment, and also from tax refunds if they incurred losses. These cases are about the tax treatment to be afforded these convertible hedge strategies.

[2] At the outset, I should mention that the conundrum in applying tax principles to the financially innovative strategy of convertible hedging is that tax laws have not necessarily kept apace with the ingenuity of the financial community. It is therefore appropriate, when viewing the transactions through the tax looking glass, that the focus not be so finely adjusted as to preclude a broad, common sense, but equally innovative, approach to the application of our tax laws. A square peg does fit in a round hole if the round hole is big enough.

[3] While normally I prefer delineating the issues at the outset, in this case, I believe it would be beneficial to appreciate the nature of the transactions and the particular circumstances of each Appellant before more explicitly setting forth the issues. I intend, therefore, to organize this decision in the following manner. I will first set out the mechanics of a convertible hedge based primarily on the expert evidence of Professor Eric Kirzner and Mr. Richard Norman Croft, as well as on information gleaned from one of the Maguire consultants, Mr. Harry Johannes Sildva. This will clarify not just the concept of a hedge, but also the concepts of margin requirements and the mark to market approach to valuing a portfolio. I will go over a couple of actual hedging transactions. It is unnecessary to illustrate every hedge of every Appellant, though I did hear evidence of all of them. I will review each Appellant's situation relying primarily on their own evidence. The issues and my findings can then be presented in a manner which flows from this background and review.

[4] The nature of the issues has shifted somewhat over the many months and years these appeals have been in the system. This has resulted in consequential changes in the tax positions proposed by each side, from the positions taken at the time of the original assessments. I am satisfied that none of these changes have resulted in the Respondent attempting to increase any assessment. However, the changes have led to an Appellant proposing to bring a greater amount into income in a particular year than is proposed by the Respondent. In such a situation, the Appellant would be prepared to have that appeal dismissed.

Background on convertible hedging

[5] The Appellants presented two experts: Professor Kirzner, in the area of corporate and investment finance, and Mr. Croft, in the area of investment counselling and portfolio management, specifically as pertaining to convertible hedges. It is primarily from these experts that I intend to paint a general picture of the strategy developed by Mr. Maguire.

[6] The convertible hedge consists of two positions, a short position and a long position. The short position is the sale of common stock of a security with borrowed stock. While this is an awkward concept for the legally trained to get a grip on, it is an acceptable means in the financial marketplace for facilitating short sales. The brokerage house holds common stock for its clients in street name; such shares are not identified as being held by any particular customer. So, when an investor wishes to sell short, the broker uses that source of common stock held in street form to make a sale for its client. This is what is meant by the client "borrowing stock" to sell. The client has an obligation to cover that short position, or in other words, to return the stock at some point in the future. The advantage of this arrangement, in a convertible hedge, is that the investor can use the proceeds from that short sale to finance a long acquisition, and consequently to earn income, for example, on a dividend from a form of preferred share.

[7] This leads to the second aspect of the convertible hedge - the acquisition of the long position. This refers to the purchase by the investor of a security convertible into the same security sold short. If the convertible security is convertible into exactly the same number of shares sold short, this is considered a fully hedged position or a one-to-one position. This does not necessarily mean the convertible security is convertible on a one-to-one basis as the conversion rate may vary. For example, a short sale of 10,000 shares may be fully hedged by a purchase of 5,000 convertible preferred shares, convertible on a two-for-one basis.

[8] There are a number of types of convertible securities available in the convertible hedge strategy: convertible preferred shares, convertible debentures, warrants and rights. The key similarity is that they all have two elements attached to them: first, an option on the underlying security, and second, an ability to earn income. For example, on a convertible debenture, there is both the option to convert into common stock and an interest-producing feature. With a convertible preferred share, again an option to convert combined with the income-producing feature of the preferred dividend. With a warrant or right, the income-producing feature is the interest from a treasury bill acquired with the funds from the short sale of the underlying stock.

[9] The costs involved in a convertible hedge (or frictions, as Professor Kirzner called them) are the rental fee on the borrowed stock sold short, compensatory dividends on the borrowed stock (this refers to any dividends on the borrowed stock for which the short seller must compensate the lender) and commissions or fees. There are two avenues for producing income or gains on the convertible hedge: the first, a positive cash flow, being the difference between the income (interest or dividends) on the one hand, and the costs just described on the other; second, the increase in value of the convertible hedge itself arising from the market direction. In a downward market, that is the underlying stock is falling in value, the convertible hedge will gain. This is as a result of the underlying common stock falling faster than the convertible security, due to the characteristics of that convertible security. Neither of the experts referred to a tax refund from the potential deductibility of losses on the disposition of a short or long position as in any way forming part of the gain or income in a convertible hedge.

[10] The convertible hedge is commonly initiated through contingent orders. This means that the purchase of one security and sale of a separate security are contingent on both sides being executed at a limit price. The price is the difference between the value of the two securities. The securities cannot be identical to constitute a contingent order. The broker would accept contingent orders on a best efforts basis, so that if the broker is unable to put the entire position in place in one fell swoop, it is still acceptable to put something less in place as long as it still meets the price requirements. This is distinguishable from an all or nothing direction to a broker, where no part of a position can be put in place unless it all can be put in place; this would be a less likely approach. One reason a broker cannot fully complete a position is because the stock being sold short does not meet the up-tick rule. This rule, imposed by all exchanges, requires that if you are going to sell a stock short, the last sale price of the stock has to be higher than the next to last sale. In other words you can only sell short in an upward swing. If the broker cannot fill the position at once, then the position may be legged in; that is, put in place in portions over time. Mr. Croft went through an example involving Mr. Hayes legging in on his Trilon hedge.

[11] There was considerable testimony of risk in a convertible hedge. Clearly, neither the broker nor investor wants to be exposed, and indeed a convertible hedge strategy minimizes exposure in relation to the value of the underlying common stock. Although, as Mr. Croft indicated, the risk to the investor, though seemingly low, is not. This is because the entire amount of the actual outlay of a few thousand dollars, for a hedge position involving stock valued significantly higher, is at risk. For example, Mr. Rezek made a $3,000 payment for a short sale of Laidlaw common stock of approximately $613,000 and a long purchase of Laidlaw convertible preferred of approximately $616,000. His maximum amount at risk was his $3,000, his whole investment, ignoring for the time being the impact of a positive cash flow from the convertible hedge.

[12] Returning then to a convertible hedge that is legged in, this necessarily means that there will be times when the investor is in a naked position; that is, one side or other of the hedge is not fully covered. Professor Kirzner referred to this as a temporal risk. If any event occurred during that period that significantly impacted that stock, the result could be much greater than simply the outlay of the investor. Professor Kirzner indicated that time does not affect the degree of risk, as the unforeseen event can occur at any time. However, the exposure to the risk obviously is greater the longer a naked position is held. I was referred to no examples in the situations before me of any unforeseen event occurring, and indeed Professor Kirzner could only think of a couple of cases in the last forty or fifty years when there had been a short squeeze, one of the events which might expose an investor in a convertible hedge to risk.

[13] One cannot discuss risk in these investments without understanding the mechanics of margin requirements. Rules with respect to margin requirements are set by the Investment Dealers Association and stock exchanges, and are also subject to the review of the Securities Commission. Margin is akin to a secured loan. The broker allows the investor to borrow from the broker part of the cost of the investment to support a purchase. This is usually done by the broker providing a debit balance in the investor's account. The margin requirements ensure that the broker's capital is protected. Short positions are always margined. The general margin requirement in a short position is for the investor to have 150 per cent of the market value of the underlying stock sold short in the investor's account. So, for example, if an investor sells 1,000 Alcan shares short at $8 a share ($8,000 proceeds) he needs to supply an additional $4,000 cash to meet the 150 per cent margin requirement. If the share price drops to $5 a share, requiring margin of only $7,500, instead of the initial $12,000 requirement, the investor could withdraw $4,500 from the account. Normally the short positions are marked to market daily for purposes of ensuring compliance with these margin requirements. This simply means the brokers track the fair market value of the stock sold short on a daily basis.

[14] In the acquisition of a long position, the margin rules permit financing of 50 per cent, so again using the 1,000 Alcan shares at $8, the investor need only provide a cheque for $4,000. The investor has in his account stock valued at $8,000 plus a loan with the broker of $4,000 - the position is fully margined. Again, changes in the value of the stock would impact that margin requirement.

[15] When a short position and a long position are put together in a convertible hedge transaction, the combination takes on different characteristics vis-à-vis margin requirements. The margin requirements are much lower. If a short position is fully covered by the ownership of the underlying stock no additional margin is required. This is the same if the long position is held in another individual's account, if that other account has guaranteed the account of the investor who holds a short position. If an account is undermargined, the broker can make a margin call on the investor, looking to the investor to top up the account. Typically, this would not happen on a convertible hedge as the investor would always have put up the capital in the form of the convertible security to cover a worst case scenario.

[16] For the most part, this overview has concerned the convertible hedge where just one individual is involved. In many of the convertible hedges in these appeals, there is another party. That other party, a relative, has always provided a guarantee. In the event an investor disposes of one component of the convertible hedge, it is the guarantee that allows the broker to continue to not insist on the more stringent margin requirements just outlined. It is this facilitating of the margin requirement, combined with the broker permitting the client to use the proceeds on a short sale to acquire a convertible security that, according to Mr. Croft, makes the convertible hedge unique. Professor Kirzner referred to the other party (the 'Guarantors' or individually the "Guarantor' - Gloria Fahrngruber, Patricia Hayes, Terry Stephens and Patricia Scott) as holding naked positions; that is, not hedged positions, though he went on to acknowledge that if both parties were treated as a single entity the resulting position would be a convertible hedge. Further, Professor Kirzner confirmed Mr. Sildva's evidence that entering into transactions which result in the Guarantor stepping into the shoes of the investor on one side of the convertible hedge, were conducted to create a tax benefit. The tax benefit is the tax to be refunded on the deductibility of the loss created by the investor's disposition of one component of the convertible hedge.

[17] It is useful to go through the first example of the convertible hedge at this point, which is illustrated on Appendix "A" attached.

[18] This is a Laidlaw convertible hedge entered into by Gordon Rezek. In referring to the Appendix, the areas shaded in grey represent the resulting positions after transactions have taken place. On April 27, 1988, Mr. Rezek sold short 30,704 Laidlaw common shares and coincidently bought 10,100 Laidlaw preferred shares. On May 20, 1988, Mr. Rezek sold the 10,100 convertible preferred shares and Ms. Fahrngruber bought 10,100 Laidlaw convertible preferred shares. The result was that Mr. Rezek held a short position in Laidlaw commons and Ms. Fahrngruber held a long position in Laidlaw convertible preferreds, convertible into 37,709 commons. Viewing the components separately, Mr. Rezek's sale created a $138,431 loss in his account - the tax benefit Professor Kirzner alluded to. In August 1988, Ms. Fahrngruber then converted the convertible preferreds into 30,709 Laidlaw common shares (note that there was a five share discrepancy from what Mr. Rezek held, so Ms. Fahrngruber simply sold the five shares). This left Mr. Rezek and Ms. Fahrngruber in what was referred to as a common-common position. The experts agreed that taken together there was absolutely no economic benefit to this position. It was clear that a common-long/common-short position cannot be held in one account, as they would simply cancel each other out.

[19] Before getting into the evidence from each of the Appellants, it is useful to review the evidence from both a Maguire associate, Harry Sildva, and a broker who handled convertible hedges for Mr. Maguire, Peter W. McCrodon.

Evidence of Harry Sildva

[20] Mr. Harry Sildva's evidence was common to all appeals before me. He worked in Mr. Maguire's office from January 1986 to December 1989 and was able to provide details of how these convertible hedges were handled by Maguire & Associates. Mr. Sildva has an MBA from the University of Toronto as well as having completed a variety of specialized courses in public finance, public accounting, options and securities. At Maguire & Associates, he had advised clients on hedge opportunities and was instrumental in creating the form of reports provided by the Maguire office. It was Mr. Sildva who generated the cash flow projections for the various hedges recommended by Mr. Maguire. He described Mr. Maguire as providing the tax consulting side of hedges. Mr. Sildva handled the administrative side of the hedges as well as later becoming adept in finding opportunities, relying very much on his computer skills. In 1989, he went to Richardson Greenshields as a broker, taking some clients with him. In 1992, he joined First Marathon as a broker and continued to handle hedged positions as well as investment advice generally.

[21] Mr. Sildva's understanding of the convertible hedge strategy conforms to the explanation provided by the experts described earlier, although Mr. Sildva emphasized the advantages of the tax-cushioning effect on a loss on a short position. He viewed his clients as wanting to be aggressively involved in the market and wanting to reduce tax. On cross-examination, Mr. Sildva acknowledged that the strategy itself was not aggressive, but the crystallizing of the loss on the losing side was. Any further investment objectives he left for the brokers to discuss with the clients.

[22] Mr. Sildva recalled meeting with Mr. Rezek and discussing tax preparation, tax strategies and the convertible hedge market. He indicated he would have referred Mr. Rezek to a broker to open a hedge account. He acknowledged the use of the term "win/win" by which he meant making money in a downward market and having a positive cash flow with a tax cushion in an upward market.

[23] In going over Mr. Rezek's Laidlaw convertible hedge, Mr. Sildva acknowledged that he recommended to Mr. Rezek entering into cross-guarantees with Gloria Fahrngruber as it would allow him to crystallize a loss on one side of his hedge, which Mr. Sildva believed to be deductible on Mr. Rezek's tax return. As Mr. Sildva indicated, they were doing December year end tax planning early. He referred to this as an adventure in the nature of trade loss. Mr. Sildva acknowledged that the ability to get $138,000 tax deductible loss on just a few thousand dollars investment was one of the reasons he got into this industry.

[24] Mr. Sildva met with Gloria Fahrngruber and discussed the convertible hedging strategy and guarantees with her, indicating how the guarantees would enable the use of margin in each account to cover transactions in the other account. He also introduced her to a broker. In involving Gloria through her acquisition of a long position in Laidlaw and the provision of a guarantee, Mr. Sildva explained this left Mr. Rezek exposed on the short position; that is, speculating on the downside. Mr. Sildva suggested that Gloria, on the other hand, was speculating on the upside, without having to invest any money, because of the margin excess in Mr. Rezek's account. As Mr. Sildva stated:

... we have Client A and Client B. One of them will do well in a scenario. The other will do well in another scenario, and there can only be one of two scenarios that will unfold, if you were to look at a strict analysis of it.

So I would always have one happy customer.

[Transcript page 1278 lines 7-13]

[25] Mr. Sildva confirmed that Gloria was concerned about being taxed on dividends she could not access. He eventually took steps to close Gloria Fahrngruber's activity in the market as he sensed there might have been a change of heart. She only was involved in the one transaction - the Laidlaw convertible hedge.

[26] Although Ms. Fahrngruber did not enter any investments herself, in Mr. Rezek's other two hedges, Royal Bank and Westcoast, Mr. Sildva suggested that Ms. Fahrngruber's account may have been relied upon when Mr. Rezek's was undermarginalized.

[27] Mr. Sildva prepared Mr. Rezek's tax returns for 1988 and 1989. In the statement of business income and expenses in each year, Mr. Sildva indicated that the type of business was "speculation", claiming Mr. Rezek was engaged in an adventure in the nature of trade. In 1992, he recorded Mr. Rezek's gain on the disposition of part of his Laidlaw short position as a capital gain. Mr. Rezek's holdings were not shown in his tax returns as inventory. A copy of a subsection 39(4) election signed by Mr. Rezek for 1992 dated April 1993 was produced as an exhibit.

[28] Mr. Sildva's contact with Mr. Hayes was not while he was at Maguire's, but while he was a broker in 1993 with First Marathon. He handled transactions involving the Ivaco and Dofasco convertible hedge, though confirmed he only spoke to Mr. Hayes and never with Mrs. Hayes.

[29] He also confirmed that he prepared the synopses of convertible hedges which Maguire & Associates sent to its clients. A synopsis would provide the following information:

- description of short position with price;

- description of long position with price;

- conversion ratio;

- hedge fee;

- commission;

- treasury bill yield if applicable ;

- spread; and

- multi-month cash flow projection.

For example, on the Laidlaw hedge, Mr. Sildva's projections indicated that for an investment of $8,349 to acquire the Laidlaw short and long position, the investment would yield a cash flow return over eight months of $6,190, or approximately a 75 per cent return on investment. These synopses were normally sent to the investor along with a cover letter from Maguire & Associates which read as follows:[1]

The attached synopsis summarizes your recently transacted trade in the Laidlaw Transport B convertible hedge, and forecasts the cash flow to be generated by the trade on the assumption that the position is maintained and the income and expense parameters do not substantially vary. We will, of course, be looking for profitable opportunities to unwind this position as soon as conditions are favourable to doing so.

I trust you find this of some value and the annexed tax-deductible invoice #20858 to your satisfaction.

There was evidence that all Appellants, except Mrs. Hayes, received such letters from Maguire & Associates.

[30] Mr. Sildva also emphasized that the conversion feature was critical:

A. The convertibility feature is everything in this case.

Q. Is critical?

A. Yes, because that affects the marginability of the account, and once it passes, then the margin changes drastically.

Q. You don't have a hedge?

A. Exactly.

[Transcript page 1383, lines 18 to 25]

Evidence of Mr. McCrodon, the broker

[31] Turning to Mr. McCrodon, although he had limited contact with the Appellants, having handled only one hedge for each of the Hayes, a transfer of accounts for Mrs. Scott, and opening accounts for the Stephens, he had handled many other Maguire convertible hedges during the years under appeal. Mr. McCrodon worked as a broker for Nesbitt Thomson from 1979 to 1989. He indicated that 90 per cent of his revenue during the years 1983 through 1989 came from Mr. Maguire's convertible hedging clients.

[32] Mr. McCrodon's usual practice with Maguire clients was to receive advice from Mr. Maguire to set up an account for a new client. Most of Mr. McCrodon's contact with the client was by phone or mail. Whenever he executed a trade, he would send a duplicate copy of the transaction to Mr. Maguire. The hedges would be initiated either by Mr. McCrodon suggesting certain hedges to Mr. Maguire within parameters determined by Mr. Maguire, or by Mr. Maguire contacting Mr. McCrodon to see if he could accommodate hedges identified by Mr. Maguire. As Mr. McCrodon handled more of these he was able to track their potential viability.

[33] Mr. McCrodon went through the hedge he handled for the Hayes which is outlined in Appendix "B". This is the second hedge I wish to describe.

[34] Mr. McCrodon described the opening position of Mr. and Mrs. Hayes as follows:

Q. Looking at these two statements here, can you tell me whether this is something that you would have done as a convertible hedge?

A. Yes. It looks like it, because they're for the same month end, to start with. One of them has a long position in Hiram Walker Resources, 8½ percent debenture, which is a convertible debenture, with a large debit in the - in the account as a net balance.

And the other - the other account has a short position in Hiram Walker Resources common shares, with a large credit in the account.

And since these are offsetting positions, convertible to common, I would identify it as a convertible hedge.

Q. Now, you also have in front of you document 2.3. And 2.3 is a document which simply summarizes a lot of the information contained in the broker statements.

In the middle portion under Philip Hayes' account is the activity in Mr. Hayes' account and in the right-hand portion, under Patsy Hayes' account, is the activity in her account.

Do you see that, sir?

A. Yes, I do.

Q. So when we look at the first two unshaded lines under 30th July of 1985, you see that those are the two trades that you've just been looking at in the broker statements?

A. Yes, I do

Q. Now, can you explain to us how this would have been initiated?

A. It would have been initiated like any other convertible hedge. We would have determined that the Hiram Walker Resources debenture was at an attractive premium relative to the common shares and that it would make a good convertible hedge candidate. And then we would have proceeded to establish the long position with an offsetting short position.

Q. We've heard the expression, contingent orders. Are you familiar with that?

A. Yes.

Q. And can you tell me how or whether they apply to these circumstances?

A. I can't remember exactly in this circumstance if we used a contingent order. My practice was to do so whenever possible, because it limits the risk in the trade.

There are circumstances where you can't use a contingent order, because the long position might be a new issue position, for example. And you know, you may know the price, but you may have had to make a commitment to it before you actually were in receipt of it and were able to short sale the common against it.

I don't know what the specific circumstances here were, but most of the time we were able to put in a contingent order.

[Transcript page 2114, line 18, to page 2116, line 23]

[35] Mr. McCrodon also stated that in initiating a hedge, the two tickets for a buy and sell would be sent to the trading desk clipped together with an indication of the amount of spread. He explained that in August the warrants in the Hayes' convertible hedge were stripped from the debenture to be traded separately but the position remained fully hedged. From February 11 to February 18, he described the Hayes' transactions as replacing the debenture and warrants position with a convertible preferred share position, remaining as of February 18 in a fully hedged position. On April 22, 1986, Mr. McCrodon put through a cross-order, that is, a single transaction from the same firm, for Philip Hayes to buy 4,650 commons to cover his short position and for Patricia Hayes to sell 4,650 commons. This was done at market price. On April 30, Philip Hayes traded his convertible preferreds for 4,650 common shares. At this point, the Hayes held offsetting positions in a common-common manner.

Evidence of Gordon and Gloria Rezek

[36] Mr. Rezek worked as a sales representative for 27 years, a job he was doing in the years under appeal, 1988 and 1989. In 1987, Mr. Rezek met Gloria Fahrngruber. By late spring of 1988, Ms. Fahrngruber and Mr. Rezek moved in together in Mr. Rezek's home. Ms. Fahrngruber paid Mr. Rezek $500 a month rent, representing approximately one-third of the household costs. In 1992, Mr. Rezek sold the home and they moved into a new home, carrying on the same arrangement until February 1993 when they were married. For the years 1988 to 1992, Mr. Rezek and Ms. Fahrngruber held no joint bank accounts, no assets jointly, transferred no property between themselves, each had their own car, had their own phone line and on vacation shared the costs.

[37] In 1987, Mr. Rezek became aware, through a fellow employee, Mr. Larry Hillman, of a financial advisor, Mr. Harry Sildva. Mr. Rezek met with Mr. Sildva to find out more about making money. From his meeting with Mr. Sildva he believed there was a form of win-win investment strategy. By this he meant he would earn income, receive a tax benefit or both. This was the extent of Mr. Rezek's understanding of the investment strategy. He had a high school education and had no familiarity with the financial investment environment.

[38] Mr. Rezek believed he could enter the market with as little as a $3,000 investment. He understood that he was required to open a broker account, which he did with Walwyn Stodgell in the spring of 1988. Mr. Sildva made all the arrangements. At that time, May 3, 1988, there was no one else authorized on the account nor any Guarantor of Mr. Rezek's account.

[39] On April 27, 1988, Mr. Rezek, through the auspices of Mr. Sildva, made two transactions for which he paid, again through Mr. Sildva, $3,000; he sold short 30,704 Laidlaw common shares for $612,925 and coincidentally bought 10,100 Laidlaw convertible preferred shares for $615,506. This is the convertible hedge described earlier in the background of convertible hedges. Mr. Rezek entered into these transactions without any discussion with Ms. Fahrngruber. He believed these transactions represented the win-win situation. He did not understand what a short sale was nor how a convertible hedge worked. His intent, as he put it, was simply to make money. He paid a $600 commission on these transactions.

[40] Subsequent to these transactions, he did discuss with Ms. Fahrngruber the possibility of her guaranteeing his account. This was on the recommendation of Mr. Sildva, as it would allow for greater investment opportunities. Having heard of Mr. Sildva from Mr. Rezek and Mr. Hillman, and upon the encouragement of Mr. Rezek, Ms. Fahrngruber contacted Mr. Sildva and arranged to meet him, which she did in May 1988. She came away from that meeting also with the impression that she could be in a win-win situation - make money and save taxes. She was advised by Mr. Sildva to open an account with Walwyn which she did on May 17, 1988, after having checked on both Maguire and Sildva through the Better Business Bureau and Ontario Securities Commission. On May 17, she signed a form opening her account. At the same time, both she and Mr. Rezek signed guarantees, guaranteeing to the broker each other's account. Neither Mr. Rezek nor Ms. Fahrngruber had a detailed understanding of the nature of the guarantee. Ms. Fahrngruber signed it on the advice of Mr. Sildva that it would allow her greater investment opportunities.

[41] On May 20, Mr. Rezek sold his 10,100 Laidlaw preferreds for $477,075. He did not discuss this with Ms. Fahrngruber. This resulted in a loss on the disposition as described earlier of $138,000, which Mr. Rezek claimed on his 1988 tax return, resulting in a tax refund of approximately $80,000 received in early 1990. Mr. Rezek confessed to not appreciating the tax intricacies of the situation. He had his return prepared by Mr. Sildva. At this point, in May 1988 Mr. Rezek held only a short position in Laidlaw. Although he sold preferreds for $477,075, he understood he could not take the funds out of his account because as he put it "Gloria's account offset that".

[42] On May 20, Gloria Fahrngruber acquired 10,100 Laidlaw convertible preferred shares. She did not put up any money for this investment but indicated her understanding was that she could do so because of her guarantee. Upon receipt of a statement, she realized she owed $477,375 for the shares. This was all being arranged by Mr. Sildva. In August 1988, Ms. Fahrngruber converted the preferred shares to common shares. She also sold five shares but had no idea why. She left everything to Mr. Sildva.

[43] Mr. Rezek acknowledged that he had been made aware of the risks from a review of risks set out in the broker's hedge agreement. The risks were identified as follows:[2]

⁰ Contingent orders can only be taken on a best efforts basis. There may be liquidating problems.

⁰ Forced conversions may result in lost premiums. Forced buy-backs will result in further commission charges.

⁰ Supply of shares can be affected by a tender offer.

⁰ Conversions can take time and cause buy-ins on short positions while the security is being converted.

⁰ Dividends which will be charged for the short positions can be increased unexpectedly.

Mr. Rezek was led to believe these would never happen. Ms. Fahrngruber had a similar understanding.

[44] As a result of Ms. Fahrngruber's investment, she was subjected to tax on dividends on the Laidlaw convertible preferred shares. She expressed her displeasure to Mr. Rezek about the additional tax burden and requested that he reimburse her for any additional tax. She blamed him for getting into this Laidlaw investment which was only causing her an additional tax obligation. She was not able to access the dividends which were simply credited to her account, but never paid to her. Mr. Rezek consequently had Mr. Sildva's office determine how much more tax she was having to pay, and reimbursed her this amount.

[45] In November 1988, Ms. Fahrngruber signed an option account. The form indicated she was not involved in a partnership, she did not hold the account jointly with anyone and no one else had authority on the account. It also indicated that the account was exclusively for hedge trading.

[46] Mr. Rezek subsequently entered into two more convertible hedges involving Westcoast and Royal Bank stock but without any involvement of Ms. Fahrngruber. He did not know whether she was doing anything similar with such stock. In fact, she was not. She had no involvement with either the Westcoast or Royal Bank convertible hedge. The only stock she ever held was the long position in the Laidlaw securities. Mr. Rezek believed the Royal Bank and Westcoast convertible hedges were the same as the Laidlaw investment.

[47] When Mr. Sildva left Maguire to go to Richardson Greenshields, Mr. Rezek moved his account to that firm. In February 1992, Mr. Rezek acquired an additional 1,000 shares in Laidlaw stock. He had no idea why. At the same time, Ms. Fahrngruber sold 1,000 shares and likewise had no idea why. There was some discrepancy as to whether the next transaction took place in February 1995 or 1994 but at that time the Laidlaw shares were transferred from Ms. Fahrngruber to Mr. Rezek. There was no payment by Mr. Rezek for these shares. He did not understand why this was done but acknowledged the effect was to bring his account balance from a deficit position to a nil position. Ms. Fahrngruber's account was reduced by the corresponding amount. Ms. Fahrngruber testified that she had pressured Mr. Sildva to do something about her ongoing losing investment, as all she believed she was getting was an additional tax burden. There was no win-win.

[48] During the years 1988 to 1994, both Mr. Rezek and Ms. Fahrngruber had their tax returns completed by Mr. Sildva. Ms. Fahrngruber recalled being billed for that service, but could recall no other fees from Mr. Sildva. She indicated that she had no knowledge of Mr. Rezek's bills from Mr. Sildva. They were his business. She could not concern herself with Mr. Rezek's situation.

[49] My overall impression of Mr. Rezek and Ms. Fahrngruber is that they got into an investment strategy neither of them quite understood. They were naive. They wanted to make money and save taxes. They saw others doing it and they wanted to derive similar benefits. They took great pains to emphasize the independence of each other's investments to the point they both testified they barely discussed what they were doing in that regard.

[50] Mr. Rezek has two years under appeal, 1988 and 1989. His position in those years is that he acted independently from Ms. Fahrngruber, was entitled to losses arising from the disposition of one component of a convertible hedge and was entitled to mark to market inventory.

Evidence of Philip and Patricia Hayes

[51] Mr. Hayes was a machinist by trade but developed considerable expertise in computer applications in industry, to the point he not only offered sales and support services but actually made software programs. He also taught in this area to students and teachers alike. It was not until the late 1980s, however, that he went into business for himself as a part owner of a mould shop (Protech), which provided materials to the automotive industry. His annual income jumped considerably, once in his own business, from the $20,000 to $50,000 range while working for others throughout the 1970s and 1980s, to in excess of $200,000 annually from Protech.

[52] Mr. Hayes had a keen interest in investing. He started exploring the stock market in the late 1970s and read voraciously about mining stocks, penny stocks, warrants, options and the like. He took home-study courses through the Money Lender. He read the Northern Miner, Financial Post and the Globe and Mail to glean all he could about the financial sector. He described in detail his understanding of options. He further advised how he assessed stocks by determining certain ratios (price to earnings, price to sales and price to book value), by considering the current market environment and by reviewing a corporation's history and past performance.

[53] In 1968, Mr. Hayes married Patricia Hayes. She was a secretary, office manager and bookkeeper. She had taken a four-year secretarial course, which she upgraded in 1985. She worked for 14 years in retail before her current office position. She had no investment experience prior to the transactions in issue before me. As far as the hedging transactions go, she knew her husband was handling these transactions on her behalf and, therefore, she took no active part. According to Mrs. Hayes, Mr. Hayes researched the investments and did what he felt would benefit them both.

[54] The Hayes described their handling of their financial affairs as joint, both their chequing and savings accounts being held jointly. Mrs. Hayes' income went to cover the daily family expenses while Mr. Hayes covered the bigger ticket items such as the mortgage. Mrs. Hayes wrote most of the cheques and dealt with the banking.

[55] Mr. Hayes was made aware of Jack Maguire through his brother who worked at Eaton's, where Mr. Maguire also worked in the early 1980s. Mr. Maguire worked in the Finance Department. Mr. Hayes wanted an accountant to do his tax returns, but wanted someone knowledgeable in the market. In his first meeting with Mr. Maguire in 1981, he discussed his objectives of developing his retirement fund. Though Mrs. Hayes did not meet with Mr. Maguire, she confirmed that her objective was to likewise build a retirement fund for herself and her husband. Mr. Hayes was impressed with Mr. Maguire's market knowledge. They discussed the concept of convertible hedging.

[56] Mr. Hayes described a short sale and distinguished it from an option. His view was that a convertible hedge strategy could best meet his objective of building a portfolio, and having a positive cash flow, in a manner that minimized risk. As he stated, it was difficult to make a mistake. His modus operandi in acquiring a hedge was to call Mr. Maguire, go over the numbers provided by Mr. Maguire, then go over them with the broker and say yea or nay, depending on his knowledge of the company, the projected cash flow and the liquidity. By liquidity, Mr. Hayes meant whether the stock was highly traded. Mr. Hayes believed that the greater volume meant greater opportunity to get out of the hedge or unwind the hedge. Mr. Hayes acknowledged that he would not assess a hedge the same way as a regular investment, primarily due to the minimal risk inherent in a hedge. In his words, the hedge investment was "always in balance". He emphasized several times the lower risk and positive cash flow of the hedge investment.

[57] While he understood that Mr. Maguire extolled the benefits of the tax effect, Mr. Hayes indicated he was not concerned about the tax write-off - it was not part of his strategy. Given his level of understanding of the investments, I am satisfied he appreciated the concept of business loss and capital gain, but I also accept his most credible evidence that tax benefits were not a motivating factor.

[58] Both Mr. and Mrs. Hayes completed a number of forms to open accounts with brokers; this involved new client application forms, guarantees, margin accounts and account opening forms. The general theme with respect to the completion of these forms was that the Hayes would receive them already filled in, for the most part, by someone at the broker's office. Mrs. Hayes spent little time, if any, reading or reviewing the forms as she considered them simply standard documents. She confessed to not understanding most of what it was she signed. She described her understanding of the guarantee of her husband's account with First Marathon in the following terms: "If he slipped town, I would be responsible".

[59] Mr. Hayes spent more time going over the forms but likewise did not study them extensively. He appreciated the cross-guarantees allowed for increase leverage on an account as well as serving as a cross-guarantee in case of financial disaster. His wife's securities could neutralize the liabilities in his account. In both Mr. and Mrs. Hayes' forms, they each answered no to the question on the form of whether the client was a corporation, trust or partnership. Also they each answered 'no' on the forms to whether anyone else had authority on their individual accounts.

[60] Mr. Hayes went through a number of his hedging transactions. First was the Laidlaw hedge. Mr. Maguire would provide a projected cash flow for a hedge before Mr. Hayes would go ahead. Once a transaction was entered, Mr. Maguire would then provide a summary of the completed transactions. The Laidlaw hedge involved a short sale of Laidlaw common along with a purchase of Laidlaw warrants. Mr. Hayes would check the conversion ratio, the warrant expiry date, the exercise price, the rate of return on the Treasury Bill into which he would put the funds from the short sale (less the costs of the warrants), the dividend rate he would owe on the short side and the rental fee (these latter two amounts representing the expense side of maintaining the position). The bottom line on Laidlaw was an outlay of $8,349, with an income from the Treasury Bills of $10,098, and expenses of $1,800 dividends and $2,100 rental, resulting in a net $6,150 cash flow on his $8,349 investment over an eight-month period. That covered the cash flow side, but Mr. Hayes also acknowledged that when he abandoned the Laidlaw warrants in August 1987, he believed he lost $76,450. Also upon his purchase to cover his short position of February 1987, he lost $46,200.

[61] Mrs. Hayes, coincidentally with Mr. Hayes' purchase to cover his short position, entered a short sale at the same price plus commission. On April 22, 1987, she entered two more short sales of Laidlaw warrants and three purchases of Laidlaw convertible preferreds. As at April 22, Mr. Hayes held a long position of 10,000 Laidlaw warrants and Mrs. Hayes held a short position of 10,000 Laidlaw warrants, a short of 15,000 Laidlaw common and a long of 7,400 Laidlaw convertible preferreds. Mrs. Hayes likewise abandoned the warrants in August 1987 resulting in a $178,175 gain or income, coincidentally with Mr. Hayes' abandonment of his warrants which triggered his $76,450 loss. In August 1988, Mrs. Hayes closed out her position altogether resulting in a $60,875 loss. Her net income or gain from Laidlaw was $117,299 compared with Mr. Hayes' overall loss of $122,650.

[62] Mr. Hayes went through other convertible hedges involving bonds or convertible preferred shares rather than warrants. Of Mr. Hayes' sixteen hedges presented in the documents at trial, Mrs. Hayes held similar positions in seven of them. In six of those (Trans World, Walker, Trilon, Guardian, Placer and Alcan), Mr. and Mrs. Hayes ended up in an inactive hedge, being one holding a common stock short position and the other a common stock long position. This was the completely neutral situation described earlier, as any dividend on one side would be offset by compensatory dividends on the other, and any increase in value on one would be offset by a corresponding decrease in the other. Mr. Hayes maintained that his objective was always the same, whether or not his wife was involved - it simply made no difference. To him it was a cash flow investment. And the cash earned was never taken out but always reinvested.

[63] With respect to the Maguire invoices, Mr. Hayes explained that Maguire billed on three basis: first, a one time fee of $600 for entering a hedge transaction; second, a fee on disposition of 15 per cent of the return on investment, not on the cash flow return but the increase realized on disposition; and third, a year end fee of 15 per cent of any tax savings resulting from a loss. As well, a fee was charged for preparation of tax returns. As Mrs. Hayes paid most bills, she acknowledged that she would have written the cheques for the purposes of Maguire's fees.

[64] Both Mr. and Mrs Hayes had Mr. Maguire prepare their returns. Both indicated they did not understand the tax intricacies but had confidence in Mr. Maguire. Mrs. Hayes did not know what the election on disposition of Canadian securities was that Mr. Maguire filled in and signed on her behalf. They had confidence notwithstanding Mr. Hayes' indication that in the early 1990s, he was becoming increasingly frustrated with Mr. Maguire's failure to communicate about their tax situation. His returns were not being filed on a timely basis due to what he believed were ongoing negotiations between Mr. Maguire and Revenue Canada. He even approached his company's accountants to assist in extricating him from the tax dispute. Mr. Hayes' frustration and emotion was evident in describing this stage of the matter - he was feeling harassed and threatened and helpless to control the situation. This was happening at a time when his business fortunes as an owner of a company were on the rise. He was desperate.

[65] Though Mr. Hayes was taken through all his hedging transactions on cross-examination, it is unnecessary to repeat all such detail here. The key points garnered from that testimony are: Maguire would initiate transactions within a hedge (rolling within a hedge) involving both Mr. and Mrs. Hayes' position, as long as it was within Mr. Hayes' parameters; Mrs. Hayes had no contact with Mr. Maguire; Mr. Maguire would attend to housecleaning of the accounts by moving credit balances on stock from one account to the other netting each other out; all investments came from the Hayes' joint bank accounts; some hedges were successful, others were not; Mr. Maguire conducted some transfers without Mr. Hayes' knowledge; the broker conducted transfers between Mr. and Mrs. Hayes' account for failure to pay fees.

[66] Mr. Hayes is appealing 1984, 1985, 1986, 1991, 1992, 1993 and 1994 on the basis that he acted independently from Mrs. Hayes, he is entitled to losses on dispositions of one component of the convertible hedge and he is entitled to mark to market inventory. Mrs. Hayes is appealing 1989, 1992 and 1993 on the basis she acted independently from Mr. Hayes and she is entitled to capital versus income treatment.

Evidence of Stephen Stephens and Terry Stephens

[67] Mr. Stephens provided an extensive background of his work career from 1977 to the present. He has a mechanical engineering degree and has obtained considerable certificates in various computing applications. His work was primarily in a project engineer capacity, often requiring considerable travel. He has at various times worked as a plant manager, production quality manager and operations manager. He has dabbled in a couple of businesses himself, one particularly of note, was a partnership with his then girlfriend and since wife, Terry Taylor in 1981. This was an Amway business. Mr. Stephens contributed $700 and Ms. Taylor $300, though they each described it as a 50-50 partnership. It only lasted one year. Mr. Stephens and Ms. Taylor married in 1983.

[68] Mr. Stephens had limited financial background. He was familiar with Canada Savings Bonds, RHOSPs and RRSPs. Mrs. Stephens worked as a teller for many years, but likewise had limited investing experience. Mr. and Mrs. Stephens each maintained a separate bank account as well as having a joint chequing account for the normal monthly expenses. They also had a rainy day account which was in Mrs. Stephens' name.

[69] Mr. Stephens first met Mr. Maguire on the recommendation of his sister in early 1982 for the purpose of preparing his 1981 tax return. Mr. Stephens was impressed with Mr. Maguire's tax knowledge as well as with his understanding of money-making opportunities. Mr. Maguire introduced the convertible hedging idea to Mr. Stephens describing it as a win-win situation. Mr. Stephens acknowledged that he understood the concept at the time Mr. Maguire explained it, but one hour later was hard pressed to describe it himself. His understanding of the win-win was that you could make profits, and even if you lost, you could claim a refund on your tax return. Mrs. Stephens indicated that Mr. Stephens described it to her as a win-win-win in the following terms: you could invest without having to put up any of your own money; you could invest in Canadian companies; if you lost, you would receive a tax benefit.

[70] Mrs. Stephens was comfortable with investing through Mr. Maguire as her husband clearly had confidence in him. She personally never met Mr. Maguire and only recalled once talking to a broker. Both Mr. and Mrs. Stephens saw the convertible hedge as an opportunity to make money, Mr. Stephens appreciating the lower risk of losing money.

[71] Mr. Stephens indicated a hedge would be initiated usually by a call from Mr. Maguire, though occasionally Mr. Maguire would simply go ahead. Mr. Stephens would next get a call from the broker. He would tell the broker that if Mr. Maguire initiated it, then it was okay to proceed.

[72] Both Mr. and Mrs. Stephens signed a number of forms to accommodate their hedge investments. These included standard new client application forms and account opening forms, cross-guarantees and a trading authorization. The new client forms stipulated the account was not a corporation or partnership account. Mr. Stephens understood the guarantee was similar to co-signing a loan. Mrs. Stephens had a similar understanding and recognized that if her account had funds and Mr. Stephens did not, her account would guarantee his. Neither of them understood the margin account forms, but saw the document as a mere formality. Both signed trading authorization forms making each an agent of the other. Mrs. Stephens explained Mr. Stephens had authority as her agent.

[73] Mr. Stephens borrowed $10,000 to make his original investment with Mr. Maguire. He paid $10,500 to RBC Dominion Securities for the Falconbridge hedge in October 1985. He paid Mr. Maguire $600 for initiating this hedge. The funds came from his personal account. When he received Mr. Maguire's report of the Falconbridge hedge he was shocked to see the magnitude of the numbers involved. On October 8, he sold short 7,500 Falconbridge common shares for $129,618 and bought long 1,500 Falconbridge warrants for $41,393. On October 15, he bought a Treasury Bill for $100,055. All these transactions were instigated by Mr. Maguire. Mr. Stephens' premiums for this hedge was approximately $12,000, being the difference between the short sale proceeds and the combined costs of the long position and the Treasury Bill. On December 23, 1985, Mr. Stephens purchased 7,500 Falconbridge commons to cover his short position for $446,365, resulting in a $16,746 loss. On the same day, Mrs. Stephens entered a short sale of Falconbridge commons for proceeds of $146,135. She understood this was done to facilitate Mr. Stephens' trade. She was likewise alarmed at the amount when she received her trading slip. With respect to the $16,000 loss, Mr. Maguire wrote to Mr. Stephens advising him of a tax saving of approximately $6,500 on the loss.

[74] The next trade was November 11, 1986, when Mr. Stephens reinstated his short position of 7,500 Falconbridge commons for $132,087. On the same day Mrs. Stephens covered her short position for $132,287, realizing a $13,847 gain or profit. At this point, Mr. Stephens was back in a fully hedged position. On February 5, 1987, Mr. Stephens sold his 1,500 Falconbridge warrants for $31,750 realizing a $9,643 loss. Mrs. Stephens bought 1,500 Falconbridge warrants at a cost of $32,000 which she immediately converted to 7,500 Falconbridge commons stock putting her and Mr. Stephens in a common-common position. This continued to December 30, 1988, when each disposed of their position, Mr. Stephens at a $78,037 loss and Mrs. Stephens at a $79,625 gain. I am satisfied neither Mr. nor Mrs. Stephens had any direction whatever over these transactions.

[75] Of the five convertible hedges in which Mr. Stephens was involved, only in one (Ivaco) did Mrs. Stephens not have any corresponding interest. In the other four, Mr. and Mrs. Stephens ultimately held a common-common position.

[76] Mr. Stephens received a number of letters from brokers requesting additional margin. He never quite understood what they were getting at, so usually sent these requests on to Mr. Maguire. Occasionally, he would call the broker. The broker would sometimes indicate a trade the next day would resolve the issue. Mr. Stephens never intended to pay anything further in response to these inquiries. In a March 29, 1990 Burns Fry request, Mr. Stephens feared legal action was being considered, so he tried to contact Mr. Maguire, but without success.

[77] In 1993, matters came to a head with Burns Fry threatening to close accounts, including those of Guarantors, if certain fees were not paid. Mr. Stephens submitted the fee too late, and the Stephens' accounts were indeed closed. This caused the disposition of Falconbridge and Placer positions held by the Stephens. The disposition of Mr. Stephens' Placer common shares at $379,556 resulted in a $129,376 loss, while the disposition of Mrs. Stephens' Placer common long position at $379,556 resulted in a $162,392 gain.

[78] Mr. Stephens maintained he had no intention to enter any of these transactions with Mrs. Stephens as a business partner. There was no agreement to split profits - any profits he made were re-invested through Mr. Maguire. He entered the Ivaco hedge without any involvement of his wife. He viewed such a hedge no differently from those in which he relied on the guarantee of his wife's account.

[79] In March 1989, RBC requested the transfer of $176,922 from Mrs. Stephens' account to Mr. Stephens' account. Mrs. Stephens signed a letter authorizing that transaction because, as she put it, she was a partner in a marriage not a partner in a business.

[80] With respect to Mr. Maguire's preparation of the Stephens' tax returns, it was clear the Stephens' did not know how they were being handled. Mr. Stephens realized that his 1987 and 1988 returns were late, but was told by Mr. Maguire not to worry as he was entitled to a refund. In Mr. Stephens' 1987 returns, specifically his statement of income and expense, it showed the type of business as 'Speculation', and a net loss of $73,904. No amount was shown as inventory. In 1988, his loss was reported as $230,188, with a capital gain of $79,615 being attributed from Mrs. Stephens on the Falconbridge disposition. It is unnecessary to go through the returns of the other years under appeal as the issues were similar.

[81] Mr. Stephens' position before the Court has changed in a number of respects from his position at the time of filing. In his position before Court, he claims both a mark to market and fair market value adjustment for the years under appeal. Also, the amount of business income or losses have been modified for some of the years. Likewise the Respondent's position has changed from the assessment stage to the Court stage. This has resulted in the rather unusual position for 1990 of Mr. Stephens' taxable income at the time of filing being significantly less than his taxable income at the time of his Court appearance. The Respondent's assessment of taxable income has likewise increased, though not by so much.

Evidence of Muriel and Patricia Scott

[82] Mrs. Muriel Scott graduated in nursing from McGill University in 1950. She worked as a nurse on a part-time basis until 1970 when she commenced full-time employment at a North York hospital. In 1982, she opened a nursing agency (Carecor) in Toronto where she worked until retirement in 1994. In 1980 Mrs. Scott took a 16-hour course on financial planning although the course did not deal with hedges, warrants or options. She indicated she was separated and needed to take care of her future.

[83] Mrs. Scott first met Mr. Maguire in 1982. She retained him to prepare her 1981 tax returns. In late 1983, Mr. Maguire suggested to Mrs. Scott that she consider convertible hedge investments. She made her first such investment in Husky Oil in December 1983 relying on $10,000 of borrowed funds. She always had sufficient funds thereafter in her account to maintain her investments. She exhibited a good basic understanding of the hedge strategy and particularly, that it was set up to generate a positive cash flow, which is what she wanted. She understood the costs involved related to fees, rentals, interest on borrowed funds and compensatory dividends, and that the income was derived from dividends. She did not recall being advised of any tax benefits in this strategy. While she understood in Court, that as well as making money from the cash flow, there was a possibility of profit or loss on the closing of the hedge, she did not fully appreciate this at the time she was investing.

[84] The usual routine in Mrs. Scott's establishment of a convertible hedge was that Mr. Maguire would contact her to explain the trade, and go over the expected cash flow. She would decide, based on the premium, and as she put it, the end result to be generated. She never discussed the investment with her daughter, Patricia. She does not recall there ever being a discussion about risk. Mr. Maguire would then contact the broker who in turn would contact Mrs. Scott to finalize the arrangements.

[85] According to Mrs. Scott, the broker required her to sign a number of forms, including a new account application, guarantee, margin account form, standard option agreement (which she later requested to be cancelled) and a trading authorization form in which her daughter Pat was designated as her agent. Mrs. Scott's overall approach to the forms was that, although she would quickly review them for accuracy, she saw them simply as standard broker requirements. With respect to the guarantee, she understood Pat was guaranteeing her liabilities, but was assured from discussions with Mr. Maguire this would never be a problem - and it was not. Mrs. Scott always believed the account opening forms, even though in Pat's name, related only to her accounts, only her investments.

[86] The parties summarized 16 of Mrs. Scott's investments in a schedule and she was questioned on every one of them. These investments were initiated from 1983 to 1992. Mrs. Scott's daughter Pat, was involved in just five of the convertible hedges, all initiated in 1987 or earlier (Husky, Cambridge, Alcan, Placer Developments and Falconbridge).

[87] It was clear from her testimony that Patricia Scott was involved in her mother's investment simply to facilitate those investments. She believed she had no risks, with no potential gain or loss. It would cost her nothing. She presumed the signing of various account opening forms was simply a broker requirement. Though she read the forms and understood they would be binding, she signed simply to accommodate her mother. Similarly, with respect to letters to brokers, she would just sign what Mrs. Scott prepared for her to sign. She referred all correspondence on the investments to her mother, and ultimately provided her mother's address for mailing purposes. Most correspondence she never even saw. She never received any payment from the investments that she considered hers. She reported dividend income on her tax returns until it was determined this was an error, and thereafter it was all recorded to her mother.

[88] With respect to specific hedges, Mrs. Scott invested in convertible preferred hedges, warrant hedges and convertible debenture hedges. For example, her first hedge in Husky in 1983 involved convertible preferred shares, which she bought long coincidentally with the short sale of Husky common shares at a premium of approximately $12,000. Mr. Maguire estimated a cash flow on this particular hedge in 1984 of approximately $3,300. In June 1985, Mrs. Scott sold the 3,000 convertible preferred shares and Patricia Scott acquired 3,000 convertible preferreds at the same price, which two days later were converted to common shares. Mrs. Scott and her daughter maintained this short common-long common position until 1987 when Mrs. Scott covered her short position and Patricia sold her long position. Mrs. Scott referred to the common-common holdings as an inactive hedge. There was a loss of approximately $12,500 combined in these transactions. Mrs. Scott acknowledged this was not a good hedge.

[89] In December 1986, Mrs. Scott entered a warrants' hedge with the short sale of 10,000 Cambridge Shopping Centre common shares and the acquisition of 10,000 Cambridge warrants. In January 1987, there was a covering purchase in Mrs. Scott's account and coincidently, a short sale in Patricia Scott's account of 10,000 commons. At this point until 1992, Mrs. Scott and her daughter held a common-common position, likewise referred to by Mrs. Scott as an inactive hedge. Mrs. Scott claimed all dividends and expenses arising from these holdings, indicating Patricia as her agent on her tax returns.

[90] In July 1987, Mrs. Scott entered a rights hedge acquiring 10,000 Falconbridge rights for $61,850 and coincidently selling short 10,000 Falconbridge common shares for $250,630. In October, the long position shifted to Patricia's account by the sale of the 10,000 rights by Mrs. Scott for $27,956 and the acquisition of 10,000 Falconbridge commons by Patricia Scott for $191,850. They maintained this common-common position until the end of 1989 when Mrs. Scott covered the short and Patricia Scott sold the long, both at $370,000.

[91] Mrs. Scott maintained both a short margin account and a margin account. From a review of the Laidlaw hedge entered in 1988 for just a few months, it appears that only the short margin account was used for the convertible hedging transactions, as a Laidlaw warrants acquisition which had nothing to do with convertible hedge was held in the separate margin account.

[92] It is unnecessary to go through all the other convertible hedges in detail, other than to highlight a few facts from some of them:

- Mrs. Scott claimed a $31,650 loss on the sale of 10,000 Alcan warrants in November 1986. Also in November 1986, Patricia acquired 10,000 Alcan common shares. Mr. Maguire charged Mrs. Scott a 15 per cent benefit surcharge on the tax saving from the $31,650 loss.

- The Minnova hedge took 3½ months to set up in 1988 before the position was fully hedged and was then held for five years before being collapsed for a gain of $3,688; throughout that period the hedge also generated some positive cash flow.

- Federal Industries was a convertible debenture hedge entered in November 1989. In October 1991, Mrs. Scott substituted one convertible debenture for another. She realized a gain on her short position, resulting in an overall gain hedge of $10,245. She could not generalize as to whether her gains were normally on the long or short position, as she maintained she was more interested in the cash flow.

- The Placer hedge was held in a common-common position between Mrs. Scott and Patricia Scott from 1987 to 1999. Mrs. Scott's explanation was that this was done due to the uncertainty of how it was to be treated for tax purposes.

[93] Mrs. Scott left the preparation of her tax returns to Mr. Maguire. She had no idea how dividends or capital gains were calculated. In her 1989 return, specifically the statement of income and expenses from business, she listed Market Speculation as the type of business. Nothing was shown in the schedule for inventory.

[94] Mrs. Scott is appealing the 1984, 1985, 1986, 1987, 1988, 1990, 1991, 1992 and 1993 taxation years on the basis that she was not in a partnership with her daughter, the losses incurred on specific components of the convertible hedge were deductible and that she is entitled to mark to market inventory.

[95] Issues and Findings

(a) Were the Appellants' gains or losses on their investments on capital account or were they income from a business either due to engaging in an adventure in the nature of trade or due to carrying on a business?

In all cases the gains or losses on "investments", which I shall shortly clarify, were income from a business, arising from engaging in an adventure in the nature of trade.

(b) What constituted the business, the adventure in the nature of trade - stock transactions or convertible hedging transactions?

The adventure in which the Appellants engaged was investing in convertible hedges, which I find are property for purposes of the Income Tax Act.

(c) Were the adventures carried on with a partner or through an agent?

The adventures were neither carried on as a partnership nor through an agent, with the exception of Mrs. Scott. They were engaged in either singly by an Appellant, where the convertible hedge was held in one account, or jointly by the Appellant and the Guarantor, where the convertible hedge was held in two accounts. Other than Mrs. Scott and her daughter, who were in an agency relationship, the remaining Appellants were joint adventurers with their respective Guarantors.

(d) What tax treatment is to be accorded the convertible hedges: specifically, the determination of when income or losses arise in the convertible hedge and in whose hands; the taxation of the cash flow element of the convertible hedge; the treatment of the Appellants' positions subsequent to the wind-up of a convertible hedge; and the reliance on the mark to market method of inventory valuation?

The income or loss from the disposition of a convertible hedge held in two accounts occurs at the time of the event which results in neither an Appellant nor Guarantor holding a position with a conversion feature. The gain or loss is on income account and is to be divided equally between the two co-adventurers. Prior to the disposition of the convertible hedge, no disposition of a component of the convertible hedge constitutes a disposition for tax purposes.

For the Hayes', and Stephens' appeals, the income and expense of the convertible hedge (the cash flow), is taxable or deductible in the hands of the co-hedgor holding the component yielding the income or expense. In Mr. Rezek's and Mrs. Scott's case the net cash flow is taxable in his or her hands alone.

Based on my finding that the convertible hedge is property, it is the convertible hedge itself that is the inventory and not the individual components of the hedge. Applying subsection 10(1) to these adventures in the nature of trade, none of the Appellants computed income in the years prior to December 20, 1995, by valuing the inventory, the convertible hedge, at the lower of cost or market. Therefore, subsection 10(1) applies to preclude any of the Appellants from relying on the lower of cost or market inventory valuation method, vis-à-vis the holding of a convertible hedge. Also, no Appellant is eligible to write down inventory of individual stock after the unwinding of a convertible hedge.

After the disposition of the convertible hedge, the investor and the Guarantor holding common-common positions hold a taxable nothing. The common-common position in two accounts may, as a hedge, be considered as a property but it is not a source for tax purposes.

(e) What is the effect of the subsection 39(4) election by Mrs. Hayes and Mrs. Scott?

The convertible hedge itself, as a separate identifiable investment, does not fall within the definition of securities as contemplated by subsection 39(4), so the election is ineffective for the determination of capital or income treatment on the disposition of the convertible hedge itself. Mrs. Hayes disposed of no other property in the year under appeal to which the election would apply.

(f) How are unused compensatory dividends to be treated for tax purposes?

Unused compensatory dividends cannot be deducted nor capitalized.

(a) Issue:

Were the Appellants' gains or losses on their investments on capital account or were they income from a business either as a result of engaging in an adventure in the nature of trade or as a result of actually carrying on a business?

Appellants' Position

[96] The Appellants argue that they were engaged in trades in one of three ways: first, as a speculator, an adventurer in the nature of trade such as Gordon Rezek; second, as a trader, such as Philip Hayes, Stephen Stephens and Muriel Scott; and third, on account of capital, such as Patricia Hayes. Appellants' counsel reviewed the various badges that are traditionally considered in categorizing income or capital: length of ownership, nature of the property, frequency of transactions, knowledge of the individual, degree of financing and intention to enter a scheme for profit-making. He talked about an evolutionary chain, placing Mr. Rezek at the beginning of that chain as a speculator and Mr. Hayes further along that chain as a trader, based primarily on volume of transactions. Mrs. Hayes never got on to the evolutionary chain as she, according to Mr. Shaw, held her positions more as investments rather than in a profit-making scheme.

[97] Mr. Shaw distinguished the trader from the speculator based on volume and the "amount of methodology" which he attempted to clarify as being a "consistency of patterns, the way in which you get the volume".

Respondent's Position

[98] In other aspects of these appeals, the Respondent has relied on Schultz v. The Queen[3] and Carter v. The Queen[4] as providing binding authorities for certain propositions. In those two cases, which I will review more thoroughly in my analysis, gains from convertible hedging transactions were held to be on income account. The Respondent has indeed throughout these appeals taken the position that income treatment is appropriate. However, because I requested argument on the capital issue, the Respondent has now suggested it is open to me, because this is a matter of law, to consider, based on the evidence, that the Appellants had only a capital intention.

[99] Mr. Hayes wished to build a portfolio of hedges, not an indication of a profit-making scheme from quick flips. Mrs. Scott, according to Mr. Gluch, clearly viewed hedges as an investment, and, like Mr. Hayes, she was in it primarily for the cash flow. To a lesser extent, so was Mr. Stephens.

Analysis

[100] There are two steps in the classification of the nature of the income in these appeals. The first step is the distinction between income and capital. I only get to the second step if I determine the answer to the first step is that these transactions were on income account. The second step is whether the income from a business is as a result of being engaged in an adventure in the nature of trade (a speculator), or as a result of carrying on a business (a trader). The answer to the second inquiry has a bearing on both the partnership issue and the inventory issue.

[101] As I have previously mentioned, the parties only addressed the issue of capital versus income as it relates to Mr. Rezek, Mr. Hayes, Mr. Stephens and Mrs. Scott because I asked them to do so. Neither side was claiming, apart from the possible application of subsection 39(4), that these Appellants' gains from their convertible hedging activities were on capital account. The analysis struck me as incomplete without that basic starting point, and although now I am satisfied that the gains on the convertible hedges were not on capital account, I believe the exercise of exploring that issue has been helpful. As a question of law, the issue was open for me to consider. I will be brief however in my reasons on this first step.

[102] The definition of 'business' in section 248 reads as follows:

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment;

In the decision of Friesen v. The Queen,[5] the Supreme Court of Canada reviewed the factors which have been used by the courts in determining whether a taxpayer was engaged in an adventure in the nature of trade or was dealing with a capital transaction. The overriding requirement to find an adventure in the nature of trade is that it involves a scheme for profit-making. The other considerations identified by the majority are:

(i) intention at the time of acquisition of the property;

(ii) nature of the taxpayer's business compared to the endeavour involved;

(iii) nature of the property and use made by it; and

(iv) use of borrowed money.

From the dissenting decision of Iacobucci J., on which there was no disagreement on this issue, the conduct of the taxpayer compared to a dealer in such property was added as a consideration.

[103] Although there was some evidence, as pointed out by Mr. Gluch, that some of the parties intended a longer term investment, their conduct and the nature of the property belies such an intention. The convertible hedge strategy was a scheme of profit-making.

[104] The strategy was marketed as a win-win. One side of that equation dealt with tax savings, which has been held by cases to not, of itself, constitute a business (see for example Moloney v. The Queen[6], Loewen v. Canada[7] and Whent v. The Queen[8]) but the other side of the win-win equation involves two elements. One is the cash flow generated by the convertible hedges while held, and the other is the increased value of the hedge itself on wind-up. That increased value depends very much on market fluctuations, but it is absolutely clear from the experts' testimony and the Appellants' testimony that this was the integral element of the venture. This is best summarized in Mr. Maguire's standard correspondence to his clients,[9] delivered shortly after the convertible hedge is established:

... We will, of course, be looking for profitable opportunities to unwind this position as soon as conditions are favourable to doing so.

The increase in the spread is the profit from the venture. The Appellants, with the exception of Mrs. Hayes perhaps, all had sufficient information to be aware of this at the time they acquired the convertible hedges.

[105] Mr. Hayes, more knowledgeable than any of the other Appellants as to how these strategies worked, might talk in terms of building a hedge portfolio, but that simply goes to volume, not to a long term holding of numerous hedges as a typical investor in a long position would hold an ordinary stock portfolio. Of Mr. Hayes eight convertible hedges, in which Mrs. Hayes was involved, six were collapsed in less than one year and two in the year following the year of investment. Of his many solo convertible hedges, only one was held for more than a few months. This conduct is indicative of an intent to be involved in a profit-making scheme, not long-term capital investments.

[106] Similarly, Mrs. Scott, while concentrating on the cash flow generated by the convertible hedge, with the exception of the Minnova hedge, did not hold the convertible hedge positions for any lengthy period of time. This is not surprising, as the nature of the convertible hedge itself is such that immediately upon acquisition, the market is tracked for a profitable unwinding. This was common to all Appellants who held convertible hedges. That was what Maguire & Associates was doing for them.

[107] Although none of the Appellants worked in a related industry, this is an insignificant factor in the overall determination. As far as using financing for the venture, some Appellants did indeed borrow to make their initial outlay, however, more telling is that all the Appellants relied on the more generous margin requirements to implement the convertible hedge. This was the very key to the success of the convertible hedge, to the point that the Guarantors were led to believe they could "invest" with no personal financial contribution.

[108] Taken in their totality, the intentions of the Appellants at the time they acquired the convertible hedge, their conduct, the method of financing and the very nature of the convertible hedge itself point overwhelmingly to a scheme for profit-making, an adventure in the nature of trade and, therefore, income from a business.

[109] The next step is more problematic although it was not vigorously pursued by either side. At what stage in the evolutionary chain, to use Mr. Shaw's line, does an adventurer, a speculator, turn into a trader, someone who is carrying on a business? By its very term, the adventurer in a nature of trade is not carrying on a business, although the income derived from the adventure is considered income from a business due to the definition in the Income Tax Act. This distinction was clearly enunciated by Jackett, P. in Tara Exploration and Development Co. Ltd. v. M.N.R.[10]

... I have concluded that the better view is the words "carried on" are not words than can aptly be used with the word "adventure". To carry on something involves continuity of time or operations such as is involved in the ordinary sense of a "business". An adventure is an isolated happening. One has an adventure as opposed to carrying on a business.

Justice Major reinforces this view in Friesen where he indicated, "by definition an adventurer in the nature of trade is neither a stock-in-trader nor does he 'carry on' a business".

[110] Mr. Shaw suggested that there is something more than just the volume of adventures that makes the difference. I agree. Yet I remain unclear as to exactly what he intended by referring to the methodology of the trader. I see no difference between what Mr. Hayes did and what Mr. Rezek did vis-à-vis the methodology of the transactions. Both engaged Maguire & Associates and a broker to implement, monitor, adjust and ultimately wind-up the convertible hedge. Granted, Mr. Hayes could discuss the hedge more knowledgeably with Mr. Maguire and the broker than Mr. Rezek, but he had no more control over the actual mechanics than Mr. Rezek. Also, Mr. Hayes maintained more detailed records, including his own schedules of the convertible hedges, but this personal record-keeping had no bearing on the operation of the convertible hedge itself.

[111] None of the Appellants earned their livelihood from convertible hedging, so that is not a factor which supports a finding that any of them carried on a business. None of them held themselves out in the financial marketplace as traders. None had business plans. None had business premises dedicated to these transactions. None had the trappings of dedicated phone lines or business cards. None kept financial statements of a business. None advertised. None employed any staff. None incurred operating expenses other than the expenses directly incurred as part of the convertible hedge itself. None entered into any contract with third parties beyond what an ordinary investor would enter, apart perhaps from the guarantees. But again, that went to the very essence of the nature of the convertible hedge, not to the determination of carrying on a business. There must be some additional element of commerciality beyond volume to take an adventurer from the status of speculator to the status of someone carrying on a business. I can find no elements of such commerciality with any of the Appellants. While that finding alone might be sufficient to find none of them were traders, I wish to comment on the volume of adventures of the Appellants and how that also influences my findings.

[112] Mr. Rezek engaged in three convertible hedges over two years. Mr. Hayes engaged in 16 convertible hedges over nine years. Mr. Stephens engaged in six convertible hedges over three years. Mrs. Scott engaged in 16 convertible hedges over 10 years. The evidence was consistent amongst the Appellants that the convertible hedge would be instituted by a phone call with Maguire & Associates and a follow-up call with a broker. There might be some activity during the life of the convertible hedge involving shifting positions or disposing of positions. Finally, there would be a call with each of Maguire & Associates and the broker on wind-up of the convertible hedge, although there was also some evidence that the wind-up could occur without any involvement of the Appellant. This is not a description of extensive business activity in connection with any one particular convertible hedge. It is also definitely not voluminous when looking at the total number of an Appellant's convertible hedges over the period of time an Appellant was engaged in the convertible hedging strategy. Even if one accepted that volume alone is the determination of when an adventure becomes trading, there is no magic number when an adventurer can be presumed to be a trader. But common sense suggests to me that not even Mr. Hayes, nor Mrs. Scott, handled such a volume of these convertible hedges that they could be viewed as carrying on a business. When I compare them to the recent phenomenon of the day trader, they pale significantly. The day trader might deal in dozens of securities a day, not a handful over a number of years. No, the Appellants would have had to engage in considerably more activity than the Appellants before me to satisfy me they were carrying on a business. They were engaged in a scheme of profit-making and are caught by the broad definition of business in the Income Tax Act. But none of them were carrying on a business.

(b) Issue:

What constituted the adventure in the nature of trade - stock transactions or convertible hedging transactions?

Appellants' Position

[113] The Appellants' counsel emphasized on more than one occasion that I must be guided by what is real. As he referred me to cases such as Shell Canada Limited v. The Queen[11] and The Queen v. Singleton,[12] it was clear his reality was a legal, as opposed to an economic, reality. Legal transactions must be respected. They ought not be recharacterized based on tax motivation. The Appellants concluded the legal reality theme with the submission that the fact a transaction may produce a result which is deemed repugnant is not in and of itself a reason for the Court to disregard it.

[114] The Appellants point to the various documents and transactions and insist they represent legal rights and obligations and have legal and binding effect. For example, a Guarantee contractually binds a Guarantor in accordance with its terms. It cannot be ignored. Likewise, a disposition of a stock is a transaction that took place. It has an effect on the person disposing of it. It has ramifications. It cannot be deemed away.

[115] So, in effect, Appellants' counsel parses the convertible hedge into its component parts and concludes the Appellants were engaged in separate, identifiable stock transactions each producing its own legal and tax result, and to find otherwise is to ignore the legal realities.

Respondent's Position

[116] The Respondent's position is that the convertible hedge, whether in one account or two accounts is only disposed of when it is closed. For example, when Gloria Fahrngruber acquired Laidlaw convertible preferred shares coincidentally with Mr. Rezek disposing of Laidlaw convertible preferred shares, the convertible hedge continued in the two accounts. They were packaged in a bundle that could not be unravelled. The cash flow was determined from the convertible hedge as a package. Similarly, the gain or loss is not to be determined upon the shifting of positions; the move from one account to another should have no tax impact. The impact is upon the wind-up of the convertible hedge, being what the Appellants initially purchased.

[117] The Respondent suggested the convertible hedge could be viewed as a capital asset which produced income. Indeed, the Respondent went so far as to argue that the convertible hedge could fit within the definition of property contained in subsection 248(1) of the Act. Although not acknowledging that a short position standing alone is a right that constitutes property, the combination of the short and long positions do constitute property. And it was that property that was the subject matter of the Appellants' adventures.

Analysis

[118] This is where the round hole of taxation principles must expand to accommodate the square peg of financial innovation: where what is real in law is not so restrictively interpreted as to deny a result that meshes economic and legal reality. The Income Tax Act provides this opportunity through its definition of 'property', which reads:

"property" means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

(a) a right of any kind whatever, ...

This is not only the broadest of definitions, it invites a non-restrictive approach - property of any kind whatever, right of any kind whatever. This is not surprising in a taxing statute that taxes income from property and proceeds from disposition of property. The net is cast as widely as possible.

[119] What then are the characteristics of a convertible hedge that would justify its characterization as property? I would suggest it is the rights implicit in the convertible hedge. As well as the Income Tax Act definition it is interesting to note Black's Law Dictionary definition of 'property':

1. The right to possess, use, and enjoy a determinate thing;

2. Any external thing over which the rights of possession, use, and enjoyment are exercised.

It further defines "thing" to include "any subject matter of ownership within the sphere of proprietary or valuable rights". The characteristics of a convertible hedge then which fall within these very broad approaches to property are the characteristics of having rights. Again referring to Black's Law Dictionary, a 'right' includes the following definitions:

1. Something that is due to a person by just claim, legal guarantee, or moral principle.

2. A power, privilege, or immunity secured to a person by law;

3. A legally enforceable claim that another will do or will not do a given act;

4. The interest, claim, or ownership that one has in tangible or intangible property.

[120] The right or rights must derive from the convertible hedge itself and not just from the accumulation of independent rights of components of the convertible hedge. The right to convert for example is a right attached to the long side of a convertible hedge. It exists whether or not it is a component of a convertible hedge. Similarly, the right to cover a short position at a time which would yield a favourable result is not dependent on the short position being part of a convertible hedge. These are both rights imbedded in the convertible hedge and arguably can be viewed together to constitute property. But the right which only arises from the convertible hedge itself, and consequently satisfies me that the convertible hedge is property, is the right to rely on one component of the convertible hedge to satisfy the margin requirements of the other component, whether this be in a single account or through the auspices of a Guarantor's account. The experts' description of the convertible hedge, combined with the evidence of Mr. Sildva and Mr. McCrodon confirmed that the brokerage houses' agreement with those engaged in convertible hedges included a provision to waive the usual strict requirements for margin, and accept that a convertible long position was in and of itself sufficient margin for the short position. This was critical to the operation of the convertible hedge, and it was something the investor was able to rely upon in the arrangement with the broker. It was, I would suggest, a legally enforceable claim that the broker would provide margin on this basis. In summary, the convertible hedge consists of components containing rights; it also, by its very essence, creates a right particular to the convertible hedge alone. The convertible hedge meets the broad Income Tax Act definition of property.

[121] That conclusion alone is not sufficient to justify a finding that it is "property" which constitutes a source for tax purposes. The characterization of something as property must fit within the scheme of the Act to catch it in taxation's net. There are many rights which would be property pursuant to the Act's broad definition, yet would not easily be pegged as "property as a source" as contemplated in section 3. The property must be viewed in context, and the context of the convertible hedge property is property of an adventure in the nature of trade, a business. The business is the source.

[122] Having determined that one can legally justify reference to the convertible hedge as a separate identifiable thing, a property for purposes of the Income Tax Act, I want to review whether the witnesses, both experts' and laymen's, understanding supports this position. I believe it does. All witnesses referred to the convertible hedge as if it was a thing of its own accord. This may be a reflection of the limitations of language, but when combined with the following features, it leads me to the conclusion that the convertible hedge was viewed as a stand-alone investment constituting a business, by virtue of being an adventure in the nature of trade.

[123] With the exception perhaps of Mr. Rezek and Mrs. Hayes, I am satisfied that all Appellants understood that the profit from the convertible hedge arose in two ways - from cash flow while holding the convertible hedge, and from an increase in the value of the spread from the time an Appellant laid out an amount to establish the convertible hedge (the spread) to the time of the wind-up of the convertible hedge. The experts confirmed these were the upsides of the convertible hedge. This is what the investment was all about. Mr. Hayes, particularly, was not motivated by the tax consideration aspect of Mr. Maguire's win-win rallying call. It was the convertible hedge itself that would yield his return.

[124] The Appellants also understood that the cash flow was not a one-sided determination - it was a net determination. The analysis from Mr. Maguire's office showed both the income from the long side and the expense on the short side. The cash flow was from the convertible hedge, not just from one component.

[125] It was evident from Mr. and Mrs. Stephens' reaction to the receipt of their first trading slips and other reporting information, that they were alarmed at the size of the numbers. Mr. Stephens put in just a few thousand dollars yet he was receiving confirmation of hundreds of thousands of dollars of investments. In his view, his investment was only a few thousand dollars, which accords to the investment being the convertible hedge itself. This position was also supported by the expert, Mr. Croft, in his discussion of risk. The idea that the convertible hedge investment was low risk was not how Mr. Croft described it, for, as he indicated, the investor puts up a few thousand dollars and that whole amount, the investor's whole investment may be lost. This is how he put it:

Q. And I put it to you that the risk that an investor was exposed to in a convertible hedge position, particularly the way these hedges were orchestrated, set up, was at best or at most the premium?

A. You're absolutely correct in that, but when you talk about low risk, I mean, in theory, you could lose the entire premium, which you've put up.

So in theory, the investment you've made, you could lose your entire investment.

[Transcript page 2010 lines 7 to 13.]

[126] Professor Kirzner had a somewhat different assessment of risk, referring to the temporal risk described earlier. This does suggest that the two components of a convertible hedge are viewed separately for purposes of assessing this temporal risk. However, the risk is only apparent when a position is legged in, leaving one side exposed to some degree in a naked position; the position is not fully hedged - in other words, there does not yet exist a full-blown convertible hedge. Once a convertible hedge has come into being, the temporal risk disappears. I do not see this position as a significant departure from the view that the convertible hedge, once in place, is a separate property with its own characteristics. Certainly, the investors' evidence was that they never felt that anything more than their outlay in the convertible hedge was at risk. And indeed there were no instances of an investor ever losing even all of that outlay.

[127] I conclude it was a common view that the investment was the convertible hedge itself. This is consistent with the finding that the convertible hedge is a property, and it is that property which is the subject of the Appellants' adventure, the Appellants' business.

[128] I wish to briefly tie in this finding of a convertible hedge as property with my finding of an adventurer rather than a trader. For how does one trade in convertible hedges? How transferable is this property? There is no exchange for convertible hedges. They are disposed of by being unwound. Nothing in the definition of property requires transferability as a requisite ingredient. It is difficult to conceptualize carrying on a business of trading in convertible hedges. Yet, there is no such difficulty in viewing transactions involving the convertible hedge as an adventure in the nature of trade. They exist in a commercial trading environment; indeed, they are a financial product of that very environment, though they cannot be traded as such. By their very nature, they are destined to remain as adventures in the nature of trade. This expression seems aptly suited to this particular application.

Were the Appellants' adventures carried on with a partner or through an agent?

[129] Given the Federal Court of Appeal's decisions in Schultz[13] and Carter,[14]it is not surprising that counsel spent the majority of their time arguing the partnership issue. Having found the Appellants' adventures were engaging specifically in convertible hedges, as opposed to stock transactions, the significance of the partnership issue, as will soon be evident, is somewhat diminished.

Appellants' Position

[130] The Appellants' position is that in none of the Appellants' situations do the essential elements of a partnership exist. The Appellants' own evidence, combined with the effect of the documents entered into by them and the views held by third parties with whom they dealt, lead to the only reasonable inference that no partnership existed.

[131] Mr. Shaw maintained that the partnership position collapses when the trades constituting the convertible hedges are closely scrutinized. He broke the convertible hedges down into categories: transactions by one investor, with which these appeals are not concerned; combined trades, with no subsequent trades, effectively what I will call solo convertible hedges (23 of them); combination trades with subsequent trades, being the convertible hedges with the involvement of a Guarantor (16 of them); and not an initial combination trade, but where the short and long positions were open in two different accounts (two of the Hayes' convertible hedges). Neither of the first two categories was assessed as being carried on in partnership. The 16 convertible hedges in the third category were so assessed. Of those 16 convertible hedges, 15 went into a common-common position, a combined position that can by its very nature not yield any profit.

[132] With respect to the solo convertible hedges, Mr. Shaw suggested that the Guarantor, and he used Gloria Fahrngruber as an example, still provided financial support and yet those hedges were not assessed as being part of the partnership. So she uses alleged partnership property in convertible hedges not being assessed as part of a partnership. This does not jive with section 8 of the Partnership Act of Ontario, which does not bind a party to such credit arrangements unless specifically authorized by the other party. In effect the partnership mould does not fit.

[133] In dealing with the convertible hedges in which a subsequent trade triggers an immediate common-common position, Mr. Shaw makes the point that if the partnership only arises upon the Guarantor engaging in a subsequent trade, and the effect of that subsequent trade is to be put in a common-common position, then how can it possibly be said that there is any common intent to profit. There is indeed no possibility to profit - there can, therefore, be no partnership.

[134] Mr. Shaw also gives the example of the Husky convertible hedge of Mrs. Scott in which the Crown assessed Mrs. Scott as being in a partnership with her daughter in 1984, yet the first involvement of Patricia Scott in a subsequent trade was in 1985. Up to that point, Mrs. Scott could not have been seen as being in a partnership as the Crown did not allege partnership in any solo convertible hedges. Yet, once a subsequent trade occurs with her daughter, a partnership is somehow backdated to the previous year. Again, the partnership mould does not fit. Mr. Shaw maintains it is simply a result-driven conclusion. A similar example was given with respect to Mr. Rezek's Laidlaw convertible hedge.

[135] The Appellants argue that the partnership does not commence until there is a partnership activity, and if the activity which commences a partnership immediately brings the alleged partnership to an end, it cannot be considered a partnership. All the Guarantor is doing is providing financing.

[136] The Appellants view the Respondent's attempt to find a husband and wife as a commercial partnership as a guise for circumventing Parliament's expressed refusal to tax families as a unit. There is no denying the husband and the wife are in a partnership of marriage, but this does not in any way imply a business partnership.

[137] The Appellants went through some considerable case law, commencing with Continental Bank of Canada v. The Queen,[15] which was relied upon for the proposition that there must be a partnership agreement which governs the affairs of the partnership. Part of that agreement must be to share profits. There is no evidence of any such agreement according to the Appellants. They further rely on Continental Bank for the proposition that if the sole reason for the creation of a partnership is to obtain a benefit from a tax loss, this is not sufficient to constitute the formation of a partnership with a view to profit.

[138] The approach Mr. Shaw urges me to accept is that established in Backman:[16]

... Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. That the alleged partnership must be considered in the totality of the circumstances prevents a mechanical application of a checklist or a test with more precisely defined parameters.

The Appellants referred to the following evidence to support the position there is no partnership:

(i) the Appellants never intended to be partners;

(ii) they never shared profits;

(iii) the documents, specifically the account-opening forms, denied partnership; and

(iv) third parties such as brokers did not consider the Appellants as carrying on a partnership.

[139] In connection with the guarantees, the Appellants' position is that they were a means of financing only, and would have to be recharacterized as redundant if I am to find a partnership existed.

[140] Finally, on the partnership issue, the Appellants had to deal with the Schultz and Carter decisions. Mr. Shaw took two approaches to this argument; first, that they are distinguishable on the facts; and second, that they were decided prior to today's new paradigm based on Shell,[17] Singleton,[18] Stewart v. The Queen[19] and Walls and Buvyer v. The Queen.[20] This new paradigm requires that the Court look to the real legal transactions in relationships, and not focus on economic realities. If there is more than one version of what took place, the Court should not be driven to accept the version that denies tax advantages.

[141] As far as factual distinctions go, a key difference, according to the Appellants, is that in Schultz and Carter the evidence was clear the transactions were undertaken for income-splitting purposes. There is no such evidence in these appeals. Also, those cases dealt with convertible hedges where the opening positions were in two separate accounts. We are faced with that situation in only two of the many cases before me. Also, unlike the Appellants' circumstances, in Schultz there were no solo convertible hedges, or, more significantly, no solo convertible hedges which, upon a subsequent trade involving a Guarantor, allegedly becomes a partnership. As Mr. Shaw put it, "you are a single or a self hedger right up until the millisecond before the alleged shift".

[142] Finally, in addressing the agency issue, the Appellants argue that agency is likewise only a way to circumvent the fundamental principle that families are not taxed as a unit. The Appellants suggest I cannot find agency where the parties deny it. To do so, other than in the case of Muriel Scott, would deny the real relationships with third parties and also render the guarantees redundant.

Respondent's Position

[143] The Respondent classified the convertible hedges as either one account or two account convertible hedges; subcategories were unnecessary. But the convertible hedge, whether in one or two accounts, has to be viewed together as a capital asset, the disposition of which produces income.

[144] Relying on Backman v. Canada[21] and Spire Freezers,[22] the three elements required for a partnership are: a business, carried on in common, with a view to profit. The Schultz case determined that all elements were in evidence in the convertible hedge arrangement before it. The same, according to Mr. Gluch, applies in the convertible hedges before me. These cases are not significantly distinguishable from the Schultz and Carter cases.

[145] The general principles relied upon by Mr. Gluch in asserting this position are:

(i) one partner may run a partnership's affairs for the other partners: there is no need for an equal role (Continental Bank);

(ii) the element of intent is a question of fact (Spire Freezers); and

(iii) a partnership exists not because of the familial relationship but because the couple were in the convertible hedge together.

[146] Although one partner was more active, that is not sufficient to deny partnership, especially where the intent gleaned from their conduct points to the common view to profit.

Analysis

[147] I agree with Mr. Shaw that legal realities cannot be ignored for the sake of surrendering to the economic realities of the situation. He suggested this could be the only justification for the finding of a legal partnership - it accords with economic realities. I suggest a corollary in Mr. Shaw's new paradigm, and that is, where the legal realities, absent sham, can be interpreted in more than one way, one of which is consistent with the economic realities, then decisions should be based on the interpretation where the legal and economic realities mesh. The Respondent maintains that indeed the legal reality is that the convertible hedge strategies were carried on in partnership. The Appellants argue that the legal reality of the convertible hedge is that of two independent investors engaging in their own stock transactions albeit guaranteeing each other's accounts as a means of providing financial support. With respect, I believe each side is attempting to force the square peg into the round hole. The reason, I suggest, is because relying on conventional applications of legal principles to unconventional financial strategies is simply inadequate. To overlap the whole business with the application of tax principles, governed by a piece of legislation that has never been praised for its simplicity, complicates an already complex situation. I do not find that the convertible hedge strategy was carried on in partnership as a business in common with a view to profit. I also do not find the convertible hedge strategy was implemented by two independent investors. What is real, both legally and economically, is that Mr. Rezek, Mr. Hayes, Mr. Stephens and Mrs. Scott invested in convertible hedges, an identifiable separate investment vehicle, a scheme. The Guarantors assisted with the financing of that investment by providing guarantees, supported by the very stock which was part of the adventure: the Guarantors very much became a part of the scheme of profit-making. With the exception of Patricia Scott, they were joint adventurers, and for a period of time, however brief, had an ownership interest in the convertible hedge. My reasons for coming to this conclusion are as follows.

[148] I have already found that none of the Appellants were carrying on a business, but received business income from the disposition of their convertible hedges as an adventure in the nature of trade. A partnership is the relation that subsists between persons carrying on a business in common with a view to profit. As I have indicated, there is a distinction under taxation principles between "carrying on a business" and "engaging in an adventure in the nature of trade". Although the Appellants' adventures were not isolated, as most of them did engage in more than one convertible hedge with a second person, a string of adventures over a period of time does not, in these appeals, constitute carrying on business for tax purposes. Does it though, constitute carrying on business in common with a view to profit for purposes of partnership law? I do not believe so.

[149] The starting point is the definition of business in the Partnership Act of Ontario which includes every trade, occupation and profession. There is no reference to an adventure in the nature of trade. The acquisition and disposition of convertible hedges is neither an occupation nor profession in the ordinary meaning of those words. What is left to consider is whether such activity constitutes a trade. The separate components of the convertible hedge involve trading, and the convertible hedge itself is acquired and disposed of in a trading environment though, as previously established, the convertible hedge itself is not traded. Can there be a business in a product you cannot trade? Where is the market for the convertible hedge? How is it advertised? What do the owners of the business do, apart from some limited communication with an advisor and broker? While the answers might raise scepticism in the idea that convertible hedging activity is a business, the Federal Court of Appeal in Schultz[23] has provided a sufficiently broad meaning of the word to rebut these concerns, as it stated:

... Lindley & Banks on Partnership ... concludes at page 8, that "virtually any activity or venture of a commercial nature ... will be regarded as a business for this purpose". Again, in Smith v. Anderson ... expressed the view that, ...

anything which occupies the time and attention and labour of a man for the purpose of profit is business. It is a word of extensive use and indefinite signification.

In my view, the trading transactions here in issue constituted a "business" as defined in the Ontario statute.

It is apparent that the Federal Court of Appeal did not consider the convertible hedge as a separate asset, being the very subject matter of the alleged "business", but viewed "trading transactions" separately, and consequently well within the ambit of the term "trade". The distinction, I suggest, does not go to the issue of business as much as to the issue of carrying on the business.

[150] Presuming then that the very commerciality of the convertible hedge, being a product of the financial marketplace, justifies there being a business, was it carried on in common with a view to profit? In Continental Bank, little activity was required to find a business was carried on, though, in that case, there was a business being carried on prior to the partnership, and although no new business was created during the partnership, it was sufficient that the existing business was carried on. In the cases before me, I would have to find that Mr. Rezek, Mr. Hayes, Mr. Stephens and Mrs. Scott were all carrying on a business and that business was continued by a partnership upon the involvement of the Guarantor. As noted, I have not found any of them individually were carrying on a business, though they were each engaged in a scheme for profit-making for tax purposes.

[151] In commercial terms can one have a business without carrying on a business? Certainly that is exactly what is contemplated in tax terms given the Act's definition of "business" to include an adventure in the nature of trade. There are situations, such as this, where business is not occasioned by being carried on; it is occasioned by being an adventure. I suggest that all the factors reviewed in determining the issue of trader or adventurer are equally pertinent in a commercial consideration of what is meant by carrying on a business. What is required is an expenditure of time, energy and labour, and trappings of a commercial enterprise, which are non-existent with these Appellants. There was no business being carried on to be continued to be carried on in the form of a partnership.

[152] This raises an interesting dilemma. If there was a partnership when did it commence? I agree with the Appellants that no partnership could have existed until the Guarantor acquired a component of the convertible hedge. The Respondent suggests that the partnership existed for all of the convertible hedges at the time the Guarantor opened accounts and signed the guarantees. Yet the Respondent has not assessed any of the Appellants' solo convertible hedges, entered into after the Guarantors signed account-opening documents, as forming part of the partnership. Only when the Guarantor is introduced to the solo convertible hedge by acquiring a component of the convertible hedge does the Respondent treat the convertible hedge as being in a partnership from the outset. The evidence from the Appellants was that they did not view their solo convertible hedges as any different from the convertible hedges in which a Guarantor ultimately held a component. Neither was carried on in a partnership.

[153] Given there was no partnership agreement, and there was an expressed intent of the parties that they were not in partnership, to find the partnership started when the Respondent suggests would require conduct of the parties overwhelmingly pointing to that finding. Their conduct is more consistent with a finding that, if there was a partnership, it did not commence until the partnership acquired a component of the convertible hedge. Prior to that, the only conduct the Respondent could rely upon would be the execution of the account-opening form and guarantee. Yet the signing of such forms by the Guarantor contained an express declaration this was not done in partnership. The conduct of the Guarantor at that time was consistent with the position that they were establishing independent accounts supported by guarantees from their respective relative. An equally probable view of their activities, and certainly the most likely view in Pat Scott's case, was that they simply signed what was necessary, not for establishing a partnership, but for providing the required margin support to assist their spouse or mother, with their investment. Their subsequent conduct is not sufficient to effectively backdate a partnership to a date when no partnership was intended, nor can be inferred. If there was a partnership, it could not have commenced until the Guarantor acquired a component of the convertible hedge.

[154] The conduct of the Appellants and the Guarantor at the time the Guarantor acquired a component of the convertible hedge likewise does not support a finding of partnership. Apart from the Hayes' two convertible hedges that they opened together in two accounts, in every other convertible hedge involving a Guarantor, the acquisition by the Guarantor of a component of the convertible hedge occurred coincidentally with an Appellant's disposition, which triggered a tax loss. Indeed, Mr. Sildva's evidence was quite blunt. This is why they did it - this is why he got into the business. To trigger an $80,000 tax refund, in Mr. Rezek's case, on a few thousand dollars investment was enticing. But how can it be this event which commenced the alleged partnership? Justice Bastarache pointed out in Continental Bank:[24]

... Lindley & Banks on Partnership makes the following observation:

... if a partnership is formed with some other predominant motive [other than the acquisition of profit], e.g., tax avoidance, but there is also a real, albeit ancillary, profit element, it may be permissible to infer that the business is being carried on "with a view of profit". If, however, it could be shown that the sole reason for the creation of a partnership was to give a particular partner the "benefit" of, say, a tax loss, when there was no contemplation in the parties' minds that a profit ... would be derived from carrying on the relevant business, the partnership could not in any real sense be said to have been formed "with a view of profit".

[155] With respect to the element of a partnership requiring a view to profit, there could have been no contemplation in the Guarantors' minds that there would be any profit from the business purportedly carried on by the Appellants, because in the majority of the convertible hedges in which the Guarantors became involved, it was known at the time of their involvement that the convertible hedge was to be unwound (disposed of) in the near future at a loss. Also, the parties went into a common-common position, with no possible economic benefit to that combined position, shortly after the so-called commencement of the partnership. Knowing the convertible hedge was to be unwound at a loss does not however preclude a finding the Guarantor joined a scheme of profit-making, an adventure in the nature of trade. For, unlike the more stringent law that has developed around partnerships for tax purposes, there are less well-defined principles as to how to treat a scheme of profit-making. When a Guarantor entered the fray by acquiring a component of the convertible hedge, and thus became a part owner of the convertible hedge, the Guarantor joined a scheme already in process. The Guarantor intended, as the conduct was masterminded by Mr. Maguire, that the convertible hedge stay alive. The scheme of profit-making required this, as the scheme involved the three elements of net cash flow, gain on the spread and tax refunds from losses. The Guarantor joined a scheme: the Guarantor did not initiate a partnership.

[156] Some examples will assist in appreciating the timing of the Guarantor's actions. First, look at Mr. Rezek's one and only convertible hedge in two accounts. On May 20, 1988, he sold his long position of Laidlaw for a $138,431 loss, coincidentally with Ms. Fahrngruber acquiring a long position. Less than three months later, Ms. Fahrngruber converted her position into common, resulting in the two of them holding a common-common position. At this point, the change in the spread for Mr. Rezek's initial outlay for acquiring the convertible hedge had gone down approximately $2,600 - the convertible hedge lost that amount on wind-up. That loss was in fact locked in at the time Ms. Fahrngruber acquired her long position. There was no opportunity for profit in the "business" of acquiring and disposing of convertible hedges.

[157] This is even more evident in the example of the Stephens' Alcan hedge (see Appendix "C"). When Terry Stephens acquired 8,000 common Alcan shares in December 1986, coincidentally with Steven Stephens selling his 8,000 Alcan warrants, the Stephens' immediately went into a common-common position, one with no opportunity for any economic gain. Mrs. Stephens' very action of acquiring a component of the convertible hedge immediately terminated the convertible hedge. Put in terms of an alleged partnership, her very act of commencing the partnership simultaneously terminated the partnership. Put in terms of an adventure, her actions were the final necessary ingredient in her husband's adventure, and by taking such action she became part of it, however briefly. There are similar examples in Mrs. Scott's convertible hedges.

[158] There are as well a few examples (a minority) where the acquisition of the Guarantor of a component of the convertible hedge does trigger a gain on the convertible hedge. (Bear in mind this is always accompanied by the alleged loss on the side of the Appellant disposing of a component of the convertible hedge.) For example, on the Stephens' Falconbridge hedge, Mrs. Stephens acquired 10,000 Falconbridge common shares on October 27, 1987, and Mr. Stephens sold 10,000 Falconbridge rights on October 28, triggering a "loss" of $33,894 on Mr. Stephens' sale, but also triggering a gain on the spread, on the convertible hedge, as these transactions put the Stephens' into a common-common position. This signifies a termination of the convertible hedge. So, while in this case there was a gain on the convertible hedge itself, the coincidental impact of Mrs. Stephens entering into the convertible hedge was to put herself and her husband in an immediately non-economic common-common position, a position with no possibility of profit. This is not even for a moment a business being carried on in partnership for profit.

[159] The foregoing is the essence of my reasons for concluding a partnership does not exist in any of the Appellants' cases. There are a couple of other factors, however, which are supportive of this position. First, a fundamental element of a partnership is a partnership contract and no such contract can be inferred from the Appellants' conduct. There remains too much vagueness from the conduct to identify with any certainty the commencement date of the partnership, the capital contributions and the arrangement for sharing of profits, if any. To find a partnership agreement existed I would have to find that the very mechanics of the convertible hedge itself was the totality of the partnership agreement. That is, if a convertible hedge is established in two accounts it follows there is a partnership agreement. This may be what the Respondent wants me to take from the Schultz and Carter cases. I do not find those cases go that far, and I will have more to comment on that shortly.

[160] Another factor to consider is the import of the cross-guarantees. Without these guarantees there could be no two-account convertible hedge, although obviously a solo convertible hedge was still possible. There are two ways to view the guarantees. One, as the Respondent contends, as supporting the notion that the Appellants and Guarantors were, as partners, jointly responsible for the partnership's liabilities. The other, as the Appellants contend, as supporting the notion that the guarantees evidence no partnership, as partners are liable for partnership obligations without the necessity of a guarantee. The guarantees went to the margin requirements, and in effect significantly reduced the margin required in either the Appellants' or 'Guarantors' accounts. It was a means of providing financial support. I do not consider the guarantees on balance as providing any support for a finding that a partnership was carrying on a business. They were certainly part of the convertible hedge strategy but are more consistent with a wife assisting a husband in a financial adventure, as something a spouse does as part of their marriage, rather than as a commercial partnership. As Associate Chief Judge Christie put it in Sedelnick Estate v. M.N.R:[25]

... Where there is no evidence of the existence of an express partnership agreement between husband and wife then in the absence of some special reason, which I cannot at the moment foresee, the existence of such a partnership should not be inferred from the conduct of the parties if that conduct is equally consistent with conduct arising out of the community of interests created by the marriage. ...

[161] It comes now to deal with the Federal Court of Appeal decisions in Schultz and Carter, which the Respondent emphasized are indistinguishable from the cases before me, binding me to find that a partnership existed with the consequential tax treatment sought by the Respondent. As already indicated, the Federal Court of Appeal found the trading transactions constituted a business, given the broadest definition of that term, and proceeded to determine the business was carried on in common with a view to profit. The trading transactions to which the Federal Court of Appeal referred were the separate stock transactions. They do not appear to have been presented with the argument that the transactions of the business were transactions in convertible hedges. This does, I would suggest, put a different spin on the use of the term "trade", for the determination of whether or not a business exists. It was unnecessary then for the Federal Court of Appeal to distinguish the "carrying on of a business" from the "engaging in an adventure in the nature of trade". The facts before me support the latter.

[162] A comparison of the facts in Schultz with the facts before me do establish some significant differences:

(i) The Schultz's agreed to consult Mr. Maguire about income splitting. In all the cases before me, the Guarantor dealt with Maguire, if at all, separate from the Appellant. There was no evidence that such discussion involved meeting any income-splitting objective. The evidence, apart from Pat Scott, suggested the discussion centred on the Guarantors engaging in their own investments. Their subsequent conduct supports a coordination with their spouse's investments, yet does not preclude an intention of a longer term holding of a common stock.

(ii) The Schultz's case involved the issue of an investment club strategy as well as the convertible hedging issue. No such background was present in any of the current appeals, which might have established a compelling backdrop for the finding of a partnership.

(iii) In Schultz, all positions were started with husband selling short and spouse buying long. In only two of the many convertible hedges before me was that the case. In the vast majority, the Appellant would acquire the solo convertible hedge. Only as a result of "tax planning" was the Guarantor introduced to assume a component of the convertible hedge. If the Guarantor never took a component of the convertible hedge, the Appellant would continue to be treated separately as sole owner of the convertible hedge.

(iv) In Schultz, there was no example of Mrs. Schultz ever selling short - she always took the long position. There are several examples of the Guarantors before me taking short positions, with the accompanying incidence of expenses.

(v) In Schultz, all payments for the acquisition of the convertible hedge came from a joint account. Not so for all the Appellants before me. Some had to borrow the initial outlay. Some funded it from their own account.

(vi) In Schultz, there appeared to be no evidence of independent dealings. Indeed, Mrs. Schultz was the driving force and Mr. Schultz simply went along. Apart from Pat Scott, there was evidence of some independent dealing with all of the Guarantors.

(vii) In Schultz, there were no solo convertible hedges, nor evidence of non-hedging investment. There are many solo convertible hedges amongst the Appellants before me, as well as some evidence of independent investing.

(viii) In both Schultz and Carter, it was determined that neither had any reasonable expectation of profit from their own transactions viewed independently from their respective cross-Guarantors. That is not the case here. Mr. Rezek, Mr. Hayes, Mr. Stephens and Mrs. Scott all expected profits from their convertible hedge activities, whether held in one account or two. This is a key distinction. In Schultz and Carter the arrangement could only make economic sense as a partnership, as a business being carried on jointly. The Guarantor in the case before me did not introduce a profit element, that, until their involvement, did not exist. The parties always intended to profit from their adventure in the convertible hedge.

(ix) In Schultz, it was indicated Mrs. Schultz's account was used to pay for Dr. Schultz losses. While margin support was provided by the Guarantors before me, I had no evidence of any payment from the Guarantors to pay for losses.

[163] Yes, the Schultzs and Carters were engaged in similar convertible hedging strategies through the auspices of Maguire & Associates, but the circumstances appear to have been quite different from the facts of the cases before me. It is these distinctions, more so than Mr. Shaw's suggested new paradigm, that allow me to depart from the findings of Schultz and Carter. Yet, the departure is legalistic only, as I concur with the findings in those decisions to the extent that I too believe there existed a coordinated scheme for profit-making. I just do not believe it has sufficient trappings of partnership to characterize it as such. I see it more as an individual engaged in an adventure in the nature of trade, and where appropriate, engaging a second individual in that same adventure.

[164] For these reasons, I do not feel that the Schultz and Carter cases bind me to a finding of partnership in every case of a two account convertible hedge. Only if the facts fit. In the cases before me, the facts do no fit.

[165] The Supreme Court of Canada in the Backman case directed courts in the following manner, in considering the issue of partnership:

[26] Courts must be pragmatic in their approach to the three essential ingredients of partnership. Whether a partnership has been established in a particular case will depend on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances. That the alleged partnership must be considered in the totality of the circumstances prevents the mechanical application of a checklist or a test with more precisely defined parameters.

In applying this common sense approach, I am satisfied the circumstances of these Appellants' convertible hedges do not justify a finding of partnership.

[166] Given my finding on this issue, it is unnecessary for me to review the question of agency. The Respondent and the Appellants, however, have agreed that in the case of Mrs. Scott, Patricia Scott acted as an agent. Patricia Scott's involvement in her mother's convertible hedge was quite different from any of the other parties. I accept the agreement between the parties that indeed an agency relationship existed in the Scotts' situation. In all other two account convertible hedges, the Appellant and Guarantor were co-adventurers in convertible hedging.

(d) Issue

[167] Based on my findings thus far, what tax treatment is to be accorded the convertible hedges, specifically:

(i) determination of when the income or losses on the convertible hedge arise;

(ii) in whose hands the income and losses are taxable;

(iii) the taxation of the cash flow generated during the convertible hedge;

(iv) the tax treatment of the Appellant's position subsequent to the wind-up of a convertible hedge; and

(v) the reliance on the lower of cost or market method of inventory valuation both during and after the convertible hedge.

Appellants' Position

[168] The Appellants' overriding view is that the tax treatment to be afforded the Appellants should not be results driven, but should present the fairest picture of the Appellants' profits over the years in question, in accordance with their legal positions.

[169] The ability of a taxpayer to avail him or herself of the provisions of subsection 10(1) of the Income Tax Act depend on the nature of the business carried on by the taxpayer. The Appellants point out that traders, that is those carrying on business, are eligible for the lower of cost or market treatment, and in certain circumstances so are adventurers. Those circumstances are set out in the amending provisions of subsection 70(1) c. 19, S.C. 1998 the "inventory amending provisions" as follows:

History: S. 10(1) was amended by S.C. 1998, c.19, s. 70(1), applicable

(a) to taxation years that end after December 20, 1995;

(b) in respect of a business that is an adventure or concern in the nature of trade, to taxation years of a taxpayer that end before December 21, 1995, except where

(ii) the taxpayer's filing-due date for the year is after December 20, 1995, or

(ii) the taxpayer has valued the inventory of the business for the purpose of computing income for the year from the business at an amount that is less than the cost at which the taxpayer acquired the property, which valuation is reflected in a return of income, notice of objection or notice of appeal filed or served under the Act before December 21, 1995; and

(c) in respect of a business that is an adventure or concern in the nature of trade, to fiscal periods of a partnership that end before December 21, 1995, except where

(i) the filing-due dates of all of the members of the partnership for their taxation years that include the end of the fiscal period are after December 20, 1995, or

(ii) the partnership has valued the inventory of the business for the purpose of computing income for the fiscal period from the business at an amount that is less than the cost at which the partnership acquired the property, which valuation is reflected in a return of income, notice of objection or notice of appeal filed or served under the Act before December 21, 1995 by any member of the partnership.

[170] Mr. Shaw acknowledges that should I find the Appellants were not carrying on business, but were only engaged in adventures in the nature of trade, then, apart from Mrs. Scott, who may be eligible due to compliance with this section just cited, the Appellants would not be able to avail themselves with the mark to market method of inventory valuation.

[171] The Appellants then go on to argue that the inventory is represented by the two separate components of the convertible hedge, that is, both the long position and the short position can be separately identified as inventory. The Appellants put forth the proposition that both the long position and the short position in securities held in a business of transacting in securities are inventory. And relying on The Queen v. Friedberg,[26] maintains that the two positions do not lose their identity as separate components, certainly in the commodity futures market.

[172] Mr. Shaw, in arguing the short position in the convertible hedge scenario is inventory, had to first establish that the short position is property. He did so by describing the short position as embodying a right, albeit a negative right, but one which can be valued. He cast the property net widely to cover any sort of interest a person may have, including this negative right.

[173] In determining the most accurate picture of the Appellants' profit, Mr. Shaw offers guidelines from the Supreme Court of Canada comments in Canderel Limited v. The Queen,[27] specifically:

... Generally speaking, the courts are free, in the absence of contrary legislation or established rules of law, to assess the taxpayer's computation of income in accordance with well-accepted business principles. Obviously, this will require an assessment in each case of which of these principles apply to the particular circumstances which present themselves. However, it is not for the court to decide that one principle is paramount, or applicable to the exclusion or subordination of all others by saying that it has been elevated to the status of a rule of law which is to be applied in all situations. That is exclusively within the province of Parliament, and the willingness of Parliament to exercise this power is exemplified by s. 18(9) and by countless other codifications in the Act of what would otherwise likely be considered well-accepted business principles: see Symes, supra, at pp. 723-725.

...

... However, when no specific legal rule has been developed, either in the case law or under the Act, the taxpayer will be free to calculate his or her income in accordance with well-accepted business principles, and to adopt whichever of these is appropriate in the particular circumstances, is not inconsistent with the law, and, as I shall elaborate upon below, yields an accurate picture of his profit for the year. The simple application by a court of one or another well-accepted business principle to a particular case or cases, moreover, will not ordinarily amount to the elevation of that principle to the status of a "rule of law". In general, the Minister will not be entitled to insist that one method supported by business practice and commercial principles be employed over another, equally supported method, unless, as I will develop below, the method chosen by the taxpayer fails to yield an accurate picture of his or her income for the taxation year.

Respondent's Position

[174] The Respondent's position, based on a partnership analysis, does not fully address some of these matters. However, it is clear that the Respondent never viewed an Appellant and Guarantor as holding separate positions. The positions should always be netted. Only this approach yields the fairest picture of possible profit.

[175] The Respondent agrees with the Appellants' analysis of subsection 10(1) of the Income Tax Act as it applies to traders, or in its limited application to those engaged in an adventure in the nature of trade. The Respondent suggests that the Appellants were not traders, a suggestion with which I have already concurred. The only Appellant who, as an adventurer, possibly qualifies is Mrs. Scott due to her form of reporting for 1989, 1990 and 1991, in which certain stock were marked to market. Yet, Mr. Rhodes makes three arguments: first, he argues that her reliance on the marked to market method in those years was limited to only certain stock, and, therefore, cannot pertain to any other stock in later years. Second, in a convertible hedge, the inventory is the convertible hedge itself, that is the property to be marked to market, not the component parts. Third, with respect to short positions, he argues that they are not property and, therefore, not inventory. He relies on the proposition from the The Queen v. Dresden Farm Equipment Ltd.[28] case that the taxpayer must have a property interest in the inventory for it to be considered as inventory. Also citing Tip Top Tailors Limited v. M.N.R.,[29] Mr. Rhodes goes on to argue that a "debt is neither an asset nor an investment - even though it may be exposed to the risk of variable value". The short position is not a negative right, as suggested by Mr. Shaw, but is more in the nature of a debt, an obligation to the lender of the security to return that security. Even if short positions were considered property, the application of subsection 10(1) of the Act is inapplicable as rather than valuing at the lower of cost or market, the alleged properties are being valued at the higher of cost at market.

Analysis

(i) When is the convertible hedge disposed of for the purposes of determining the income or loss on a convertible hedge?

[176] The adventure in which the Appellants engaged, the business for tax purposes, is convertible hedging - acquiring and disposing of convertible hedges. The acquisition cost of the convertible hedge is the spread at the time the convertible hedge is fully established. The proceeds of disposition of the convertible hedge are determinable upon the unwinding of the convertible hedge. The timing of that unwinding depends on the nature of steps taken to unwind. In all of the convertible hedges in which a Guarantor was involved, the unwinding was by the action of going into a common-common offsetting position. That action may have been by converting or subscribing to common from the convertible security; it may have been by an abandonment of the convertible security; it may have been by coincidental purchase and sales in two separate accounts. What is significant is that there is an occurrence resulting in a common-common position, and that unwinds the convertible hedge, in effect disposes of the convertible hedge. After that point in time there is no scheme of profit-making; it is acknowledged there is no possibility of a profit. There is certainly no adventure in convertible hedging. What is there? Two people holding identical offsetting positions in a hedge, co-owners of a hedge if you will.

[177] Can the proceeds from the unwinding be identified with certainty? Yes. It is a matter of comparing the spread on acquisition of the convertible hedge with the spread at the time of wind-up. The mathematical calculation is accomplished by comparing all proceeds from the disposition of components of the convertible hedge against all outlays for acquisitions of components of the convertible hedge, occurring during the life of the convertible hedge. This can be seen by referring to Appendix "D", a reproduction of part of Tab 4 of Exhibit 5.3.

[178] If one simply adds all the amounts in column G and column L, representing the outlays and intakes on the components of the convertible hedge, one reaches a positive $6,971. This represents the increase in the spread, or the gain on the convertible hedge. The Respondent declared that a notional disposition was necessary to determine this amount, as there is no actual subsequent disposition of the two positions once they went common-common. I suggest that it does not matter that there is no subsequent disposition for purposes of calculating the gain or loss from the convertible hedge, as that calculation should take place on the actual disposition of the convertible hedge, which is in the case of the co-adventurers at the time they went common-common. In the example in Appendix "D" that would be on July 2, 1987, notwithstanding Mrs. Scott and her daughter continued to hold a common-common position thereafter.

[179] With respect to the convertible hedges held in just one account, in all but two of them, the convertible hedge is unwound by actions that completely dispose of both components of the convertible hedge. Again, this is accomplished in a number of ways including a conversion, or a coincidental purchase to cover the short position and sale of the long position. In the single account convertible hedge it is readily ascertainable what terminated the convertible hedge and when. The difference in the spread is also calculable on the same basis as for the two-person-account convertible hedge.

[180] In only two cases, the Hees stock held by Mr. Hayes and Mrs. Scott, did the Appellants hold a position, in both cases a long position in Hees warrants, subsequent to the disposition of the convertible hedge. In both those cases, the warrants were abandoned in the year following the unwinding of the convertible hedge. However, the gain or loss on the convertible hedge is still determinable, as in all other cases, at the time of unwinding, by the same mathematical formula. It is inappropriate to make such a calculation when the warrants are actually abandoned. At the time the warrants are abandoned by Mr. Hayes and Mrs. Scott there is no gain or loss attributable to the warrants: the cost of the warrants at the time of unwinding the convertible hedge would be zero and the proceeds on abandonment are likewise zero.

[181] An aspect of these cases critical to the Appellants is whether alleged losses, incurred during the life of the convertible hedge, on a disposition of a particular component of the convertible hedge, are deductible to the Appellants. The simplest example to review is Mr. Rezek's Laidlaw convertible hedge. Looking again at Appendix "A", we can determine the loss in the convertible hedge was $2,880, relying on the method I have previously outlined; that is, the income and outlays of both co-adventurers in convertible hedging up to the date of disposition of the convertible hedge being August 12, 1988. On May 20, 1988, Mr. Rezek claims a loss on the sale of the long component of the convertible hedge. But the convertible hedge has not actually collapsed. It continues in two accounts. In the life of the convertible hedge there has been no disposition. In tax terms this can perhaps be described as a rollover of the convertible hedge from a single account to a dual account convertible hedge. The co-adventurer, Gloria Rezek, has now joined Mr. Rezek in his convertible hedge adventure. The property forming the substance of the adventure, the convertible hedge itself, has not changed; it has not been disposed of. There is simply no disposition for tax purposes until the subject matter of the adventure has been disposed of. This does not ignore the legal realities as Mr. Shaw might proclaim. Indeed, it is the legal reality.

[182] The Appellants were engaged in a profit-making scheme, an adventure in convertible hedging. The documents, their actions and, yes, the economics all point to this conclusion. To pluck one legal transaction out of the context of this adventure and tax it separately is not correct within the scheme of the Income Tax Act. This is not a matter of one accounting method being preferable to another; it is a matter of identifying what is to be captured by the provisions of the Income Tax Act - what is taxable. And what is taxable is the subject matter of the adventure - the convertible hedge.

[183] Subsections 3(a) and 9(2) of the Income Tax Act read:

3 The income of a taxpayer for a taxation year for the purposes of this Part is the taxpayer's income for the year determined by the following rules:

(a) determine the total of all amounts each of which is the taxpayer's income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada, including, without restricting the generality of the foregoing, the taxpayer's income for the year from each office, employment, business and property,

...

9(2) Subject to section 31, a taxpayer's loss for a taxation year from a business or property is the amount of the taxpayer's loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source with such modifications as the circumstances require.

[184] There must be a source and the loss must be from that source, business or property. The source in these cases is the convertible hedge adventure, the business for tax purposes - it is not stock trading. This is an entirely different situation from either the Ludco or Singleton cases, where in the latter it was determined that separate events must be viewed independently for an appropriate application of the Act. In the cases before me the separate components must be viewed together as only together do they constitute the business, the source to be taxed. I am not in any way derogating from the principles enunciated in Mr. Shaw's new paradigm; indeed, I am relying on them to determine the true legal reality of the situation before me.

(ii) In whose hands is the gain or loss in the two-account convertible hedge taxable?

[185] I have determined that in the two-account convertible hedge the parties involved were co-adventurers, with the gain or loss from the convertible hedge determinable upon the wind-up of the convertible hedge. The wind-up is triggered by the parties taking their convertible hedge position to a completely equally offsetting common-common position. The scheme for profit-making convertible hedge becomes a hedge with no possibility of profit. If one position goes up, the other goes down in an exactly equivalent amount. This reflects an equal ownership position in the convertible hedge just ended and in the hedge just started.

[186] Not having appreciated the somewhat complicated legal niceties of their positions, the Appellants would not have had any agreement as to who was to claim the income or loss from the disposition of the convertible hedge. They accounted for each component separately, which I have found is inappropriate for taxing purposes. I cannot point to any purported agreement as to the sharing, if any, of the income or loss from the disposition of the convertible hedge. It just was not contemplated by the Appellants. Therefore, as the co-adventurers did not have an explicit agreement as to who was entitled to the income or loss, the best evidence to rely upon in apportioning the income or loss on wind-up is to regard the result of the wind-up itself, the result being the exactly equal common-common positions. I determine that the income or loss on wind-up therefore is likewise to be shared equally. That best reflects what the parties agreed to by implication from their actions.

(iii) How is the cash flow, generated throughout the holding of the convertible hedge, taxed?

[187] With respect to the tax treatment of the cash flow (the income from the long position versus the expenses on the short position during the convertible hedge's life), it is only the two-account convertible hedges that are at issue. Does the reasoning for finding equal treatment on wind-up pertain similarly to the treatment to be afforded to the cash flow? Is it to be a net determination divided equally between the co-adventurers based on their equal positions on wind-up? Only, I would suggest, if there is no agreement to the contrary. It is one thing to determine an ownership interest of property in an adventure in the nature of trade at the time of the disposition of such property, based on the resulting position from the disposition: it is quite another to find on that basis alone that the co-adventurers agreed to be treated equally in every respect throughout the duration of the ownership of the property, especially where the ownership may have been initiated in only one party's hands. In reality, with the exception of Gloria Fahrngruber, each of the co-adventurers regarded the income or expense from the component of the convertible hedge held by him or her as particular to him or her. There was no sharing of the respective income or expense. Unlike a partnership, where the rules are clear as to the allocation of the income and expense, the adventure in the nature of trade is less certain, especially so when the co-adventurers are uncertain legally as to the status or nature of their adventure. Without appreciating that they were dealing with a separate property, they agreed, by their actions, to record separately the income or expense from the separate components. I am aware of nothing that precludes one co-adventurer from agreeing to take the expense and the other the income from the property during the adventure, though still agreeing on the disposition of the property on wind-up to share the profits or losses from such disposition equally. The fact alone of co-ownership of the convertible hedge as part of an adventure in the nature of trade, does not in and of itself, imply an equal sharing of the net cash flow, especially where the co-adventurer's actions indicate otherwise. Unlike the situation upon winding-up of the convertible hedge, where the co-adventurers actions point to an equal position, there is not sufficient evidence to make a similar finding of an equal sharing of the net cash flow.

[188] There is though a separate agreement with respect to the cash flow in the case of Gordon Rezek. Ms. Fahrngruber objected to paying tax on dividends, which, as far as she was concerned, she never received. Mr. Rezek agreed to pay her ensuing tax liability. This arrangement suggested the parties intended that only Mr. Rezek accounts for the net cash flow. In his appeal, therefore, the net cash flow is to be taxed solely in his hands. Of course, as Mrs. Scott and her daughter were in an agency relationship, the net cash flow is taxable solely in Mrs. Scott's hands.

(iv) How are the Appellants to be taxed on their stock holdings after the unwinding of the convertible hedge, where they are left in a common-common position?

[189] This requires an examination of their status at that point. It would be difficult to suggest that once an Appellant unwound the convertible hedge and simply sat on the stock for a period of time that his or her activity has moved along Mr. Shaw's evolutionary chain from adventurer to trader. No, if anything, the Appellant has defied evolution and headed back towards capital property treatment. There is no evidence of any of the Appellants engaging in significantly greater stock trading transactions once a convertible hedge has ended.

[190] On all the indices of an adventurer in the nature of trade versus capital property reviewed earlier, the Appellant's actions are not sufficient once they are in a common-common position to qualify even as an adventurer. The adventure of convertible hedging certainly has ended - has a new adventure begun? No. There was no evidence that going into a common-common position was considered by any of the Appellants as entering a scheme for profit-making. The sentiment was unanimous that this position, by its very nature, gave rise to no possible economic benefit. As Mrs. Scott called it, an inactive hedge. Also, all Appellants held the common-common position for some considerable period of time. There was no incentive for any quick disposition. Neither was there any evidence of any income-splitting intention at the time of going common-common. Indeed, in a couple of Mr. Hayes' common-common positions with Mrs. Hayes, it was he who held the long income producing position and Mrs. Hayes who held the short expense side position. Finally, there were not a great many common-common positions even held by any of the Appellants, and with respect to those few positions there was little, if any, ongoing activity. They were simply left untouched.

[191] This leads me to the conclusion that once the convertible hedge ended by going into a common-common position, not only did the convertible hedge adventure come to an end, no new adventure started. The Appellant and Guarantor held a common-common hedge as capital property.

[192] Mr. Shaw says, just as with the convertible hedge, the common-common position represents two separate identifiable positions - naked long in one account and naked short in the other. Mr. Gluch, however, argues that no, these individuals remain in a partnership. I reject both notions. Just as there was no partnership in the convertible hedge, as there was no business being carried on, there is no partnership in the common-common hedge. There is neither an adventure in the nature of trade. As already made clear, there is zero possibility of any economic gain. What is left is the simple ownership of capital property. And just as I found the convertible hedge was a property, so too do I find the common-common hedge is a property. There exists a right of each individual in the common-common hedge to call for and rely on the margin support of the other. The significant difference, of course, from the convertible hedge, where the scheme is entered with a view to profit, is that there is no possibility of profit in the common-common hedge.

[193] The holders of the common-common hedge hold the property, the common-common hedge, together, completely equally, not as partners, nor as co-adventurers, but simply as co-owners of capital property. The common-common hedge cannot by its very nature ever be considered a source of income. It is a position, according to the experts and broker, that could not be held in one account, as the two components would simply cancel each other out. In two accounts it is effectively a taxable nothing. What happens from a tax perspective when one side or the other deals with the component held? Nothing. Neither side can "cash in" its position without the proceeds remaining in the account to continue to provide the necessary margin support for the other side. In effect, the hedge continues. Indeed, it is absurd to imagine, with these Appellants, that one position would be closed out without the coincidental closing of the other. The legal reality of a common-common position is the co-ownership of a hedge, something that yields, for tax purposes, no tax impact. It just does not belong on the list of sources identified in section 3 of the Act.

[194] As there is no source, there can likewise be no taxable income nor deductible expenses arising from the common-common position prior to disposition. There is no net cash flow. There will always be a zero result on the co-owned common-common hedge. One side cannot deduct compensatory dividends while the other brings taxable dividends into income; that ignores the legal and economic reality that this hedge is not a source of income and not caught up in the scheme of the Act.

(v) Can an Appellant rely on the lower of cost or market method of inventory valuation during or after the convertible hedge?

[195] There are two aspects of inventory write-down with which these cases deal; first, the inventory of the adventurers in convertible hedging; second, the inventory outside the convertible hedge. I have dealt with those engaged in convertible hedging and found them to be adventurers. I have also found the property in their adventure is a separate property of the convertible hedge - that is the inventory. I have also determined that once the position becomes a common-common hedge, that the individuals co-own the hedge as capital property, but it is not a source for tax purposes.

[196] With this background, the starting point is a review of subsection 10(1) of the Actand the inventory amending provisions.[30] Section 10(1) reads:

10(1) For the purpose of computing a taxpayer's income for a taxation year from a business that is not an adventure or concern in the nature of trade, property described in an inventory shall be valued at the end of the year at the cost at which the taxpayer acquired the property or its fair market value at the end of the year, whichever is lower, or in a prescribed manner.

Mrs. Scott is the only one in the potential position of adopting the mark to market method, as only she valued stock less than cost, and reflected that in returns of income before December 21, 1995, namely, in her 1989, 1990 and 1991 returns. None of the other Appellants can raise this argument. Mr. Hayes may have completed a return on this basis, but it was past the critical time of December 21, 1995.

[197] I look first then to Mrs. Scott's treatment of her stock as inventory while such stock was held as part of the convertible hedge. The key distinctions between this situation and the commodity future situation of Friedberg[31] is that although the Federal Court of Appeal referred to the commodities' spread, it did not view the spread as in and of itself the property at issue. The legs of the spread were considered as separate holdings and consequently, could be, and were, separately afforded the lower of cost or market treatment. It is interesting to note the Supreme Court of Canada's comment in this case that:

... Similarly, while we recognize that the "lower of cost or market" method advocated by the respondent suggests that unincurred losses can be deducted in the calculation of income, no unincurred losses were deducted by the respondent on the facts of this case. Accordingly we need not determine the income tax validity of this implication of the "lower of cost or market" method in this case. ...

[198] The convertible hedge is not the same as the commodity future contracts. The convertible hedge is a property that by its nature demands the marked to market method to be applied to the whole, not separately to the components. From the evidence of the experts, the broker, and the Maguire associate, it appears that the value of the spread can be determined at any point in time. It is that value that is to be compared to the opening cost of the spread, the opening cost of the convertible hedge, in determining what additions or deductions are to be made from income by way of inventory adjustment. To be clear on what is intended I refer to the Labatt convertible hedge held by Mrs. Scott in 1992 which she disposed of in 1993. In 1992, she claimed a fair market adjustment of the Labatt short position of $16,828, representing the difference in her short sale proceeds and the December 31, 1992 fair market value of the Labatt common stock (as the value of the stock increased, that increased value represents a decrease in the short position value for inventory purposes). On the long side, the Labatt convertible shares increased $10,000 in value over costs, so she relied on the lower of cost to determine no change in inventory value on the long side. In accounting for each position separately, she records therefore the alleged $16,828 loss on the short side only. This, however, does not reflect the appropriate change in inventory value of the convertible hedge itself, if the convertible hedge is considered the inventory. The change would be the difference between the opening spread position (approximately $12,000) and the spread position at December 31, 1992 (approximately $4,500) - in effect a $7,500 difference. That is the true reflection of the changed inventory position.

[199] Continuing to use the Labatt stock as the example, is Mrs. Scott entitled to claim the approximate $7,500 adjustment, relying on the fact that she reported certain individual stocks on the mark to market method in 1989, 1990 and 1991? Let me repeat the pertinent words of the inventory amending provisions, in that it applies except where:

... the taxpayer has valued the inventory of the business for the purpose of computing income for the year from the business ...

Mrs. Scott did not, in 1989, 1990 or 1991, value the inventory of the convertible hedging business, being the convertible hedge as a separate property, at an amount less than cost. She did value some separate components of the hedge, but as it has been seen, that leads to an altogether different result than if the convertible hedge inventory itself had been valued. Mrs. Scott did not value the inventory of the business of adventuring in convertible hedges at less than cost at any time. She did not do so, as she simply did not appreciate that was the nature of the inventory with which she was dealing. She marked certain stock to market in 1989, 1990 and 1991 on the basis she was engaged in separate stock transactions. Her reliance, therefore, on subsection 10(1) of the Act in years subsequent to 1989, 1990 and 1991 must be limited to the business arising as a result of adventures in separate stock transactions, not the business of adventuring in convertible hedges. An adventure in the sophisticated financial form of convertible hedges is distinct from an adventure in the stock market in stock trading transactions.

[200] In reviewing Mrs. Scott's claims for an inventory adjustment the following adjustments involve stock that was at the time of the adjustment part of the convertible hedge, and therefore for the foregoing reasons not eligible for adjustment:

Stock	Year
Husky	1984
Cambridge	1986
Minnova	1988, 1990, 1991, 1992
Federal Industries	1990, 1991
Ivaco/Dofasco	1990, 1991, 1992, 1993
Memmotec	1991, 1992, 1993
Labatt	1992

[201] I turn now to Mrs. Scott's stock for which she seeks an inventory adjustment at a time when such stock was no longer part of convertible hedge, being:

Stock	Year
Husky	1985
Westar	1987, 1988
Falconbridge	1988
Hees	1990
Cambridge	1991
Canhorn	1993
Horsheim	1993
Cascades	1993
Placer	1993

Four of the stock which Mrs. Scott attempts to adjust (Husky, Falconbridge, Cambridge and Placer) were held in common-common positions with her daughter, her agent. As the parties have agreed this case was an agency relationship, (as opposed to a co-owner of the common-common hedge with her daughter). It is as if Mrs. Scott held both sides in her own name. The evidence was clear that a broker would not permit one account to hold offsetting positions - they would simply cancel each other out. That, I find, must be the effect of the agency relationship in Mrs. Scott's case. She legally holds nothing; there is nothing to write down, nothing to tax. That leaves the long positions in Westar, Hees, Canhorn and Horsham and the short position in Cascades. As I have found that after the wind-up of the convertible hedge, no Appellant was engaged any longer in an adventure in the nature of trade, the long positions held by Mrs. Scott were simply held by her as capital: inventory adjustments are not available.

[202] That leaves only the short position in Cascades. If a short position is not property, it cannot be inventory. If a short position is property, then based on my previous analysis of the status of Mrs. Scott outside her convertible hedges, that is, that she simply holds capital property, then I would find this type of property held by her would likewise be capital and, therefore, not inventory. It is therefore unnecessary for me to go through the exercise of determining whether or not a short position is property for inventory purposes, as whether it is or is not, Mrs. Scott would not be in a position to claim it as inventory.

(e) What is the effect of the subsection 39(4) of the Income Tax Act elections purportedly filed by Mrs. Hayes and Mrs. Scott?

Appellants' Position

[203] The Appellants maintain that both Mrs. Hayes and Mrs. Scott filed valid subsection 39(4) elections: Mrs. Hayes filed hers in July 1996, with the filing of her 1992 return and Mrs. Scott filed her election in March 1991 for her 1990 taxation year. In keeping with Mr. Shaw's position that components of both a convertible hedge and a common-common hedge are to be viewed separately, he argues that any gains arising from either Mrs. Hayes' or Mrs. Scott's stock dispositions after 1992 and 1990, respectively, should be on capital account. Late elections in these cases do not constitute retroactive tax planning and are perfectly valid.

Respondent's Position

[204] Mr. Rhodes declares that both Mrs. Hayes' and Mrs. Scott's elections are invalid as they are both filed too late. It is not open to a taxpayer to see which way the wind blows on security holdings and then file a subsection 39(4) election for past years. If a return is filed late, then even though the election is filed with the return, it is likewise late and there is no provision for a late-filed election. Mr. Rhodes did recognize that it is a rebuttable presumption that because there is no provision for filing an election late, then the taxpayer simply cannot make an election.

Analysis

[205] Firstly, with respect to Mrs. Hayes, the only property to which her subsection 39(4) election, if valid, would apply in the taxation years under appeal would be the property disposed of in 1992. Such a property, at that time, was part of a common-common hedge, which, as previously indicated, is not a property capable of increasing in value and, therefore, not subject to tax. The election is meaningless for such property.

[206] I reach a similar conclusion with respect to stock dispositions arising from Mrs. Scott's common-common positions held with her daughter, her agent. As I found earlier, such positions are a taxable nothing. It appears the only such disposition in an assessment year is the Cambridge stock in 1992.

[207] Having found that individual stock dispositions after the unwinding of the convertible hedge are not part of an adventure in the nature of trade, but are on capital account, a subsection 39(4) election is redundant.

[208] It then only remains to determine whether a subsection 39(4) election applies to the unwinding or disposition of the convertible hedge itself. I do not believe it does. Subsection 39(4) reads:

Except as provided in subsection (5), where a Canadian security has been disposed of by a taxpayer in a taxation year and the taxpayer so elects in prescribed form in the taxpayer's return of income under this Part for that year,

(a) every Canadian security owned by the taxpayer in that year or any subsequent taxation year shall be deemed to have been a capital property owned by the taxpayer in those years; and

(b) every disposition by the taxpayer of any such Canadian security shall be deemed to be a disposition by the taxpayer of a capital property.

It refers specifically to a Canadian security which is defined pursuant to subsection 39(6) as:

For the purposes of this section, "Canadian security" means a security (other than a prescribed security) that is a share of the capital stock of a corporation resident in Canada, a unit of a mutual fund trust or a bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation issued by a person resident in Canada.

[209] A convertible hedge, not surprisingly, is not part of such a definition. Any gain or loss incurred by Mrs. Scott on the disposition of a convertible hedge is on income account, unaffected by any subsection 39(4) election. It becomes unnecessary for me to determine the question of the validity of the elections.

(f) How are unused compensatory dividends to be treated for tax purposes?

Appellants' Position

[210] The Appellants point out that the effect of subsection 260(5) of the Income Tax Act along with paragraph 82(1)(a) is to only allow the deductibility of compensatory dividends made by an Appellant up to the amount of taxable dividends received by the Appellant. Any excess compensatory dividends should intuitively be added to the cost base of the short position. Mr. Shaw in effect maintained this was the only sensible result, and he relies on Professor Kirzner's explanation of frictions, expenses of the convertible hedge, as evidence of a well-accepted principle to that affect.

Respondent's Position

[211] The Respondent's position was that the rules in section 260 and paragraph 82(1)(a) are exhaustive, and because paragraph 82(1)(a) does not deal with the excess compensatory dividends one can only fall back on subsection 260(6) which imposes a blanket prohibition on the deduction of the compensatory dividends, thus denying any deduction directly or indirectly of unused compensatory dividends. There are no well-established principles to support the Appellants' positions and certainly Professor Kirzner's evidence does not go that far.

Analysis

[212] The relevant provisions are subparagraph 82(1)(a)(ii) and subsections 260(5) and (6) which read as follows:

82(1) In computing the income of a taxpayer for a taxation year, there shall be included

(a) the aggregate of

...

(ii) the amount, if any, by which

(A) the total of all amounts received by the taxpayer in the year from corporations resident in Canada as, on account of, in lieu of payment of or in satisfaction of, taxable dividends, other than an amount included in computing the income of the taxpayer because of subparagraph (i) or (i.1)

exceeds

(B) where the taxpayer is an individual, the total of all amounts paid by the taxpayer in the year that are deemed by subsection 260(5) to have been received by another person as taxable dividends,

plus

...

260(5) For the purposes of this Act, any amount received (other than an amount received as proceeds of disposition or an amount received by a corporation under an arrangement where it may reasonably be considered that one of the main reasons for the corporation entering into the arrangement was to enable it to receive an amount that would otherwise have been deemed by this subsection to be a dividend)

(a) under a securities lending arrangement from a person resident in Canada, or a person not resident in Canada where the amount was paid in the course of carrying on business in Canada through a permanent establishment as defined by regulation, or

...

as compensation for a taxable dividend paid on a share of the capital stock of a public corporation that is a qualified security shall, to the extent of the amount of that dividend, be deemed to have been received as a taxable dividend on the share from the corporation.

260(6) In computing a taxpayer's income under Part I from a business or property

(a) where the taxpayer is not a registered securities dealer, no deduction shall be made in respect of an amount that, if paid, would be deemed by subsection (5) to have been received by another person as a taxable dividend; and

(b) where the taxpayer is a registered securities dealer, no deduction shall be made in respect of more than 2/3 of that amount.

Prior to June 1989, subsection 260(6) read:

260(6) In computing the income of a taxpayer under Part I from a business or property, no deduction shall be made in respect of an amount that, if paid, would be deemed by subsection (5) to have been received by another person as a taxable dividend.

I interpret these provisions as limiting the ability of a borrower of securities to deduct compensatory dividends only as against taxable dividends received. Any excess compensatory dividends are not addressed in clause 82(1)(a)(ii)(B). The Appellants say it is both intuitive and a well-established principle that such unused portion is to be added to the cost base of the short position. The Respondent says such unused compensatory dividends are simply subject to subsection 260(6) of the Act, which makes them non-deductible. I agree with the latter position.

[213] To accept the Appellants' positions flies contrary to subsection 260(6), as an increase in the cost base of the shares sold short would reduce the income gain on covering the short position. In effect, capitalizing the unused compensatory dividends defers a direct deduction from income to a later year. This is what subsection 260(6) specifically prohibits.

[214] Obviously, the situation cannot arise when an Appellant and Guarantor are in a common-common position as compensatory dividends will always equal dividends received on the long position. So it is only in the convertible hedge scenario or a naked short scenario where unused compensatory dividends may arise. I appreciate Mr. Shaw's reliance on what may seem intuitive or what might make the most common sense. However, this does not lead to a finding to a well-established principle. I am not satisfied there is any such well-established principle notwithstanding Mr. Rezek may have accounted for unused compensatory dividends in that fashion. Failing that, I am left with clear prohibitory language in subsection 260(6). Unused compensatory dividends cannot be deducted nor capitalized.

Conclusions

[215] The difficulty with these cases is the shortcoming of personal property and commercial laws in defining late twentieth-century financial arrangements, compounded by tax principles that require clarity and certainty for their proper application. So, Mr. Shaw well asked, repeatedly, what is real? I have attempted to determine what is real for tax purposes. What legal position did the Appellants hold? What did they dispose of? When? How were they to be taxed? As there are 26 taxation years under appeal in these appeals I find it expedient to simply provide conclusions to these questions. I will then go through one Appellant, Mr. Rezek, by way of example to illustrate the effect of these conclusions. This should enable the parties to redraft their reconciliation schedules for all Appellants. The conclusions are as follows:

1. A convertible hedge is a separate identifiable property.

2. The Appellants' dealings in convertible hedges were adventures in the nature of trade engaged in solely by an Appellant in a single account convertible hedge and, with the exception of Mrs. Scott, engaged in jointly with the Guarantor in a two-account convertible hedge - co-adventurers not partners.

3. Mrs. Scott and her daughter were in an agency relationship, requiring all cash flows as well as any income or losses on the disposition of convertible hedges to be solely for Mrs. Scott's account. As an individual cannot hold a common-common position, such position between Mrs. Scott and her agent daughter simply cancel each other out for all purposes.

4. The only gain or loss on a convertible hedge is the increase or decrease in the spread, calculated by determining the difference between all income on short sales versus outlays on long purchases during the life of the convertible hedge.

5. The convertible hedge is wound-up or disposed of in the case of the two-account convertible hedge, when the two accounts first go into a common-common position, not when there is a disposition of a common-common position.

6. The disposition of the two-account convertible hedge results in a gain or loss to be divided equally between the co-adventurers.

7. There are no taxable dispositions from a source during the life of the convertible hedge triggering either a deductible loss or income or capital gain. The only source is the convertible hedge itself. To be clear, and by way of example, Mr. Rezek did not incur a $138,000 loss on his Laidlaw stock.

8. Other than in Mrs. Scott's and Mr. Rezek's appeals, the income and expense arising during the life of the convertible hedge (the net cash flow) is allocable to the Appellant or Guarantor in accordance with their respective holdings in the short or long position. It is not to be netted and divided equally, nor netted and allocated to just one of the co-adventurers, except in Mr. Rezek's case, where it is to be netted and allocated entirely to Mr. Rezek. For the sake of completeness, any income or expense from a credit or debit balance in an account arising from transactions making up the convertible hedge, notwithstanding such income or expense arises after the disposition of the convertible hedge, shall likewise be treated as income or expense of the account holder. Such income or expense is distinguishable from income or expense arising from a common-common hedge.

9. A common-common hedge in two accounts is a property owned equally by two people (who are neither in partnership nor engaged in an adventure in the nature of trade), with no possibility of an income or decrease in value - it remains constantly at zero, resulting in neither any gain or loss on disposition, nor any income or expense while held. It is not a source for tax purposes.

10. None of the Appellants are eligible to write-down inventory.

11. Subsection 39(4) does not apply to the convertible hedge or the common-common hedge.

12. Unused compensatory dividends cannot be added to the cost base of shares sold short for purposes of determining any resulting gain.

13. Should the application of any of the foregoing conclusions:

(i) result in any greater tax liability than assessed to an Appellant in any particular taxation year, the appeal for that year is simply dismissed;

(ii) result in a lesser tax liability to an Appellant in a particular taxation year than sought by the Appellant, the appeal is allowed to reflect such lesser tax liability.

[216] To illustrate the effect of these conclusions the following is an indication of the consequences flowing to Mr. Rezek for 1988:

(i) He experienced a business loss on the disposition of the Laidlaw convertible hedge of half of $2,880.48 (Ms. Fahrngruber experiencing the other half).

(ii) He incurred no deductible loss of $138,431 on the sale of 10,100 Laidlaw stock.

(iii) The dividend income attributable to Mr. Rezek from Laidlaw stock was that arising while he held the Laidlaw preferred shares from April 27 to May 20, and while Ms. Fahrngruber held the Laidlaw preferred shares from May 20 to August 12.

(iv) The compensatory dividends on the Laidlaw short position are attributable to Mr. Rezek up to August 12 (the start of the common-common position).

(v) There was no dividend income or expense arising from the Laidlaw common-common hedge after the establishment of that hedge on August 12.

(vi) Mr. Rezek had a $1,300 business loss on the disposition of the Royal Bank convertible hedge.

[217] For Mr. Rezek's 1989 appeal the following consequences flow:

(i) There is no dividend income or expense arising from the Laidlaw common-common hedge. Only the management fee of $9,660 which related to a purported benefit arising during the convertible hedge, is deductible.

(ii) Mr. Rezek had a $3,789 business loss on the disposition of the Westcoast convertible hedge.

(iii) Mr. Rezek is entitled to no fair market value adjustment of inventory of $193,054.

[218] This one example illustrates the effect of my findings. I do not believe it is necessary to go through the remaining 24 taxation years under appeal. The parties should be able to sort that out. The exercise does bring home however the significant impact these findings will have on Mr. Rezek and the rest. Particularly of concern is the alleged "management fee" paid to Mr. Maguire for the illusory tax benefits. This may not be considered by Mr. Rezek, in hindsight, as money well spent. The enticement, as Mr. Sildva put it, of significant tax refunds on minimal dollar investments is not real - legally or economically. Regrettably, well-intentioned, yet perhaps naive, investors saw the convertible hedge for something more than what it was. What it was, was an investment property with a potential positive cash flow and a potential to increase in value over a relatively short period. Mr. Hayes certainly understood this. It was not, however, a guarantee of a significant tax refund.

[219] As is clear from comments throughout this judgment, I am of the view our taxation laws must exhibit sufficient elasticity to accommodate novel financial arrangements without having to resort either to relying entirely on economic realities, or to deeming legal relationships that in fact do not exist. So I have approached questions such as what is property and what is a source with both an eye to the true legal nature and an eye to adaptability of tax laws to the moving target of financial innovation.

[220] I would like to thank counsel for their diligence, cooperation and thoroughness in their preparation and presentation of the matters before me. The appeals have been most capably argued.

[221] Some appeals are dismissed due to the circumstances set forth in item 13(i) of paragraph 215. The remaining appeals are allowed and the assessments are referred back to the Minister for reconsideration and reassessment in accordance with these reasons. Although there was some suggestion at the conclusion of the trial as to the possibility of argument on costs, I do not find that will be necessary. I award costs to the Respondent on the basis of 75 per cent of the costs calculated in accordance with the Court's tariff. While the Respondent has been substantially successful in the appeals, I have not accepted their major argument regarding the existence of partnerships. It is for that reason I am awarding less than the full tariff.

Signed at Ottawa, Canada, this 9th day of September, 2003

"Campbell J. Miller"

Miller J.

REZEK V. HMQ

Analysis of Security Transactions-Laidlaw [1]

GORDON REZEK ACCOUNT

GLORIA FAHRNGRUBER (REZEK) ACCOUNT

Date

Investment Instrument

# Units

Price/Units ($)

Amount($)

Income/(loss)

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

Position

Transaction Type

Position

27-Apr-88

Laidlaw Trans Ltd - B NVS

Short sale

30,704

20.012

612,925.52

27-Apr-88

Laidlaw Trans CV 1st PR-F

[3]

Long purchase

10,100

60.891

(615,506.12)

27-Apr-88

Laidlaw Trans Ltd - B NVS

Short position

30,704

27-Apr-88

Laidlaw Trans CV 1st PR-F

[3]

Long position

10,100

20-May-88

Laidlaw Trans CV 1st PR-F[3]

[3]

Sale

10,100

47.250

477,075.00

(138,431.12)

Purchase

10,100

47.250

(477,375.00)

20-May-88

Laidlaw Trans Ltd - B NVS

Short position

30,704

20-May-88

Laidlaw Trans CV 1st PR-F

[3]

Long position

10,100

12-Aug-88

Laidlaw Trans CV 1st PR-F[3]

[3]

Conv'n from pref to 30,709 common

10,100

12-Aug-88

Laidlaw Trans Ltd - B NVS

Conv'n to Common from pref

30,709

12-Aug-88

Laidlaw Trans Ltd - B NVS

Short position

30,704

Long position

30,709

25-Aug-88

Laidlaw Trans Ltd - B NVS

Sale

14.875

24.37

(53.35)

25-Aug-88

Laidlaw Trans Ltd - B NVS

Short position

30,704

Long Position

30,704

20-Feb-92

Laidlaw Trans Ltd - B NVS

Purchase

1,000

11.000

(11,000.00)

8,962.40

25-Feb-92

Laidlaw Trans Ltd - B NVS

Sale

1,000

11.250

11,185.00

(4,360.11)

25-Feb-92

Laidlaw Trans Ltd - B NVS

Short position

29,704

Long position

29,704

22-Feb-95

Laidlaw Trans Ltd - B NVS

Transfer from Gloria's

Account

29,704

N/A

(461,752.17)

131,210.95

Transfer to Gordon's Account

29,704

N/A

461,752.17

$1,742.23

$ (4,413.46)

Note:

[1] Source: Various brokerage statements for dates indicated.

[2] Effective May 22, 1991, Walwyn Stodgell Cochran Murray merged with Midland Walwyn.

Brokerage house changed to Richardson Greenshields efective May 22, 1991.

Brokerage house changed to First Marathon effective Sept. 9, 1992.

[3] During 1988, 4,460,583 Laidlaw First Preference share Series F were converted to

13,561,915 Class B Non-voting shares (ratio of 1:3.040). Source: Laidlaw Transportation Ltd. 1988 Annual Report.

Hedge Summary

Gordon Rezek Account $1,742.23

Gloria Rezek Account (4,413.46)

Cumulative net income/(loss) (2,671.23)

HAYES vs. HMQ

Analysis of Security Transactions-Walker Resources Inc. [1]

PHILIP HAYES ACCOUNT

PATSY HAYES ACCOUNT

Date

Investment Instrument

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/(loss)

Position

30-Jul-85

Walker H Resources Ltd.

[4]

Short sale

4,650

33.250

153,822.95

30-Jul-85

HWalker Res8.5% Deb15Jan94

Long Purchase

150,000

108.310

(162,988.97)

30-Jul-85

Walker H Resources Ltd

Short Position

4,650

30-Jul-85

Hwalker Res8.5% Deb15Jan94

[4]

Long Position

150,000

30-Aug-85

WT-H Walker Res 15Jan88

[5]

Rec'd - Exchange

4,650

30-Aug-85

Walker H Resources Ltd.

Short Position

4,650

30-Aug-85

Hwalker Res8.5% Deb15Jan94

[4]

Long Position

150,000

30-Aug-85

WT-H Walker Res 15Jan88

[5]

Long Position

4,650

11-Feb-86

Walker H Res7.5%CV VTG

[9]

Long Purchase

100

26.000

11-Feb-86

Walker H Res7.5%CV VTG

[9]

Long Purchase

2,500

26.125

(68,341.50)

11-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

100

2.800

11-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

2.850

398.53

11-Feb-86

Walker H Resources Ltd

Short position

4,650

11-Feb-86

Walker H Res7.5%CV VTG

[9]

Long Position

2,600

11-Feb-86

Hwalker Res8.5% Deb15Jan94

[4]

Long Position

150,000

11-Feb-86

WT-H Walker Res 15Jan88

[5]

Long Position

4,505

12-Feb-86

Walker H Res7.5%CV VTG

[9]

Long purchase

1,465

25.375

(37,416.11)

12-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

1,680

2.700

12-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

565

2.800

5,967.58

12-Feb-86

HWalker Res8.5% Deb15Jan94

[4]

Sale

150,000

89.750

135,603.09

(27,385.89)

12-Feb-86

Walker H Resources Ltd.

Short position

4,650

12-Feb-86

Walker H Res7.5%CV VTG

[9]

Long position

4,065

12-Feb-86

WT-H Walker Res 15Jan88

[5]

Long Position

2,260

Hayes vs. HMQ

Analysis of Security Transactions-Walker Resources Inc. [1]

PHILIP HAYES ACCOUNT

PATSY HAYES ACCOUNT

Date

Investment Instrument

Transaction Type

Position

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

Position

# Units

Price/Units ($)

Amount($)

Income (Loss)

13-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

25.625

13-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

25.750

13-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

25.875

13-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

465

26.000

(15,535.06)

13-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

300

2.700

13-Feb-86

WT-H Walker Res 15Jan88

[5]

Sale

1,960

2.800

6,144.32

13-Feb-86

Walker H Resources Ltd

Short position

4,650

13-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long position

4,650

14-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

265

26.000

(6,933.73)

18-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long purchase

283

26.000

(7,404.70)

18-Feb-86

Walker H Resources Ltd

Short position

4,650

18-Feb-86

Walker H Res 7.5% CV VTG

[9]

Long position

5,208

22-Apr-86

Walker H Resources Ltd

Purchase to cover short

4,650

38.000

(176,800.00)

(22,977.05)

Short sale

4,650

38.000

176,600.00

30-Apr-86

Walker H Res 7.5% CV VTG

[9]

Suscribed to Common

5,208

30-Apr-86

Walker H Resources Ltd

Common subscribed

4,650

30-Apr-86

Walker H Resources Ltd

Long position

4,650

Short position

4,650

28-Oct-86

Walker H Resources Ltd

Exchange [2]

4,650

Exchange [2]

4,650

28-Oct-86

Gulf Canada Corporation

Exchange [2]

12,090

Exchange [2]

12,090

28-Oct-86

Gulf Canada Corporation

Long position

12,090

Short position

12,090

Hayes vs. HMQ

Analysis of Security Transactions-Walker Resources Inc. [1]]

PHILIP HAYES ACCOUNT

PATSY HAYES ACCOUNT

Date

Investment Instrument

# Units

Price/Units

($)

Amount($)

Income/(loss)

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

Position

Transaction Type

Position

21-Jul-87

Gulf Canada Corporation

Exchange

[3]

12,090

Exchange

[3]

12,090

21-Jul-87

Gulf Canada Res Ord Shares

Exchange

[3]

8,060

(62,543.41)[6]

Exchange

[3]

8,060

81,053.99 [7]

21-Jul-87

Abitibi

Exchange

[3]

3,554

(48,791.98)[6]

Exchange

[3]

3,554

63,636.51 [7]

21-Jul-87

GW Utilities Res Vtg

Exchange

[3]

2,418

(24,295.71)[6]

Exchange

[3]

2,418

31,459.50 [7]

21-Jul-87

Gulf Canada Res Ord Shares

Long position

8,060

Short position

8,060

21-Jul-87

Abitibi

Long position

3,554

Short position

3,554

21-Jul-87

GW Utilities Res Vtg

Long position

2,418

Short position

2,418

9-Jan-91

GW Utilities Res Vtg

Sale

2,418

27.750

67,099.50

42,803.79

Purchase to cover short

2,418

27.750

(67,249.50)

(35,790.00)

9-Jan-91

Gulf Canada Res Ord Shares

Long position

8,060

Short position

8,060

9-Jan-91

Abitibi

Long position

3,554

Short position

3,554

27-Feb-92

Gulf Canada Res Ord Shares

Transfer to Patsy

8,060

Received from Philip

8,060

18,960.58 [8]

27-Feb-92

Abitibi

Transfer to Patsy

3,554

Received from Philip

3,554

14,844.53 [8]

19,826.74

(16,860.35)

Notes:

[1] Source: Various brokerage statements for dates indicated.

[2] Gulf and Hiram Walker entered into an agreement to combine the two companies. Under the arrangement submitted to the shareholders of Hiram Walker, each Hiram common share was exchangeable for either 2.6 Gulf common or $36 cash plus interest. Source: financial Post Survey of Industrials 1987.

[3] In July 1987, for each Gulf Canada Corp share, shareholders received 0.666 Gulf Canada Resources Ltd. shares, 0..29 Abitibi shares, and 0.2 shares of GW Utilities Ltd. Source: Financial Post Survey-Predecessor and Defunct 1999.

[4] Each $1,000 principal amount of the January 15, 1994 debenture is convertible on or before January 15, 1988 through the concurrent exercise of 31 warrants plus a payment of $7.50 into 31 common shares. Source: Financial Post Survey of Industrials 1985.

[5] 31 warrants were attached to each $1,000 principal of debenture. Each warrant entitles the holder to purchase one common share at $32.50 until January 15, 1988. Source: Financial Post Survey of Industrials 1985.

[6] The cost of these shares is based on the cost to purchase the Walker H Res 7.5% CV shares in February 1986. The cost allocation between the three issues based on the proportional market values of the shares combined in July 1987.

[7] The cost of these shares is based on the cost to sell Walker H Resources shares in April 1986. The cost allocation between the three issues based on the proportional market values of the shares combined in July 1987.

[8] These gains arrived at by taking the cost allocated for the shares as in [6] and netting against the short sale amounts allocated as in [7].

[9] Each 7.5% CV VTG share entitles the holder to convert to one common share at $28.00 per share to December 31, 1989. Source: Financial Post Survey of Industrials 1985.

Hedge Survey

Philip Hayes Account 19,826.74

Patsy Hayes Account (16,860.35)

Cumulative net income/(loss) 2,966.39

STEPHENS v. HMQ

Analysis of Security Transactions -

Alcan Aluminium [1]]

STEPHEN STEPHENS ACCOUNT

TERRY STEPHENS ACCOUNT

Date

Investment Instrument

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/(loss)

Position

10-Nov-86

Alcan Aluminium Ltd

Short sale

8,000

43.750

349,520.00

10-Nov-86

WTS-Alcan Alum 31Dec86

[2]

Long Purchase

8,000

7.750

(62,480.00)

10-Nov-86

Alcan Aluminium Ltd

Short position

8,000

10-Nov-86

WTS-Alcan Alum 31Dec86

Long position

8,000

11-Dec-86

WTS-Alcan Alum 31Dec86

[2]

Sale

8,000

5.625

44,520.00

(17,960.00)

11-Dec-86

Alcan Aluminium Ltd

Long purchase

8,000

41.000

(328,480.00)

11-Dec-86

Alcan Aluminium Ltd

Short position

8,000

Long position

8,000

...

Scott vs. HMQ

Analysis of Security Transactions-Placer Development (Placer Dome Inc) [1]

MURIEL SCOTT ACCOUNT

PATRICIA SCOTT ACCOUNT

Date

Investment Instrument

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/

(loss)

Transaction Type

# Units

Price/Units ($)

Amount($)

Income/(loss)

Position

20-May-87

Placer Development Ltd

Short sale

1,500

49.750

20-May-87

Placer Development Ltd

Short sale

3,500

49.875

20-May-87

Placer Development Ltd

Short sale

500

50.125

249,012.50

20-May-87

WTS-Placer Dev 30Sep88

[2]

Long purchase

1,500

20.625

20-May-87

WTS-Placer Dev 30Sep88

[2]

Long purchase

3,000

20,750

20-May-87

WTS-Placer Deve 30Sep88

[2]

Long purchase

500

21.000

(103,987.50)

20-May-87

Placer Development Ltd

Short position

5,000

20-May-87

WTS-Placer Dev 30Sep88

[2]

Long position

5,000

10-Jun-87

Placer Development Ltd

2 for 1 split

5,000

10-Jun-87

Placer Development Ltd

Short position

10,000

10-Jun-87

WTS-Placer Dev 30 Sep88

[2]

Long position

5,000

29-Jun-87

WTS-Placer Dev 30Sep88

[2]

Sale

250

11.500

2,860.00

(2,339.38)

29-Jun-87

Placer Development Ltd.

Long purchase

600

14,125 US

(11,355.14)[5]

29-Jun-87

Placer Development Ltd

Long purchase

5,000

19.500

(97,650.00)

29-Jun-87

Placer Development Ltd.

Short position

10,000

Long position

5,600

29-Jun-87

WTS-Placer Dev 30Sep88

[2]

Long Position

4,750

30-Jun-87

WTS-Placer Dev 30Sep88

[2]

Sale

900

11.000

9,846.00

(8,871.75)

30-Jun-87

WTS-Placer Dev30Sep88

[2]

Sale

250

11.125

2,766.25

(2.433.13)

30-Jun-87

Placer Development Ltd

Long purchase

1,400

14.125 US

(26,485.42)[5]

30-Jun-87

Placer Development Ltd.

Short position

10,000

Long position

7,000

30-Jun-87

WTS-Placer Dev 30Sep88

[2]

Long position

3,600

Scott vs. HMQ

Analysis of Security Transactions-Placer Dome Inc. [1]

MURIEL SCOTT ACCOUNT

PATTRICIA SCOTT ACCOUNT

Date

Investment Instrument

Transaction Type

Position

# Units

Price/Units ($)

Amount($)

Income/(loss)

Transaction Type

Position

# Units

Price/Units ($)

Amount($)

Income (Loss)

2-Jul-87

WTS-Placer Dev 30Sep88

[2]

Sale

1,500

10.750

16,080.00

(15,116.25)

2-Jul-87

WTS-Placer Dev 30Sep88

[2]

Sale

1,100

11.000

12,034.00

(10,843.25)

2-Jul-87

WTS-Placer Dev 30Sep88

[2]

Sale

1,000

11.375

11,315.00

(9,482.50)

2-Jul-87

Placer Development Ltd.

Long purchase

3,000

19.125

(57,465.00)

2-Jul-87

[3] Placer Development Ltd

[4]

Short position

10,000

[6]

(49,086.26)

CITATION:

2003TCC93

COURT FILE NO.:

96-2573(IT)G, 96-2737(IT)G, 97-653(IT)G,

97-749(IT)G, 98-806(IT)G, 98-2507(IT)G and

99-2414(IT)G

STYLE OF CAUSE:

Pat Hayes, Philip Hayes, Stephen Stephens,

Gordon Rezek, Muriel Scott and

Her Majesty the Queen

PLACE OF HEARING

Toronto, Ontario

DATE OF HEARING

October 28, 29, 30, 31, November 4, 5, 6, 7, 18, 19, 20, 21, 25, 26, 27, 2002

REASONS FOR JUDGMENT BY:

The Honourable Justice Campbell J. Miller

DATE OF JUDGMENT

September 9, 2003

APPEARANCES:

Counsel for the Appellant:

Geoffrey B. Shaw and Stevan Novoselac

Counsel for the Respondent:

Henry Gluch, David Chodikoff and James Rhodes

COUNSEL OF RECORD:

For the Appellant:

Name:

Geoffrey B. Shaw and Stevan Novoselac

Firm:

Cassells Brock & Blackwell

For the Respondent:

Morris Rosenberg

Deputy Attorney General of Canada

Ottawa, Canada

[1] Exhibit 2.5, tab 24.

[2] Exhibit 1.5B tab 2 page 2.

[3] 93 DTC 953 (TCC), [1996] 1 F.C. 423 (FCA).

[4] 99 DTC 585, affirmed 2001 DTC 5560.

[5] [1995] 3 S.C.R. 103.

[6] [1992] F.C.J. No. 905.

[7] 94 DTC 6265.

[8] [1999] F.C.J. No. 1874.

[9] Exhibit 2.5, tab 28.

[10] 70 DTC 6370 at page 6376.

[11] 99 DTC 5669 (S.C.C.).

[12] 2001 DTC 5533 (S.C.C.).

[13] supra.

[14] supra.

[15] [1998] 2 S.C.R. 298.

[16] supra.

[17] supra.

[18] supra.

[19] 2002 DTC 6969 (S.C.C.).

[20] 2002 DTC 6960 (S.C.C.).

[21] 2001 DTC 5149.

[22] supra.

[23] supra at paragraph 27.

[24] supra, at paragraph 163.

[25] 86 DTC 1563 at page 1564.

[26] 93 DTC 5507(SCC).

[27] 98 DTC 6100 at pages 6107-08.

[28] 89 DTC 5019 (FCA).

[29] 57 DTC 1232(SCC).

[30] See inventory amending provisions in paragraph 169.

[31] supra, at page 5508.

You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.

Do not display this message anymore