by Michelle Kosarnia

by Jeffrey Liu

CRA ArticlesFebruary 18, 20250 comments

Rudolph v The King: Are the Proceeds of Your Share Disposition Business Income or Capital Gains?

In Rudolph v the King, 2024 TCC 148, Justice Lafleur provides an overview of the law regarding the factors that must be considered in determining whether the proceeds of a corporate share disposition are business income or capital gains. There is a general presumption that shares are sold on capital account (Irrigation Industries Ltd. v. MNR, [1962] SCR 346), but as this case illustrates, this is not a definitive rule. Each case must be determined on its particular facts.

Case Facts

In this case, the Appellant was a practicing dentist, who was also a shareholder and director of Keltic Petrochemicals Incorporated, the company whose shares he disposed of. This case involved a complicated factual dispute over when these shares were actually sold and the underlying context for this sale. The key facts include that:

• Keltic was a privately owned corporation that sought to develop a petrochemical plant. It required capital to fund this project, so it sought out the investment of various individuals, including Mr. Rudolph.
• Keltic was a high-risk, high-reward investment, as its success largely depended on a deal with strategic partners, but this proposed deal fell through due to the 2008 Financial Crisis.
• Prior to the deal falling through, the directors of Keltic were looking to replace Mr. Rudolph as director. To avoid this, the Appellant reached an agreement with a third-party, whereby the Appellant would purchase and exercise options in Keltic and sell them to the third party, who agreed to support the Appellant’s directorship.

Governing Law

There is no specific criteria provided by the Income Tax Act for determining whether a receipt is a capital gain or business income – this is an area of the law largely governed by case law. The case cited by Justice Lafleur was Happy Valley Farms Ltd v MNR, 1986 2 CTC 259, which provided six key factors to consider:

• The Nature of the Property Sold: Property that does not provide its owner with passive income or personal enjoyment is generally considered to be held on income account. For this reason, shares are generally presumed to be held in capital account due to their income-producing potential (Irrigation Industries). However, this is a rebuttable presumption (MNR v Freud, [1969] SCR 75).
• The Length of Period of Ownership: The longer the subject property is held, the stronger the presumption that it is held in income account.
• The Frequency or Number of Other Similar Transactions: The more frequently the same type of property is sold, the stronger the presumption that the property is held on income account.
• Work Expended On the Property: If effort is put into bringing the property into marketable conditions, there is a presumption in favour of income.
• Circumstances for the Sale of the Property: The above presumptions in favour of income can be rebut where there is a reasonable explanation for a sudden sale.
• Motive: An important factor is whether the taxpayer intended to flip the property for quick profit. However, motive must be evidenced and is considered in conjunction with the taxpayer’s overall conduct.

Application

In the case at bar, factors that weighed in favour of the share dispositions being on income account were:

• The Appellant participated in 34 transactions involving the purchase of shares and 16 transactions to buy stock options.
• The Appellant obtained third-party financing to purchase the share options, which he quickly realized a profit on. This is in spite of the fact that the Appellant had also held shares of Keltic for years.
• The Keltic shares had great growth potential but were risky investments. The evidence showed that the shares were a speculative venture.
• Shares in Keltic never paid dividends and was not in a position to pay dividends in the foreseeable future as they were in a deficit position.
• The court found that the Appellant had an intent to sell the shares acquired from the exercise of options as quickly as possible.
• The Appellant had particular knowledge of the subject corporation and was sufficiently involved in its operations, such that he could not be considered a passive investor.
• The Appellant was highly knowledgeable about the financial sector despite his full time employment as a dentist.

Conclusion

This case illustrates that taxpayers are not always entitled to assume that the proceeds of their share dispositions are capital gains, particularly when they are engaging in options trading and/or the purchase of speculative shares (including even “meme stocks” held for a quick flip). Determining the appropriate legal characterization of proceeds of disposition is a highly fact-specific exercise, and for this reason, taxpayers are well advised to consult an expert on this matter.

***Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.