While the “late market timing trades,” scandal of 2003 is a distant memory, some of its consequences are still rippling through the tax system.

That episode was marked by investigations into trading practices at a range of companies in the U.S. and Canada, including several that sell mutual funds.

In Canada, the Ontario Securities Commission, together with the Investment Dealers’ Association (now part of IIROC) and the Mutual Fund Dealers’ Association of Canada, reached settlements with five mutual fund companies, including Franklin Templeton Mutual Funds and AIC Mutual Funds.

The settlements included compensation for mutual fund investors due to the sketchy trading practices: the issue relating to these payments in a recent Tax Court of Canada case, was whether or not those funds should be taxed in the hands of individual mutual fund investors.

While the amount in question in Lavoie v. The Queen was small — $303.00 — the issue is “significant,” the ruling by Justice E.A. Bowie notes, because of the “large number of other taxpayers who received payments as a result of these agreements because they held units of the mutual funds [that were investigated] within their registered retirement savings plans.”

The issue was complicated by the manner in which the payments were offered to fund members. Russell Lavoie, who challenged the CRA’s contention that his settlement was taxable, is a member of an RRSP offered by Manulife Securities International Limited. That RRSP owns units in AIC and Franklin Templeton Mutual Funds.

The letter offering him a settlement noted that he had the option of taking the settlement in cash or, by default, having the amount paid directly into his fund.

Lavoie chose to take the cash directly, noting during the litigation that he had no further contribution room in his RRSP and did not want to be assessed a penalty for over-contributions.

Nevertheless, those amounts should not be taxable, he argued, on the basis that the compensation money amounted to a “windfall” and was therefore not taxable.

In holding for the CRA, the judgment includes a discussion of the features of a windfall; they include elements such as whether or not the recipient might have been able to recover the money using litigation (if yes, it is not a windfall); whether or not there was an organized effort to collect the money; whether it was expected and whether it was received in exchange for other value, among other considerations.

In holding that it was not a windfall, the judgment notes that it was the compensatory nature of the payments that prevented them from being a windfall.

Further, the court found that it was appropriate to treat the compensation as if it were part of Lavoie’s fund holdings, since the compensation was paid to make up for impairment of the value of his fund due to the prohibited trading practices.

Thus, by cashing the cheques and not allowing the amounts to be paid into his RRSP, Lavoie was compelled to treat them like any other amounts removed from his fund — taxable in his hands. In countering the objection about over-contribution penalties, the court stated that he would have been able to make the contribution, free of such penalties, since the amounts were not new contributions, but designed to compensate him for his losses due to the unfair trading practices.

IE