Words and Phrases - "speculation"
MacDonald v. Canada, 2020 SCC 6, [2020] 1 S.C.R. 319
The taxpayer had held a significant investment in the common shares of a listed bank (“BNS”) since 1988. In 1997, due to “storm clouds,” he entered into a forward contract with TD Securities Inc. for the forward sale by him of a reference number of BNS shares, except that the Forward Contract could only be cash settled. The forward sale date initially was June 26, 2002, but the contract was subsequently extended. He made cash settlement payments under the contract in 2004, 2005 and 2006 totalling approximately $10 million (which he fully deducted as being on income account), and the contract was terminated on March 29, 2006. At all times, the reference number of shares under the forward contract did not exceed the number of BNS shares owned by him.
In 1997, he also monetized a portion of his BNS shareholding by receiving a loan from an affiliate of TD Securities (TD Bank) equalling approximately half of his shares’ value and pledging most of his BNS shares and the forward contract as security. He repaid the entire balance of the loan in 2004.
The Tax Court had accepted the taxpayer’s testimony that he had intended to profit from the anticipated decline in the value of the BNS shares under the forward contract but nevertheless retained ownership of the shares based on his belief that they would perform well in the long term. The Court affirmed the Federal Court of Appeal’s reversal of this decision in finding that the taxpayer had realized his losses under the forward contract on capital account.
In framing the issue as being whether there was sufficient linkage between the forward sales (viewed, at para. 18 as being, along with options, one of the “two basic types of derivatives”) and the BNS shareholding, Abella J stated (at paras. 20, 22):
The income tax treatment of gains and losses arising from derivative contracts depends on whether the derivative contract is characterized as a hedge or speculation. Gains and losses arising from hedging derivative contracts take on the character of the underlying asset, liability or transaction being hedged … . In contrast, speculative derivative contracts are characterized on their own terms, independent of an underlying asset or transaction. ...
Purpose is ascertained objectively (Ludco …). … As the cases demonstrate, the primary source of ascertaining a derivative contract’s purpose is the linkage between the derivative contract and any underlying asset, liability or transaction purportedly hedged. The more closely the derivative contract is linked to the item it is said to hedge, the stronger the inference that the purpose of the derivative contract was hedging.
In finding that there could be linkage notwithstanding that the forwards could only be cash settled and were settled without a sale of the BNS shareholding, she stated (at para. 34, see also para. 42) that “The absence of a synchronous transaction used to offset gains or losses arising from a derivative contract is not equivalent to the absence of risk and is not, by itself, determinative of the characterization of a derivative contract” and (at para. 36) adopted a principle endorsed in Placer Dome that “cash settled forward contracts and forward contracts settled by physical delivery are economically equivalent and treating them differently for tax purposes would create ‘an unjustified artificial distinction’.”
In finding that linkage was established here, she stated (at para. 37):
The forward contract had the effect of nearly perfectly neutralizing fluctuations in the price of Bank of Nova Scotia shares held by Mr. MacDonald, pointing to a close linkage. The purpose of the forward contract as a hedging instrument is most apparent when one considers the forward contract alongside the loan and pledge agreements between Mr. MacDonald and TD Bank. Seen in this light, there was considerable linkage between the forward contract and Mr. MacDonald’s Bank of Nova Scotia shares.
Locations of other summaries | Wordcount | |
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Tax Topics - General Concepts - Purpose/Intention | intention re forward contract determined on basis of objective linkage to hedged asset rather than testimony as to subjective purpose | 335 |
Tax Topics - Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Loss v. Loss - Hedges | cash-settled forward “objectively” was a capital share hedge notwithstanding no matching share sale | 542 |