Budget 2017: Timing Of Recognition Of Gains And Losses On Derivatives

In Budget 2017, the federal Government proposed both new rules to introduce an elective regime to respond to recent jurisprudence relating to the recognition of certain gains and losses on derivative transactions, as well as anti-avoidance measures designed to discourage taxpayers from entering into "straddle transactions". While the former elective provisions could promote flexibility and reduce uncertainty to taxpayers, the breadth of application of the straddle transaction provisions could give rise to unexpected tax consequences.

Elective Mark-to-Market Methodology

The Government introduced an elective regime in Budget 2017 that would generally permit taxpayers to elect (the "Election") to recognize gains and losses attributable to certain derivative agreements that were held on income account on a "mark-to-market" basis. Taxpayers that choose not to make the Election would generally be liable to tax in connection with any such derivatives when the derivative agreement was disposed of (e.g., settled, extinguished, assigned or transferred) on a realization basis, subject to certain restraints identified below.

The draft legislation released with the Budget documentation states that an "eligible derivative" for purposes of making the Election generally means a swap agreement, a forward purchase or sale agreement, a forward rate agreement, a futures agreement, an option agreement or a similar agreement if:

the agreement is not a capital property, a Canadian resource property, a foreign resource property or an obligation on account of capital of the taxpayer, either the taxpayer has produced audited financial statements prepared in accordance with generally accepted accounting principles in respect of the taxation year, or the agreement has a readily ascertainable fair market value; and in the case of property held by a "financial institution" (a "Financial Institution"), the agreement is not a "tracking property", other than an "excluded property", of the Financial Institution, each as defined in subsection 142.2(1) of the Income Tax Act (Canada) (the "Tax Act"). A taxpayer that has made the Election, is not a Financial Institution, and holds eligible derivatives (i.e., is a party to an agreement that is an eligible derivative) at the end of a taxation year is deemed to dispose of, and immediately reacquire, reissue or renew, as applicable, such eligible derivatives, at their fair market value, immediately before the end of the taxation year. Accordingly, increases or decreases in the value of an eligible security would be deemed to be taxable in the year as a gain or loss, respectively. Analogously, eligible derivatives held by a taxpayer that has made the Election and is a Financial Institution in a year are deemed to be "mark-to-market property", as defined in subsection 142.2(1) of the Tax Act, of the taxpayer for the taxation year.

As a transitional measure...