Introduction To Canada Tax System'Taxable Income Or Loss

• Published date: 21 September 2022
• Subject Matter: Tax, Income Tax, Tax Authorities
• Law Firm: McCarthy Tétrault LLP
• Author: Mr Spotlight Can-Asia, Joyce Lee, Chia-yi Chua, Ming G Zheng, Julien Leblanc and Xin Yue Zhang

What is a taxable income under the Canadian Federal Income Tax Act?

Under the Canadian Income Tax Act (the "ITA"),¹ the concept of a source of income is fundamental: there can be no taxation without income under the ITA and, subject to some very narrow exceptions provided in the ITA, there can be no income without a source.² Very generally, section 3 of the ITA provides the basis for the computation of income; the income of a taxpayer includes its income for the year from worldwide sources (inside or outside of Canada) such as income from employment, business and property,³ as well as its taxable capital gains.⁴ Although section 9 of the ITA states that income from a business or property is the taxpayer's profit from that business or property, the concept of "business" is not extensively defined in the ITA, and it is therefore jurisprudence that establishes in what situation a taxpayer is considered to have received income or loss from a business in a year.

Judicial authority has established that in order to receive income from a business, a taxpayer needs to undertake an activity in pursuit of profit.⁵ In the recent decision Canada v Paletta, 2022 FCA 86, this principle was challenged by the taxpayer on the alleged basis that the commerciality and non-personal nature of a transaction is sufficient. In its reasons, the Federal Court of Appeal (the "FCA") disagreed with the conclusions of the Tax Court of Canada and held that an activity with no intent of profit but with an exclusive intent to avoid tax⁶ cannot give rise to a source of business income under section 9 of the ITA, despite its appearance of commerciality. Despite the commerciality of a transaction being insufficient by itself, businesses should be mindful that losses arising from non-commercial activities might also not be deductible under section 3 of the ITA.

The facts before the FCA in Paletta were the following: for its taxation years 2000 to 2007, Mr. Paletta entered into numerous forward foreign exchange trades with several brokerage firms. Mr. Paletta entered these trades in pairs of offsetting forward contracts to buy and sell the same amount of foreign currency on different but proximate dates.⁷ By doing so and by taking advantage of currency rate fluctuations, one transaction in each pair would generate a loss while the other would generate an offsetting gain.⁸ Since Mr. Paletta executed the transactions carefully to realize the loss transaction before the end of each taxation year...