Kruger: FX Derivatives Gains/Losses Taxed Only When Realized

In Kruger Incorporated v. The Queen (2015 TCC 119), the Tax Court held that the taxpayer could not value its foreign exchange options contracts on a mark-to-market basis, with the result that certain losses were not deductible by the taxpayer in a year. The Kruger case is another recent judgment of the Tax Court in the developing law on the Canadian tax treatment of financial derivative products (see George Weston Limited v. The Queen (2015 TCC 42)).

Facts

Kruger's core business was manufacturing newsprint, paper-coated products and tissue paper. In the 1980s, Kruger started trading in foreign currency contracts, and over time these activities grew to involve more than 10 employees trading in currency, bonds and securities.

In 1997, Kruger was advised that it was required to start reporting its financial trading activities on a mark-to-market basis, which required the recognition of any change in market value in a year as an income gain or loss.

In 1998, certain of Kruger's U.S. currency options contracts were "under water" due to fluctuations in the Canada-U.S. exchange rate. Accordingly, for its 1998 tax year, Kruger claimed losses totaling $91,104,379 from a business of trading in derivatives. The CRA reassessed to deny the deduction of $91,104,379, but excluded from income the amount of $18,696,881, which Kruger had included as the amortized portion of the net of premium income and expenses for the foreign exchange options contracts. The CRA also included the amount of $91,104,379 in Kruger's taxable capital for the purposes of the large corporations tax (which has now been generally repealed).

Kruger appealed the reassessment on the basis that, in accordance with section 9 of the Act, it was entitled to value its foreign exchange options contracts using the mark-to-market method, and argued in the alternative that its foreign exchange options contracts were inventory and were to be valued at the lower of cost and fair market value under subsection 10(1) of the Act.

Analysis

The Court reviewed the key Canadian judicial authorities regarding the test for determining income under the Act, including Friedberg v. The Queen ([1993] 4 S.C.R. 285),Canderel Limited v. The Queen ([1998] 1 S.C.R. 147), Friesen v. The Queen ([1995] 3 S.C.R. 103). The Court referred to the oft-cited principles from Canderel that the determination of profit is a question of law, and a taxpayer is free to adopt any method for determining profit that is not...