Supreme Court Of Canada Decision In MacDonald Minimizes Role Of Taxpayer Intent In Characterizing Derivative Contracts

In a rare decision of the Supreme Court of Canada (SCC) in the derivatives law area, the Court characterized a derivative contract for tax treatment purposes by looking at the underlying economics of the contract rather than the intention of the parties and most notably the intention of the taxpayer.

Background

The Court's judgment in MacDonald v Canada [2020 SCC 6] (MacDonald) released on March 13, 2020, considered the extent to which a taxpayer's intent in entering into a derivative contract was determinative in characterizing such contract as a hedge or speculation for tax purposes.

The appellant taxpayer in MacDonald, a former banking executive with extensive experience in capital markets and corporate finance, held common shares in the Bank of Nova Scotia (collectively, the BNS Securities). The taxpayer entered into a lending transaction with Toronto-Dominion Bank (TD) and a cash-settled forward contract with TD Securities Inc. (TDSI) on the BNS Securities. Availability under the credit facility could not exceed 95% of the value of the BNS Securities on a mark-to-market basis and was secured by, among other things, a pledge of the BNS Securities and any cash settlement payment entitlements (namely, in-the-money settlement payments made by TDSI to the appellant) arising from the forward contract in the ordinary course.

In the tax years 2004, 2005 and 2006, the appellant made cash settlement payments to TDSI in satisfaction of his out-the-money position in respect to the forward contract. The appellant's corresponding tax filings characterized the forward contract as being speculative in nature, which would result in gains or losses being treated as basic income for tax purposes. By contrast, tax treatment for hedge transactions takes on the characteristic of the underlying asset being hedged.

The Ministry of National Revenue (the Ministry) disputed the taxpayer's characterization as being "speculative in nature" and reassessed the forward contract as a hedge of the BNS Securities which, being capital assets in nature, resulted in losses being treated as "capital losses." The Tax Court sided with the taxpayer and his characterization and held the forward contract was speculative in nature, finding the appellant's sole intention was to speculate on the value of the BNS Securities, rather than to mitigate underlying risk. On appeal, the Federal Court of Appeal unanimously overturned the Tax Court decision and held that a taxpayer's...