The Queen v Paletta ' Guidance From A Canadian Tax Lawyer Regarding The Legal Test For Business Income

• Published date: 01 July 2022
• Subject Matter: Litigation, Mediation & Arbitration, Tax, Trials & Appeals & Compensation, Professional Negligence, Income Tax, Tax Authorities
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

Tax Court of Canada ruled Taxpayer's trading activities designed to avoid tax constituted a business

In the Queen v Paletta, 2022 FCA 86, the Canadian tax litigation lawyer acting for the Canada Revenue Agency (CRA) appealed the Tax Court of Canada's decision regarding Mr. Pasquale Paletta (the "Taxpayer")'s appeals from reassessment regarding the 2000 through 2007 taxation years. During these years, the Taxpayer entered into year end foreign-currency straddle contracts to simultaneously buy and sell the same amount of foreign currency at different but closely proximate dates in the future, which allowed him to realize a loss in the first year and a corresponding gain in the subsequent year. In 2014, the CRA issued reassessments that denied the Taxpayer's trading losses for the 2000 through 2006 taxation years and assessed the Taxpayer for the 2007 taxation year that denied the loss carry-over of prior years' losses. Although the Tax Court of Canada found that the Taxpayer had no intention to earn profits and that his trading activity was solely designed to ensure immediate loss realization and indefinite gain deferral for tax purposes, it ruled that the Taxpayer's trading activities gave rise to a business. The CRA then appealed to the Federal Court of Appeal, which eventually set aside the Tax Court's decision and sided with the CRA.

Tax Issues in dispute

The CRA specifically raised two issues in its appeal to the Federal Court of Appeal:

Whether the Tax Court erred in ruling that the Taxpayer's trading activities gave rise to a source of income in the form of a business despite having found that the trades were not made for profit, and

If so, whether the CRA could reassess the years in issue beyond the normal reassessment period and apply gross negligence penalties under the Income Tax Act.

A view for profit is required for business income

The Federal Court of Appeal identified the legal principles regarding business income and found that the Tax Court made a mistake in concluding that the Taxpayer's trading activities gave rise to a business. The two-step legal test regarding business income was set out by the Supreme Court of Canada (SCC) in Stewart v Canada, 2002, SCC 46, [2002] 2 SCR 645:

Is the activity of the taxpayer undertaken in the pursuit of profit, or is it a personal endeavor?

If it is not a personal endeavor, is the source of income a business or property?

Where the activity contains no personal element and is clearly commercial, no...