Netupsky v. The Queen, 92 DTC 2282, [1992] 2 CTC 2531 (TCC)

Brulé, T.C.C.J.:—This is an appeal involving the 1988 and 1989 taxation years of the appellant in which he claimed certain business losses but was only granted capital losses by the respondent. In addition the appellant claimed that Revenue Canada had exceeded a“ reasonable period of time” to reply to the notice of objection sent to the appellant. This latter claim was abandoned at the trial.

Facts

The appellant, a consulting engineer, engaged in three other activities, viz speculation in commodities, revenue producing apartment ownership, and investing in common stocks.

In 1985 one of the appellants real properties, the Manor House, required refinancing and originally the funds for such came from the Swiss Bank in Swiss francs. These were converted to Canadian dollars and the refinancing was completed. As security for the Swiss loan the Manor House and other rental properties in which the appellant had interests were pledged. The loan was originally a joint loan by the appellant, his son, and daughter-in-law.

On December 15, 1988 a sale and repurchase of Swiss francs was carried out by the appellant causing a loss of $194,155. The appellant claimed this as a business loss but was reassessed claiming this transaction as a capital loss. Thus the appeal for 1988.

On May 1, 1989 a similar transaction took place resulting in a claimed business loss for that year of $550,028 which was disallowed. This loss was due to the difference in value of the Swiss franc between the date of borrowing in 1985 and the date of repayment in 1989. The appeal for the 1989 taxation year resulted.

Appellant's position

It was stated by the appellant that he had acted as a consulting engineer since 1963, had been an apartment owner since 1965, had traded in stocks since 1967 and dealt in commodities, including currencies, since 1978. All of these dealings were reflected in his income tax returns and accepted by Revenue Canada, the commodity trading always reported on income account.

The appellant maintained that in this case he had a choice of borrowing in Canadian dollars for the mortgage or borrowing foreign currency and converting this to Canadian dollars. Before deciding on the “foreign funds” alternative he did a thorough analysis of the historical chart patterns and other factors of two foreign currencies, the Japanese yen and the Swiss franc. Copies of his research were reproduced as part of Exhibit A-1 given to the Court. A decision was made to go the Swiss franc route.

The Court was told that the transaction in its entirety involved two of the appellants business endeavors, financing real estate properties and commodity dealing. The two should be separate in that the Swiss franc route was taken in the hope of a commodity trading profit and was not in itself a part of the mortgage financing.

The appellant maintained that the transaction with the Swiss Bank was of a highly speculative nature, and as such, was secured by a promissory note payable on demand. Other provisions were that the loan or any part thereof could be repaid on five days' notice, the appellant was required to maintain a margin of 110 per cent of the amount borrowed or the loan would be considered in default. A personal guaranty had to be given and the appellant was required to pledge additional security in the form of his equity interests in two other apartment buildings. A monthly payment was required to buy a requisite amount of the foreign currency in respect of interest payments. As a result of these requirements the loan was highly speculative and on current account.

The loan could not be reasonably hedged since any hedging cost would wipe out the interest rate differential. The appellant said this loan was a perfect example of an adventure in the nature of trade, consciously and deliberately taken out for speculative purposes and as such wes a part of one of the taxpayer's businesses he engaged in since 1978.

As a result he said the appeal should be allowed.

Respondent's position

One of the principal arguments advanced was that the loan was taken out to deal with a capital asset of the appellant and any resulting profit or loss in the transaction should be on the appellant's capital account. Not all foreign currency transactions are made for speculative purposes. Here the loan was sought to refinance a capital property.

The following cases were referred to by counsel for the respondent:

Tip Top Tailors Ltd. v. M.N.R., [1957] C.T.C. 309, 57 D.T.C. 1232;

Canadian SKF Co. v. M.N.R. (1966), 40 Tax A.B.C. 187, 66 D.T.C. 140;

D.W.S. Corporation v. M.N.R., [1968] C.T.C. 65, 68 D.T.C. 5045;

Trans-Prairie Pipelines Ltd. v. M.N.R., [1970] C.T.C. 537, 70 D.T.C. 6351;

Columbia Records of Canada Ltd. v. M.N.R., [1971] C.T.C. 839, 71 D.T.C.

5486;

Alberta Gas Trunk Line Co. v. M.N.R., [1971] C.T.C. 723, 71 D.T.C. 5403.

In all of these cases there was a corporation involved and foreign exchange became a part of the business of each. There were different results depending on the circumstances and counsel suggested that the present case was similar in nature. It was said that the money was borrowed in this appeal for a capital purpose and no element of speculation was a part of the transaction with the real property.

While it was recognized that the appellant was a speculator this does not mean that every transaction he enters into falls into speculation. The primary goal here was refinancing and hence the eventual loss suffered should be on capital account.

Analysis

The principal consideration here is whether or not the borrowing of the Swiss francs was a part of the mortgage financing in which case the respondent's position would be upheld or whether there were two separate and distinct parts to this transaction, one being the borrowing of the Swiss francs and the second being their conversion to Canadian dollars and then placed for the mortgage. If the latter situation is determined then the resulting loss would be a business loss and an income account.

Any of the taxpayer's normal trading activities resulting in profit or loss from foreign currency dealings would be considered as adventures in nature of trade and regarded as being an income account. Here the taxpayer appellant maintained that he frequently deals in foreign exchange and exhibits of his dealings since 1978 were presented to the Court.

There is no question that before making the Swiss franc loan the appellant studied the situation carefully. This was evidenced in Exhibit A-1. Not only was the interest rate lower than borrowing in Canadian dollars but the possibility for gain in foreign exchange rates seemed very possible according to the appellant's research and as shown to the Court.

This position would seem to be borne out by the decision in the case of MacMillan Bloedel Ltd. v. Canada, [1990] 1- C.T.C. 468, 90 D.T.C. 6219 wherein the Federal Court allowed a taxpayer to deduct the foreign exchange loss incurred in a hedging transaction the proceeds of a loan being to finance corporate needs. The Court held that the foreign exchange hedging transaction was separable from the underlying borrowing transaction and that the foreign exchange loss on the hedging transaction was an expense of borrowing and so deductible under subparagraph 20(1)(e)(ii) of the Income Tax Act. It appeared to be immaterial whether the related borrowing was on capital account.

In Ethicon Sutures Ltd. v. The Queen, [1985] 2 C.T.C. 6, 85 D.T.C. 5290 Cullen, J. said at pages 10-11 (D.T.C. 5294):

I am of course aware of the principle cited in Salada Foods Ltd. v. The Queen, [1974] C.T.C. 201, 74 D.T.C. 6171, by Urie, J. that when a foreign exchange gain has been realized, the mode of its application (e.g., whether it is used to pay dividends or trade payables) has no bearing whatever upon whether the gain was of a capital or income nature. It is however a guide to buttress the decision made at the outset whether the fund is of capital or income nature.

The Court also said in that case at page 10 (D.T.C. 5293):

Where the foreign currency was acquired as a result of the taxpayer's trading operations, or for the purpose of carrying on trading operations, any gains will be treated as occurring in the course or the taxpayer's trade and will be treated as income. I believe in this case, as shown by the evidence, that the appellant dealt in commodities including foreign currency as one of his endeavors and a careful study was made before undertaking this project. He had always reported gains or losses on income account and these were accepted by Revenue Canada.

Another aspect of the Swiss franc loan was that it was covered, in addition to other security, primarily by a promissory note from the appellant payable on demand. As such this placed the loan in the category of a current liability and hence on current and not capital account. Even the monthly interest payments were in a speculative category in the sense that each month the required Canadian amount for the purchase of foreign funds for interest payments varied according to the exchange rate at the time of the due date for the interest payment, so that the balance remaining varied from month to month.

Conclusion

I do not believe that the characterization of the currency loss follows the transaction from which it results to place it on capital account. Looking at the transaction as a whole would seem to bring it in line with the authorities relied upon by the respondent. In the present case there is a difference. I conclude that there were two separate and distinct transactions as borne out by the evidence with the result being that the appeal is allowed.

The matter is referred back to the Minister for reconsideration and reassessment.

Appeal allowed.