Kruger – Federal Court of Appeal finds that non-statutory mark-to-market accounting was permissible under s. 9, and that derivatives not held for resale are not inventory

Kruger engaged in extensive trading of FX options, mostly writing European style puts and calls, although it also purchased FX options.

Noël CJ found that Kruger was entitled to use mark-to-market accounting for tax purposes in recognizing a loss on its FX option position for its 1998 year, stating:

[T]he mark to market method is consistent with well accepted business principles….[T]he realization principle can give way to other methods of computing income pursuant to section 9 of the Act where these can be shown to provide a more accurate picture of the taxpayer’s income for the year… . Canadian General Electric is in direct contradiction with the Tax Court judge’s holding that realization is an overarching principle… .

He went on to indicate the option contracts written by Kruger were not inventory (as they instead were liabilities) and that the option contracts purchased by Kruger also were not “inventory” as the s. 248(1) definition thereof had an implicit requirement that, to qualify as inventory, property must be held for sale (so that the purchased options were “a type of property that is neither capital property nor inventory.”) Accordingly, the mark-to-market tax accounting of Kruger occurred strictly under s. 9.

This case will put the banks and other financially regulated enterprises on a more comfortable footing given that, in 2012, CRA indicated (in 2008-0289021E5) that it may no longer accommodate non-statutory mark-to-market accounting.

A procedural oddity: the reassessment of CRA added back $72M to Kruger’s income for 1998, being the difference between its claimed mark-to-market loss on its options of $91M, and the 1998 amortization as to $19M of net option premiums. Noël CJ considered that premium amortization did not accord with mark-to-market accounting, and directed CRA to reassess on the basis that Kruger was entitled to use the mark-to-market accounting, but without deferring or amortizing any portion of the premiums paid or received during 1998. This might effectively be a direction to reduce Kruger’s taxable income to below that originally reported.

Neal Armstrong. Summaries of Kruger Inc. v. The Queen, 2016 FCA 186 under s. 9 – timing, s. 248(1) – inventory.