Paletta – Federal Court of Appeal finds that straddle trading, with an appearance of commerciality but not engaged in for profit, was not a business

In order that he could shelter most or all of his income for an extended period of years, Paletta entered into an FX straddle-trading program, with each straddle entailing both a “long leg”, and a matching “short leg” that established a short position (under which he agreed to sell the same currency on a slightly different (future) value date), so that he was almost completely hedged - and then, near each year end, realized the targeted loss by closing out whichever of the long and short legs at that time was the loss leg of the straddle. The corresponding gain leg was closed out at the beginning of the next year. In that following year, the same trading pattern was repeated but on a larger scale, given that the entire gain from closing out, in that year, the gain leg from the previous year’s trading needed to be offset in addition to his other taxable income for that year.

After noting the Tax Court’s factual findings that the taxpayer had no intention to profit from these “trades” and that their only purpose was the realization of the losses for tax purposes, Noël C.J. found that the taxpayer’s straddle trading activity was not a business or other source of income, so that the claimed losses were not deductible. In this regard, he indicated that “where as is the case here, the evidence reveals that, despite the appearances of commerciality, the activity is not in fact conducted with a view to profit, a business or property source cannot be found to exist.”

Noël C.J. went on to confirm the imposition of gross negligence penalties. He noted that although Paletta had informally consulted on three separate occasions with three well-known tax lawyers, it appeared that “Mr. Paletta … presented the plan as not being materially different from the one that was in issue in Friedberg” whereas “the facts in Friedberg were fundamentally different as Mr. Friedberg was conducting his trading activities for profit whereas Mr. Paletta’s sole purpose was tax avoidance.” Indeed, “no minimally competent tax lawyer could have sanctioned Mr. Paletta’s plan to portray his trades as a business, if informed that he was making these trades not for profit but for the sole purpose of generating tax losses in order to avoid paying taxes.”

Neal Armstrong. Summaries of Canada v. Paletta, 2022 FCA 86 under s. 3(a) – business source, s. 163(2), s. 248(1) - business and s. 152(4)(a)(i).