Economic exposure requirement (p. 2198)
…before a sale agreement will be considered to be a DFA [derivative forward agreement], the agreement must be part of an "arrangement" that has the effect of eliminating a majority of the taxpayer's risk of loss and opportunity for gain or profit with respect to the property (which we will refer to as "economic exposure")….
Economic exposure where one-sided exposure (p. 2199)
…The inclusion of this version of the economic exposure test in the DFA rules also highlights questions about how the test should be interpreted generally, and whether it involves a one-pronged or a two-pronged inquiry, which is discussed below in the context of the SDA rules. In the technical notes, Finance has indicated that this new condition should exempt from the DFA rules sales of securities pursuant to the exercise of both typical "covered calls" and the call rights commonly used in "exchangeable share" structures, in each case because the taxpayer would retain significant exposure to the value of the underlying property. [fn 3: It is interesting to note that in its discussion of "exchangeable share" structures, the technical notes indicate that an agreement to sell a share for an amount based on the value of another security does not eliminate the taxpayer's economic exposure to the share (and therefore does not give rise to a DFA) if the share itself contains an "embedded exchange right" for the other security and therefore naturally tracks its value. If the "embedded exchange right" was not present, however, the technical notes indicate that a DFA would arise. Under the DFA rules, therefore, a special significance is attached to exchange rights that are "baked in" to the terms of shares or other securities.]
Embedded interest in forward as an underlying interest (p. 2199)
… The technical notes reiterate that the concept of an "underlying interest" is intended to be interpreted broadly, and list several examples. In addition to unsurprising items (such as the value of a reference fund or a multiple of the return on the TSX), this list also includes "an express or implied fixed interest rate." This suggests that the implicit interest rate used in setting a fixed forward price in a typical forward sale contract would be an "underlying interest" and that the difference between the fair market value of the property at the time that the forward sale contract was entered into and the fair market value at the time of sale should therefore be on income account.
Full tainting of gain (p. 2199)
… the revised DFA rules continue to treat the full amount of the inclusion under paragraph 12(l)(z.7) or deduction under paragraph 20(1)(xx) on income account, even if that gain is only partially attributable to a "bad interest", and even if that "bad interest" would not itself have been on income account if realized directly. Also, the revised rules still do not appear to apply if a DFA is cash settled.
One-sided v. two-sided test (p. 2200)
One interesting question that is not fully resolved (but that is highlighted by the inclusion of an elimination of risk and opportunity test in the DFA [derivative forward agreement] rules, as discussed above) is whether eliminating all or substantially all of (or, alternatively, a majority of) a taxpayer's "risk ... and opportunity" is a two-pronged or a one-pronged test. That is, does the test require the elimination of substantially all of the risk of loss as well as the elimination of substantially all of the opportunity for gain or profit, or is it sufficient to eliminate substantially all of the aggregate of the risks and opportunities. This distinction would be particularly relevant for properties presenting highly asymmetric profit and loss potential (such as short-term government bonds) or in the context of the DFA rules where the lower "majority of threshold is used. The language of the proposed rules standing on its own appears to be ambiguous on this point, but the technical notes at least suggest the former interpretation - though falling short of a definitive statement.
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