23 November 1999 External T.I. 9824405 - TIMING OF LOSS RECOGNITION--FUTURES CONTRACTS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

In which year would a loss that is to be realized in a series of foreign currency futures contracts be reported in - the year the loss is economically incurred or in the following year when the loss is realized?

PositionS:

When realized unless the Canderel approach to determining income can prevail.

Reasons:

In Schultz (FCA) circumstances the taxpayer cannot claim the loss until both sides of the hedge are closed. In Friedberg (SCC) the realization approach was applied. Canderel sets out a methodology for determining income under section 9 which may be relevant to some factual situations. Other positions are outlined in Interpretation Bulletins IT-95R and IT-346R.

XXXXXXXXXX 	982440
		Allan Nelson
(613) 443-7253
Attention:	XXXXXXXXXX 

November 23, 1999

Dear Sirs:

Re: Futures Contracts -- Timing of Loss Recognition

We are writing in reply to your letter dated September 18, 1998, wherein you asked for our views as to the appropriate time to recognize a loss for income tax purposes. You describe a situation where, at different times in Year 1, a taxpayer enters into two separate futures contracts, each with an arm's length third party. The first contract requires that in Year 2 the taxpayer must buy a predetermined amount of U.S. dollars at a preset price. The second contract requires that in Year 2 the taxpayer must sell the same predetermined amount of U.S. dollars at a different preset price. The result of entering into these two contracts is the taxpayer will experience a net economic loss. This is so, regardless of what the U.S. dollar is trading at when the futures contracts mature in Year 2.

It is your view that since the taxpayer's economic loss is a certainty, the taxpayer will use the accrual method (in accordance with GAAP) to report the economic loss for accounting purposes in Year 1. For income tax purposes, the taxpayer has consistently reported all gains and losses from currency transactions on income account, using the accrual method. You have also advised that the taxpayer is a speculator and is not a trader of U.S. currency. As referred to in paragraph 6 of Interpretation Bulletin IT-95R, the foreign exchange loss will not be a result of transactions that form part of the taxpayer's business operations.

Our Comments

The determination of the appropriate income tax treatment for currency futures transactions (both with regard to their nature and their timing) involves a question of fact which can only be resolved after reviewing all the available facts in a particular instance. These facts are not presently available and, as noted in Information Circular 70-6R3, we do not provide opinions with respect to proposed factual transactions other than in reply to an advance income tax ruling request. However, in order to assist you in answering your question, reference is made to extracts from our publications, as well as to relevant jurisprudence, as follows.

Extracts from Relevant Publications

Paragraph 6 of Interpretation Bulletin IT-95R states

A taxpayer who has transactions in foreign currency or foreign currency futures that do not form part of business operations...will be accorded by the Department the same treatment as that of a "speculator" in commodity futures see 7 and 8 or IT-346R...

Paragraph 8 of Interpretation Bulletin IT-346R states

If a speculator prefers to use the income treatment in reporting gains and losses in commodity futures or commodities, it may be done provided this reporting practice is followed consistently from year to year...

Paragraph 7 of Interpretation Bulletin IT-95R states

The Department will accept any method used to determine foreign exchange gains or losses on income transactions provided that method is, under the circumstances, in accordance with generally accepted accounting principles. Further the method used should be the same for both financial statement and income tax purposes...

Relevant Jurisprudence

In Canderel Limited v. Her Majesty the Queen [98 DTC 6100] the Supreme Court of Canada decided on the matter of the deduction of certain tenant inducement payments for the purpose of the computation of income under section 9. In this case the Court stated that in ascertaining profit, the taxpayer is free to adopt any method that is not inconsistent with (a) the provisions of the Act, (b) established case-law principles or "rules of law", and (c) well-accepted business principles. Once a taxpayer has chosen a method of computing profit that provides an accurate picture of income for the year, which is consistent with the Act, the legal principles, and well-established business principles, the onus shifts to the Minister to show that the method does not represent an accurate picture, or that another method provides a more accurate picture.

Beyond the particular facts of Canderel and the general approach established therein, two other cases directly addressed commodity transactions, as noted below.

In the Federal Court of Appeal case of Louis Schultz and Thomas M.G. Schultz v. Her Majesty the Queen [95 DTC 5657] the Court decided that each hedging transaction concluded when both positions were closed. Thus losses and expenses were not incurred in a particular hedging transaction until both sides of the hedge were closed out. It should be noted that this case was decided on its peculiar set of facts involving a husband and wife partnership where each spouse/partner was carrying out mutually offsetting convertible hedging transactions in publicly traded securities. The Canada Customs and Revenue Agency (CCRA) (formerly Revenue Canada) refused to recognize "losses" on the mere shifting of a position between the husband/wife/partners.

In the Supreme Court of Canada decision in Her Majesty the Queen v. Albert D. Friedberg [93 DTC 5507], the Court allowed the taxpayer to deduct business losses realized from the trading of gold futures on the commodities market after only one leg of the hedge was closed out in a particular taxation year (hereinafter referred to as the "realization method" of reporting).

In conclusion, it is our view that the realization method of reporting transactions in futures contracts is acceptable. However, in certain fact situations the principles of Canderel may have application.

In accordance with paragraph 22 of Information Circular 70-6R3, the above comments are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CCRA. Our views expressed in this letter may change after reviewing all the relevant documents in any particular arrangement.

Yours truly,

Paul Lynch
for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch