Commodities, and commodities futures and derivatives

Commentary

Commodities such as lead (see Taylor) and toilet paper (see Rutledge, and see also Fraser) are by their nature not of an investment character, so that their sale likely will be considered to be on income account. Similarly, it has been stated that trading in (silver) commodity futures should be viewed as being on income account given that the commodity does not bear interest or dividends (Tamas). However, gold has been found to have been acquired on capital account where there was an overriding capital preservation objective as opposed to an objective of reselling at a profit (see Harms but cf. Wisdom v. Chamberlain). Property acquired in order to pursue a hobby also may be acquired on capital account (see Armstrong).

In the circumstances described in IT-346R, CRA will permit a speculator in commodities and commodity futures to treat those transactions as being on capital account, provided that this is done consistently.

Paintings acquired in order to donate them (an event giving rise only to a deemed disposition) rather than to sell them have been found to have been acquired on capital account. See Zelinski and Pustina. One-off sales of timber (even if quite material in amount) by farmers potentially can be on capital account (see Mel-Bar and Wright, cf. Orlando).

The sale of property that normally would be considered to be inventory of a business and, thus, held on income account has been found to be sold on capital account where its sale occurred as part of the sale of all the assets of a business (see Frankel and Doughty).

Cases

Canada v. Zelinski, 2000 DTC 6001 (FCA)

paintings acquired on capital account for donation

The taxpayers purchased numerous paintings of Morrisseau - initially because of the advantageous price and, later, in greater volume after they learned of the tax benefits of donating the paintings. In rejecting a submission that the gains realized on donation did not qualify for exemption under s. 39(1)(a)(i.1) because the paintings were acquired on income account, Sexton J.A. found that properties purchased for the purpose of donation are, therefore, not acquired in connection with a 'scheme for profit-making'. Furthermore, the doctrine of the secondary intention could not be applied to the taxpayers because their primary intention (i.e., purchasing the paintings either with no specific intention, or with the intention to donate them) was not frustrated and, in any event, the possibility of reselling was not an operating motivation for the acquisitions.

The Queen v. Mel-Bar Ranches, 89 DTC 5189 (FCTD)

$291,134, which a farmer received pursuant to an agreement whose "essential purpose" was for the felling and removal of all usable timber on a specified area of his land, where his main objective in entering into the contract was to clear the land for grazing, was a capital receipt.

Armstrong v. The Queen, 85 DTC 5396 (FCTD)

unexpected sale of race horse

It was held that a thoroughbred racing horse had not been bought by the taxpayer with a view to its eventual sale, and its sale three years later for stud purposes following an unexpected injury to its leg gave rise to capital gain. In rejecting an argument that because horse racing is highly speculative, with little assurance of winnings, the horse must have been bought with a view to eventual sale, Rouleau J. stated: "On such logic every person who purchases property to pursue a hobby is, for income-tax purposes, in the business of buying and selling that type of property."

He also noted that the notion of secondary intention should be used cautiously in an era when capital gains no longer are completely exempt from taxation.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence 49

Westcon Engineering and Contractors Ltd. v. The Queen, 77 DTC 5398, [1977] CTC 567 (FCTD)

exercise of aircraft purchase option and immediate resale

After a corporate jet leased by the taxpayer ceased to be useful to it, it located a purchaser, exercised a purchase option contained in the lease and resold the aircraft to the purchaser for $7,500 more than the exercise price. In finding that this gain was realized on capital account, Maguire D.J. noted (at p. 5399) that the taxpayer "had never been involved in trading of aircrafts" and (at pp. 5399-5400) "it cannot be said that in executing the lease, containing the option to purchase clause, the Plaintiff did so with an intention at that time of ultimately disposing of the aircraft for profit".

Doyle v. MNR, 70 DTC 6251, [1970] CTC 365 (Ex.Ct.), briefly aff'd 78 DTC 6027, [1978] CTC 530, 1 S.C.R. 547

alternative execution of purpose to resell equipment at gain

Equipment was purchased by a syndicate whose purpose was to resell the equipment at a substantial gain to a known purchaser. When the purchaser was unable to honour its commitment due to financial difficulties, the equipment was sold instead a year later to a second purchaser in exchange for shares of the employer of the taxpayer, who was the managing member of the syndicate.

The taxpayer's gain was a taxable profit from an adventure, rather than from the extinguishment of a capital interest in the syndicate. "[T]he original intention of the appellant as to how he was to obtain his profit from this adventure was not accomplished. Instead, the appellant obtained his profit in another way, but that is of no significance."

Orlando v. The Minister of National Revenue, 62 DTC 1064, [1962] CTC 108, [1962] S.C.R. 261

course of conduct of selling topsoil

The chief source of income of the taxpayer from farm land which she held in Scarborough was the sale in most of the years from 1945 to 1952 of topsoil to a company controlled by her husband, which then removed the topsoil at its expense. In 1953, the taxpayer sold the portion of the lands from which she had been removing topsoil, obtained the covenant of the purchaser to remove the topsoil from the purchased lands and deposit them on the remaining lands held by her, and then sold that topsoil to her husband's company for a lump sum.

All the sums received by her for the sale of topsoil were ordinary income.

Frankel Corporation Ltd. v. Minister of National Revenue, 59 DTC 1161, [1959] CTC 244, [1959] S.C.R. 713

inventory included in business sale

The taxpayer, which was engaged in dealing in scrap metals, smelting and refining non-ferrous metals, and in carrying on a wrecking and salvage operation and a steel fabrication and erection operation received $78,096 over book for the inventory of its non-ferrous division on the sale of all the assets (including goodwill) of the non-ferrous operation.

Because the non-ferrous operation was a separate business, the above profit of $78,096 was received on capital account. The sale of the inventory "was not a sale in the business of the appellant, but was made as a part of a sale of a business of the appellant."

MNR v. Taylor, 56 DTC 1125, [1956] CTC 189 (Ex Ct)

executive's substantial lead purchase with view to resale to employer/meaning of adventure

Because the parent corporation of the taxpayer's employer ("Canada Metal") prohibited Canada Metal from dealing in futures or purchasing lead substantially in advance of its delivery, the taxpayer, who was Canada Metal's general manager and who perceived a substantial business advantage to Canada Metal in securing a substantial purchase of lead from overseas, entered into a contract for the purchase of lead from overseas with a view to selling the lead to Canada Metal at the time of delivery. The gain which he realized from doing so was held to have arisen from an adventure in the nature of trade, and therefore was fully taxable. The transaction was highly speculative, "he dealt with the lead in exactly the same manner as any dealer in imported lead would have done", and the fact that the subject matter of the adventure was a commodity "excluded any possibility that it was of an investment nature involving the realization of a security or resulted in a fortuitous accretion of capital" (p. 1139).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Business purchase of large quantity of lead for resale was an adventure 125

Atlantic Sugar Refineries v. M.N.R., 49 DTC 602, [1949] S.C.R. 706

hedging of commodities purchased for business use

The taxpayer, whose business was purchasing, refining and selling sugar, purchased 15,000 tons of raw sugar at elevated prices due to the outbreak of war. In an attempt to recoup part of the loss represented by these high prices, the taxpayer made short sales of sugar on a New York commodities exchange over the following month. The taxpayer’s president testified that these transaction were speculations (similar to share trades) and not hedges.

In finding that the gains of the taxpayer from closing out these transactions were profits from a trade under s. 3 of the Income War Tax Act, Locke J stated (at 711-712, SCR):

While not carried out contemporaneously with the purchases, the short sales were in effect a hedge by the company against a possible loss on the purchases made… . In trades where natural products are purchased in large quantities, hedging is a common, and in some cases, a necessary practice, and the cost of such operations in trades of this nature is properly allowable as an operating expense of the business. Where, as in the present case, the trader elects to close out his short sales and take a profit, this is, in my opinion, properly classified as profit from carrying on the trade.

See Also

Wright v. The Queen, 2003 DTC 763 (TCC)

sale of timber from former farm on capital account

The taxpayers and their father had used 430 acres of a 5,700 acre property in Manitoba for farming for many years before farming ceased in the early 1970s. Commencing in 1995 they entered into two contracts for the sale of all the timber on different sections of the property for a stipulated price plus one-half of any increased revenue realized by the contractor as a result of an increase in the price of lumber.

Miller T.C.J. found that, on balance, the actions of the taxpayers, when compared to those of a commercial wood lot operator, did not display sufficient characteristics of a trader in timber to substantiate that they were involved in an adventure in the nature of trade.

Pustina v. The Queen, 96 DTC 1594 (TCC)

paintings acquired for donation

In finding that the taxpayers (three lawyers) had acquired various paintings by Morrisseau on capital account, Mogan TCJ. stated (at p. 1602):

"Once they decided to donate their early and subsequent purchases to public galleries, that method of disposition crystallized the character of the Morrisseau Art as capital property in their hands because (i) they had no opportunity for profit from that method of disposition; and (ii) they had no other established use or intended method of disposition before that time. They were not like the car dealer who donates a new car to a local charity ..."

Wain v. Cameron, [1995] BTC 299 (Ch. D.)

sale of papers produced by author on capital account

A sale by the taxpayer (who was an author as well as a professor) of his working papers, notebooks, drafts and memorabilia (but not of any copyright) to Edinburgh University gave rise to a taxable gain because such chattels were produced in the course of his vocation.

Harms v. MNR, 84 DTC 1666 (TCC)

potential resale of gold not a motivating factor

The taxpayer, who carried on an accountancy practice but also traded in corn, wheat, gold and cotton futures, purchased gold bars and coins in 1978 and in 1980 in response to investment advisory letters which predicted an economic crash in which only gold would retain its purchasing power. Rip TCJ. found that the taxpayer "fully expected he would require the gold for barter" and "that the potential resale of gold was not a factor in arriving at the decision" to purchase (p. 1670). Accordingly, a capital gain was realized by the taxpayer when he sold the gold in December 1980, after the investment advisories predicted that deflation rather than hyper-inflation might occur.

Wisdom v. Chamberlain (1968), 45 TC 92 (C.A.)

purpose for silver purchase was to profit from devaluation

On the advice of his accountant the taxpayer used borrowed money to purchase £200,000 worth of silver, with a right to put the silver back to the vendor at a price of £210,000 within six months. Although the motivation of the taxpayer in making this purchase (and a similar purchase made three months previously) was to hedge his assets (worth between £150,000 and £200,000) against a devaluation of the pound, in fact such a devaluation did not materialize within the relevant period, and the price of silver rose significantly for unrelated reasons.

In affirming the Commissioners' finding that the taxpayer on closing out his position had realized a gain from "an adventure in the nature of trade", Harman L.J. stated:

"It was expected that there would be devaluation, and the reason for wanting to make a profit was that there would be a loss on devaluation; but that does not make any difference, it seems to me, to the fact that the motive and object of the whole transaction was to buy on a short-term basis a commodity with a view to its resale at a profit."

Commissioners of Inland Revenue v. Fraser (1942), 24 TC 498 (Ct. of Ses. (First Div.))

isolated large transaction in whiskey on income account

The taxpayer, who had no previous dealings in whisky and none afterwards, and no special knowledge of the whisky trade, purchased whisky in bond in three lots, and then resold the whisky at a significant gain in three lots. In finding that the gain was from an adventure in the nature of trade, Lord President Normand stated (at pp. 502-503):

"A man may purchase land with a view to realising it at a profit, but it also may yield him an income while he continues to hold it. There may be also a certain pride of possession. But the purchaser of a large quantity of a commodity like whisky, greatly in excess of what could be used by himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to account except by a process of realisation, I can scarcely consider to be other than an adventure or transaction in the nature of a trade ...".

Rutledge v. Commissioners of Inland Revenue (1929), 14 TC 490 (Ct. of Ses. (First Div.))

large purchase of toilet paper at profitable price

The taxpayer, a businessman with many interests (lending money, the film business, and dealing in real property) happened to be in Berlin in connection with those interests and had the opportunity of making a purchase of a very large quantity of toilet paper from a bankrupt German firm for less than 10% of the amount for which he was ultimately able to sell the toilet paper to a British purchaser. In finding that the profit was from an "adventure ... in the nature of trade", Lord Sands stated (at p. 497) that:

"The nature and quantity of the subject dealt with exclude the suggestion that it could have been disposed of otherwise than as a trade transaction."

Doughty v. Commissioner of Taxes, [1927] AC 327 (PC)

appreciated inventory transfer as part of business drop-down on capital account

On the formation of a partnership, the excess of the nominal value of the shares issued over the net book value of the assets transferred was assigned, in part, to goodwill, and the balance was applied to write-up the book value of the inventory. In finding that this transaction did not give rise to a taxable profit on the transfer of the inventory, Lord Phillimore applied the principle (at p. 331) that:

"Income tax being a tax upon income, it is well established that the sale of a whole concern which can be shown to be a sale at a profit as compared with the price given for the business, or at which it stands in the books, does not give rise to a profit taxable to income tax."

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence step up in recorded carrying value not profit 125
Tax Topics - Income Tax Act - Section 9 - Capital Gain vs. Profit - Goodwill 128

Administrative Policy

23 December 2013 Internal T.I. 2013-0514701I7 - Bitcoins

sale of Bitcoins can be on capital account

Question. "Given the enormous appreciation of the [Bitcoin] currency - how does Capital Gains tax apply?" CRA response:

The determination of the income tax consequences relating to the treatment of gains and losses arising from the purchase and sale of Bitcoins would be generally the same as for transactions involving other types of commodities.

Example

Mr. X bought a Bitcoin on June 1, 2013 for $100. Mr. X then sold the Bitcoin on December 1, 2013 for $500. Based on his particular facts and circumstances, Mr. X determined that the gain was on account of capital. Mr. X has a capital gain...[of] $400 ($500 less $100).

5 November 2013 CRA Press Release "What you should know about digital currency"

capital/income treatment of Bitcoin sales informed by securities trading principles

Digital currency is virtual money that can be used to buy and sell goods or services on the Internet. Bitcoins are an example of digital currency. …

Digital currency can also be bought or sold like a commodity. … Paragraphs 9 to 32 of Interpretation Bulletin IT-479R, Transactions in Securities, provide information that can help in determining whether transactions are income or capital in nature.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 9 - Computation of Profit 67

10 July 2012 Internal T.I. 2011-0418541I7 - XXXXXXXXXX hedges

insufficient linkage between Cdn hedge book and foreign mining subs

Canco acquired FCo, a non-resident corporation. Canco did not directly hold reserves or production assets, but had a head office in Canada with employees engaged in treasury and hedging activities. FCo had a hedging book of derivatives contracts including long and short positions, forwards, call and put options, knock-in and knock-out options and other complex derivatives.

This hedge book was assigned to and assumed by Canco and a hedging partnership ("Canco Partnership), as a result of a novation, in consideration for the payment to Canco by FCo and certain affiliates of FCo of the "Compensation Amount". Over time, Canco settled the assumed hedge book with cash payments, which it treated as being on income account, so that it reported both net aggregate hedging gains and losses over various fiscal years, taking into account the Compensation Payment. The hedging contracts has been treated as hedges for purposes of the consolidated financial statements of Canco.

In accepting this reporting by Canco, CRA stated that it was its position that:

  • generally, unless a derivative contract is a hedge for tax purposes of a capital transaction, the closing out of a derivative contract is on account of income; and
  • whether a specific derivative contract held by a taxpayer is a hedge for tax purposes of a capital transaction would depend on whether there was sufficient linkage between that specific derivative contract and an underlying capital transaction of the taxpayer such as the acquisition or disposition of a capital asset by the taxpayer or the repayment of a debt of the taxpayer which itself was on account of capital.

There is no evidence that the derivative contracts contained in the Hedge Book were held by Canco as hedges for tax purposes of capital transactions of Canco. In our view, the better view is that the Hedge Book was acquired by Canco as part of its ongoing treasury, financial and hedging operations and perhaps as an accounting and/or economic hedge for its investment in FXXXXXXXXXXco, however, neither of these uses of the Hedge Book constitutes a linkage to an underlying capital transaction of Canco.

25 February 2011 External T.I. 2011-0392061E5 - Commodities and mutual Funds

speculator election not available to mutual fund

A mutual fund's gains and losses from transactions in commodities futures are generally considered to be derived from adventures in the nature of trade, and consequently are on income account. Moreover, the election available to speculators in para. 7 of ITR-346R is not available to mutual fund corporations or trusts.

16 December 2004 External T.I. 2004-008197 -

precious metals of mutual fund generally on income account

Respecting a mutual fund that purchased precious metals to be physically held by it in its vaults in the expectation of long-term appreciation, the Directorate stated that it was "of the opinion that transactions in commodities or commodity related instruments should generally be treated for tax purposes as ordinary income."

1996 Alberta CA Roundtable Q. 5, 5-961695 -

timber sale: chattel sale v. licence grant

Whether a contract relating to disposal of timber constitutes a sale of chattels, or constitutes a grant of an interest in land or a licence analogous to a profit à prendre depends upon the intention of the parties as evidenced by the terms of the contract itself and upon any relevant statutory provisions. A sale of chattels generally will be on income account, whereas a grant of an interest in land or a licence analogous to a profit à prendre may be considered to be on capital account.

21 April 1995 T.I. 950986

sale of standing timber may be on capital account

Because standing timber normally is not an asset distinct from the land on which it stands, an individual owning the underlying real property can effectively make the capital gains election with regard to the timber.

6 September 1994 External T.I. 5-941294 -

commodities transactions of mutual funds

RC is "of the opinion that gains and losses resulting from transactions in commodities by mutual fund trusts are, generally, considered to be derived from an adventure [in] the nature of trade. Consequently, such gains or losses are on income account and mutual fund trusts may not elect to treat their gains or losses on capital account as contemplated by paragraph 7 of Interpretation Bulletin IT-346R".

23 February 1994 Memorandum 940210

Generally, it is RC's position that a property subject to a long term lease is capital property.

11 January 1994 External T.I. 5-9325855

not "speculator" if locked-in gain

A taxpayer purchases gold on the spot market and simultaneously sells it forward for an amount which exceeds his cost, thus locking in a gain. Is the gain on capital account? CRA responded:

[T]he taxpayer would not be considered a “speculator”, as that term is defined by the Department for purposes of [IT-346R] as the taxpayer would not be assuming any risk on the proposed transactions. The taxpayer would presumably only proceed with the transactions if the spread between the spot price and the forward price was at least equal to a predetermined minimum amount, thus insuring a predetermined gain.

It is therefore our view that the purchase… will give rise to fully taxable income.

2 September 1992 Memorandum (Tax Window, No. 24, p. 17, ¶2222)

Proceeds received by land owners from the sale of logs and wood products are included in their income. However, where the removal of trees is occasional and incidental to their principal business activity, proceeds from the sale of cutting rights will be capital receipts which reduce the adjusted cost base of the land.

13 May 1992 Internal T.I. 7-921151 -

gold loans of producers

Fluctuations in the amount of the liability of gold producers for gold loans are on income account.

IT-373R "Farm Woodlots and Tree Farms"

"Amounts received (whether in a lump sum or on a stumpage basis) for permitting other persons to remove standing trees from the woodlot are considered to be on account of capital."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 43 - Subsection 43(1) 39

IT-346R "Commodity Futures and Certain Commodities"

3. For taxpayers who take futures positions in, or who have transactions in, commodities connected with their business as part of their business operations, the trading in such futures or commodities creates fully taxable profits or fully allowable losses on account of income (hereinafter called "income treatment'). For example, this includes distillers who use certain grains in their business and also take futures positions in those grains.

4. Also accorded income treatment for tax purposes are transactions in commodity futures or commodities by taxpayers who, while not carrying on a business that utilizes a particular commodity, have access to special (insider) information about the commodity which they use to their benefit in one or more such transactions. ...

5. Corporate taxpayers whose prime or only business activity is trading in items to which the comments in this bulletin apply are subject to the income treatment.

SPECULATORS

6. In this bulletin, a "speculator" is a taxpayer who takes one or more futures positions or acquires a commodity other than in the circumstances described in 3, 4 and 5 above.

7. As a general rule, it is acceptable for speculators to report all their gains and losses from transactions in commodity futures or in commodities as capital gains and losses...provided such reporting is followed consistently from year to year.*

8. 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.

CPP-3 "Speculators in Commodity Futures and Certain Commodities"