Words and Phrases - "hedging"

The taxpayer sold its gold production to bullion dealers at the spot price but also, in order to manage the risk associated with fluctuations in the spot price of gold, entered into cash-settled derivatives such as forward contracts, spot deferred contracts, fixed interest floating lease rate contracts, put options and call options. “Proceeds” for purposes of computing its mining profits under the Mining Tax Act (Ontario) referenced: (a) consideration received from the output of a mine; (b) consideration from hedging; and (c) consideration from future sales or forward sales of the output of the mine That Act in relevant part defined “hedging” as including “the fixing of a price for output of a mine before delivery by means of a forward sale or a futures contract on a recognized commodity exchange.”

In finding that the mining profits of the taxpayer included its profits from settling such derivatives, and in rejecting the taxpayer’s arguments that hedging referred only to contracts which entailed the physical delivery of mine output, LeBel J first noted (at para. 31) that

at least for the purposes of GAAP, the way in which a derivative contract functions as a “hedge” is unaffected by the method by which the contract is settled

and then went on to find (at para. 46) that the interpretation advanced by the taxpayer had the effect of making the “hedging” component of determining “proceeds” redundant. As to the meaning of “hedging,” he quoted (at para. 33) the statement in Echo Mines that

under generally accepted accounting principles, a producer’s gain or loss from its execution of forward sales contracts may be considered a “hedge” and therefore matched against the production of the goods produced, if four conditions are met. . . .

1. The item to be hedged exposes the enterprise to price (or interest rate) risk.

2. The futures contract reduces that exposure and is designated as a hedge.

3. The significant characteristics and expected terms of the anticipated transactions are identified.

4. It is probable that the anticipated transaction will occur.

and stated (at para. 35) that such general principles “have some relevance here.”

He also stated (at para. 51):

[A]lthough forward sales and options are distinguished from one another in terms of the particular way in which each is used to hedge price risk, both are used in much the same way to “fix the price” for output. PDC’s argument about the serious distortion implicit in treating options as a subset of forward sales is belied by the PDC’s own Annual Reports … .