Currency Hedging – Gains Capital or Income?

Currency Hedging – Gains Capital or Income?

George Weston Limited v The Queen, 2015 TCC 42

At issue was whether the gains realised from the dissolution of a currency hedge were on account of capital or income.  The Court identified the defining characteristics of a “hedge”, and stated that the nature of hedge gains or losses is linked to the nature of the underlying item the risk of which is being hedged.

FACTS

The Appellants is a holding company parent of a number of operating subsidiaries, many of which are in the USA.  In order to protect itself against fluctuations of the US dollar in relation to the Canadian dollar (the currency in which it had to reports its financial statements in), the Appellant entered into currency swaps.  When the Canadian dollar rose in relation to the US, reaching parity, the swaps were terminated resulting in a gain of about 317 Million.

The Appellant took the position that this gain was on account of capital and only half included in income. The respondent took the position that the gain was on account of income and, therefore, fully included.

ANALYSIS

The Court determined that it was appropriate to admit expert evidence of a risk management person because (i) hedge is not defined in the ITA and in the context of this case it was appropriate to consider the commercial context of hedging, as “well-accepted principles of commercial trading are acceptable as guidance”: Symes v. Canada, [1993] 4 S.C.R. 695, and (ii) expert testimony on industry practice and on accounting principles related thereto are relevant:  Echo Bay Mines Ltd. v. Canada,  [1992] 3 F.C. 707.   Where a statutory definition is absent, the Courts should be careful to disregard the valuable guidance offered by well-established business principles: Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147.

The Court moved on to define “hedge” and noted that the ITA does note provide a definition (other than in the context of weak currency debts in subsection 20.3(1), which provides indirect guidance). In subsection  20.3(1),  hedge is a derivative that is entered into primarily to reduce risk, where the derivative is properly designated as a hedge.  In Placer Dome Canada Ltd. v. Ontario (Minister of Finance), [2006] 1 S.C.R. 715, the SCC characterized hedging as referring to a transaction that offsets financial risk, and a transaction is a hedge where  the party to it genuinely has assets or liabilities exposed to market fluctuations, and not in an amount in excess of risk exposure (which indicated speculation).

Here the Court held that the swaps were entered into over a period and that this period  was close to the transaction dates that gave rise to the need to hedge against financial risk.  The court did not find a problem with a parent holding company entering into the swaps on behalf of its subsidiaries.

The Court distinguished Tip Top Tailors Ltd. v. Minister of National Revenue, [1957] S.C.R. 703 and Atlantic Sugar Refineries Ltd. v. Minister of National Revenue, [1949] S.C.R. 706, as both those cases involved earnings from derivatives linked to commodities used in the business of the taxpayer.  Here, the swaps were not the purchase or sale of commodities; rather they serve to stabilize the value of foreign currency assets exposed to currency risk on the company’s balance sheet (para 77).   The character of the hedge gain or loss depends on the characterization of the underlying item to which the hedge relates – the risk being hedged  (para 80).

It appears that the Court accepts a transaction to be a hedge where: (i) the transaction is recorded as a hedge in its financial statements for accounting and tax purposes; (ii) the transaction was not speculation ; and (iii) the amount of the hedge matches as closely as possible the amount of the financial risk being hedged against (Para 96).  Further, the character of the hedge gains or losses depend on the character of the underlying item being hedged – if the risk being hedged is capital in nature, the gain or loss from the hedging transaction will also be capital in nature (absent a secondary intention) (para 97).  The Court concluded, at paragraph 98:

[98]        In sum, the present case involves a situation that has not previously been brought before the courts, at least that I am aware of. The appellant made a commercial and business decision, after careful consideration, to enter into the swaps in order to protect its consolidated group equity. It knew better than anyone else the consequences of having its net investment assets exposed to the risk of currency fluctuations. The swaps are commercial derivatives designed expressly to circumvent that kind of risk. As stated by Ms. Frost, the swaps were not speculative transactions. They were designed for hedging in the financial market. Now when the risk vanished, there was no need to keep the swaps. Here, GWL was satisfied that the swaps were no longer necessary when the risk exposure of the net investment assets was reduced significantly. They therefore decided to unwind the swaps. I have concluded that the swaps were entered into to protect a capital investment, and therefore they were linked to a capital asset. Absent unacceptable risk with regard to those capital assets, the swaps had to be terminated since the reason for their existence no longer applied, and the gain or loss from unwinding the swaps should, in my view, be treated as being on capital account. The swaps were not linked in any manner to any business income per se.

The Court rejected the Crown’s alternative argument that the gain was from an adventure or concern in the nature of trade, by referring to the factors that determine whether an adventure is an adventure or concern in the nature of trade in Belcourt Properties Inc. v. The Queen, 2014 TCC 208, and  Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259.  Having rejected the existence of an initial and/or secondary intention to enter into a profit making scheme, the transaction failed to meet this test.

- Sas Ansari, JD LLM PhD (exp)

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Kleven, Equitable Sharing, and Just Democracies

Kleven, Equitable Sharing, and Just Democracies

Get the book review here:  http://ssrn.com/abstract=2570912

Equitable Sharing presents a strong argument for the pursuit, development, and dynamic maintenance of cooperative and complementary regulatory and governance systems (including taxation) that all have the same aim: promoting equitable sharing and countering the concentration, entrenchment, and propagation of power and privilege. We are asked to look at the reasons why societies form, the ideologies justifying and supporting social formation and cooperation by all of society’s members, the manner in which they function, and the very necessary relations that form the core of social existence and operation. We are then asked to develop systems that order society and distribute the resultant desirable and burdensome outputs/outcomes in light of this. Like Plato in the Republic, Kleven is pursuing the design of an ideal society. Unlike Plato, however, Kleven seeks to find the ideal in equality (not class stratification), in truth and reality (not virtuous lies), and in dynamic responses to necessarily/naturally changing social needs/growth (not in stable enclaves that prevent change or growth).

Sas Ansari, JD LLM PhD (exp)

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Lawyers and Anti Money Laundering Laws

Lawyers and Anti Money Laundering Laws 

Canada (Attorney General) v. Federation of Law Societies of Canada, 2015 SCC 7

The SCC had read down provisions of Proceeds of Crime (Money Laundering) and Terrorist Financing Act, S.C. 2000, c. 17 , and the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulations, SOR/2002‑184, that impose reporting obligations on lawyers and law firms (paragraphs 5(i) and (j), and sections 62, 63, 63.1 of the Act) ti exclude legal counsel and law firms.  

The majority of the Court stated:

[1]  Lawyers must keep their clients’ confidences and act with commitment to serving and protecting their clients’ legitimate interests. Both of these duties are essential to the due administration of justice.  However, some provisions of Canada’s anti-money laundering and anti-terrorist financing legislation are repugnant to these duties. They require lawyers, on pain of imprisonment, to obtain and retain information that is not necessary for ethical legal representation and provide inadequate protection for the client’s confidences subject to solicitor-client privilege. I agree with the British Columbia courts that these provisions are therefore unconstitutional.  They unjustifiably limit the right to be free of unreasonable searches and seizures under s. 8  of the Canadian Charter of Rights and Freedoms  and the right under s. 7  of the Charter  not to be deprived of liberty otherwise than in accordance with the principles of fundamental justice.

[…]

[59]                          I accept, of course, that the objectives of combating money laundering and terrorist financing are pressing and substantial as both the application judge and the Court of Appeal held.

[60]                          With respect to the proportionality analysis, the appellant has the burden of proving that (i) the objective is rationally connected to the limit; (ii) the limit impairs the right as little as possible; and (iii) there is proportionality between the effects of the limitation of the Charter  right and the objective. The rational connection does not impose a particularly onerous threshold: Little Sisters Book and Art Emporium v. Canada (Minister of Justice), 2000 SCC 69, [2000] 2 S.C.R. 1120, at para. 228. There is a logical and direct link between, on one hand, the combating of money laundering and terrorist financing (in which lawyers may unbeknownst to them be participating) and, on the other, governmental supervision through searches conducted at law offices.

[61]                          In my view, however, the justification fails the minimal impairment test. There are other less drastic means of pursuing the same identified objectives. The Court has previously outlined the sorts of protections that are required in order to meet the constitutional standard of protection for solicitor-client privilege: Lavallee.

[62]                          I am therefore of the view that s. 64 , and to the extent that they operate in relation to lawyers’ offices, ss. 62, 63 and 63.1 of the Act, cannot be justified.

- Sas Ansari, JD LLM PhD (exp)

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Canadian Exploration Expense – Seismic Data

Canadian Exploration Expense – Seismic Data

McLarty v The Queen, 2014 TCC 30

At issue was whether the taxpayer, who purported to participate as part of a Joint Venture that included the purchase of seismic data, was entitled to claim deductions against income related to the purchase as Canadian Exploration Expense (as defined in ITA subsection 66.1(6)).  The purchase amount was inflated through a series of purchases from about $800,000 to $6.5 Million, and was paid part in cash and part in the form of a limited recourse promissory note.

[The facts and assumptions made by the Minister are in the decision and will not be repeated here].

ANALYSIS

The first issue was whether the Appellant purchased the undivided interest in the technical data for the “purpose of exploration” as required by paragraph (a) of the definition of “Canadian Exploration Expense” in subsection 66.1(6).  In looking at this purpose test, courts must look to what was actually done on the ground of or with the seismic data: Global Communications Ltd. v. R.,  99 DTC 5377; Petro-Canada v. The Queen., 2004 FCA 158.  What is required is some connection between the purchased seismic data and actual exploration work – either in the form of actual exploration or in the form of a credible plan for the use of the data in an exploration program within a reasonable time after its acquisition (para 53).

The second issue was determining the correct “cost amount” of the technical data purchased for purposes of the Canadian Exploration Expense.   The Crown conceded that the promissory note was not a “contingent liability”, leading the court to conclude that the amount of the promissory note is equal to an “incurred expense” (para 58).  The Minister relied on section 67 of the ITA to stated that any expense in excess of the cash payment made and the future liability actually incurred (50% of net licencing revenues for 9 years) is unreasonable.

In determining whether an expense is unreasonable, is to ask whether a reasonable businessman would have contracted to pay such an amount having only the consideration of the appellant in mind: Gabco Limited v. Minister of National Revenue, [1968] 2 Ex.C.R. 511; Petro-Canada v. The Queen., 2004 FCA 158.  Reasonableness is a question of fact and paying fair market value for something (a matter not challenged by the Minister in this case) is prima facie reasonable.  It is a question of fact whether paying more than FMV in the circumstances is reasonable or not.

Where an asset is difficult to value, and the sale is at arm’s length, it is not appropriate to challenge the business judgment of the taxpayer:  McLarty v. The Queen, 2005 TCC 55.

The court also allowed the interest deduction claimed by the Appellant as the liability to pay interest was a real one and interest was in fact paid.

In responding to the Minister’s “sham argument” – that the transaction was conducted with an element of deceit so as to create an illusion meant to deceive the tax man by disguising reality: Stubart Investments Ltd. v. The Queen, [1984] 1 SCR 536 pages 545-46 – the court stated that what is required is:

  • an intention of the parties to the transaction
  • to give a false appearance
  • that the legal rights and obligations have been created that are different from the actual legal rights and obligations of the parties

[for a summary of the Sham Doctrine see HERE]

Here, the required elements of a Sham were not present in the transactions carried on by the Appellant or the Joint Venture.  Any claims of Sham relate to transactions by other entities.  The court said:

[78]        In my opinion, the Crown cannot apply the doctrine of sham to only a part of a particular transaction while considering another part of the same transaction as being legally valid and effective. For example, I have difficulty with the Crown being permitted to apply the doctrine of sham to only that part of the acquisition by the appellant of an undivided interest in the Seismic Data that was paid for by the appellant’s Promissory Note.

[…]

[88]        Considering the evidence before me, I cannot accept the Crown’s position that the creation of the Joint Venture and the transactions carried on by it and by Compton Petroleum Corporation on its behalf were mere window dressing intended to deceive the Minister. The legal rights and obligations created by the said transactions were not different from the actual legal rights and obligations of the parties. The way in which the financial statements of the Joint Venture were presented is not relevant in the circumstances because the issue does not involve determining whether or not the Joint Venture was an oil and gas entity for accounting purposes or whether or not the licensing revenues derived from the Seismic Data were incidental to the exploration activities of the Joint Venture or were related to a separate business. The financial statements of the Joint Venture were audited financial statements with no qualified opinion. As such, they were accurate and reliable.

- Sas Ansari, JD LLM PhD (exp)

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Holding Company ITCs – Management Services

Holding Company ITCs –  Management Services

MiedzI Copper Corporation v The Queen, 2015 TCC 26

The Appellant, a holding company whose only activity was holding shares in foreign entity Op-Cos, claimed Input Tax Credits (ITCs) for HST paid on management, professional, and geological survey fees.   At issue was the interpretation of “in relation to” in Excise Tax Act subsections 186(1) and (3), allowing a holding company to claim ITCs.

The TCC held that where a HoldCo does nothing else but hold shares of the subsidiary, everything theHoldCo “does can be said to be done in relation to the shares or indebtedness of” the subsidiary (para 35).

FACTS

The Appellant is a holding corporation headquartered in Vancouver that carries out no activity other than holding all of the shares of a foreign corporation that in turn owns shares of a number of mineral exploration companies.   The Appellant has no employees or premises of its own, but raises funds to loan to its subsidiary to be loaned to the operating companies. All of its operations are carried out by contractors providing services to the Appellant.

ARGUMENTS

The Appellant argued that subsection 186(1) is a look-through provision that allows a HoldCo to claim ITCs that the underlying corporation would have been claimed if the costs were incurred by it directly.

The Crown argued that the costs were HoldCo’s own corporate costs, that the “in relation to”must be interpreted in the context of “to the extent that” and “can reasonably be regarded”, limiting the eligible costs to those related to shares or indebtedness – an actual relationship between the expense and the shares or indebtedness.

ANALYSIS

Absent ETA subsection 186(1), a holding company would not be able to claim ITC. This subsection permits such claims so long as the conditions in the provision are met.  One condition is that the services in respect of which the ITCs are claimed can “reasonably be regarded as having been… acquired… for consumption or use in relation to the shares or indebtedness” of the subsidiary corporation.

The Court referred to the TCC decision in Stantec Inc. v. Her Majesty the Queen, 2008 TCC 400, aff’d 2009 FCA 285 where the phrase “in relation to” was given a broad interpretation such that no direct or substantial link between the cost and the shares of the subsidiary are needed (paras 14-15):

“Reasonably regarded in relation to” is an expression of the widest possible import. The Supreme Court of Canada addressed the phrase “in relation to” in Slattery (Trustee of) v. Slattery [1993] 3 S.C.R. 430 suggesting it implies a wide, rather than narrow, view in connecting two matters. When this expansive approach has a lead-in with the words “reasonably regarded”, I reach the inevitable conclusion that it should not take very much to draw a nexus between acquiring the listing services and the shares of either Keith Companies or Stantec California. 

There is no question there is a strong nexus between the listing services and the Stantec shares – they were the very shares listed, but the connection need not be one of a primary nor substantial nor directly related nature. The concept of “in relation to” is not one of prominence let alone exclusivity.

The TCC held that where a HoldCo does nothing else but hold shares of the subsidiary, everything theHoldCo “does can be said to be done in relation to the shares or indebtedness of” the subsidiary (para 35).  The Court concluded that  “there is a clear nexus between the administrative, management and legal services in issue and the shares or indebtedness of [the subsidiarty]. But for its ownership of the [subsidiary’s] shares and its funding of [subsidiary] by debt, [HoldCo] would not have acquired those services” (para 35″.

- Sas Ansari, JD LLM PhD (exp)

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Income Tax (Federal & Provincial) – HST/GST – International Tax