Your Business News

Federal Court of Appeal overturns Tax Court decision on losses incurred by straddle trading

May 30, 2022

Authored by RSM Canada LLP

Cleo L. Melanson, CPA, CA, CMA shared this article

TAX ALERT | May 30, 2022


In Canada v. The Estate of Pasquale Paletta, the Federal Court of Appeal (FCA) unanimously sided with the Minister of National Revenue (Minister) in finding that a plan involving foreign exchange straddle contracts did not give rise to a source of income under subsection 9(1) of the Income Tax Act (the Act) and, therefore, Paletta was not entitled to deduct losses from the foreign exchange trading. 

Pasquelle Paletta, year over year, entered into offsetting forward exchange contracts – one long and the other short. He straddled the contracts by crystalizing a loss position before the end of one tax year and realizing a gain at the beginning of the next. The result of these transactions was almost $49 million in net losses from 2000 to 2007, which the Minister denied for a number of reasons, the primary reason being that Paletta did not conduct the foreign trading activity in pursuit of profit and, therefore, it was not a source of income. 

The Tax Court of Canada (TCC) found that Paletta’s sole purpose for purchasing the straddles was to avoid income taxes, and there was no pursuit of profit. However, the TCC cited the Supreme Court of Canada’s decision in Stewart v. Canada (Stewart) to conclude that, because foreign exchange straddling is a commercial activity, it must be a source of income under the Act, notwithstanding the tax motivation. 

The FCA disagreed, overturning the TCC’s decision on the basis that the TCC misinterpreted Stewart. The FCA clarified that Stewart reaffirmed the principle that a pursuit of profit is the decisive consideration in ascertaining the existence of a business, and that a business cannot exist without a pursuit of profit. The FCA applied this principle to the factual finding that Paletta had no intention to profit from the trading, and thereby held that the foreign exchange trading was not a commercial activity and, therefore, not a source of income. As such, the FCA denied the losses. 

The FCA also determined that the Minister was justified in (i) reassessing Paletta’s tax returns after the expiry of the normal reassessment period and (ii) imposing gross-negligence penalties. The FCA cited that, although Paletta had informally consulted with tax lawyers as to the validity of the plan, he had withheld the fact that he did not have a pursuit of profit with his trading activity and had not sought a fully- informed legal opinion on its legitimacy. The court equated his inaction in this regard to indifference or willful blindness. 

In light of this decision, taxpayers who engage in similar hedging strategies and have sustained consistent loss balances will need to grapple with the deductibility of their losses on the basis of whether a profit motive can reasonably be considered to exist. 

Let's Talk!

Call us at 1 855 363 3526 or fill out the form below and we'll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by Simon Townswend and originally appeared on May 30, 2022 RSM Canada, and is available online at https://rsmcanada.com/insights/tax-alerts/2022/federal-court-of-appeal-overturns-tax-court-decision-on-losses-incurred.html.

The information contained herein is general in nature and based on authorities that are subject to change. RSM Canada guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM Canada assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM Canada Alliance provides its members with access to resources of RSM Canada Operations ULC, RSM Canada LLP and certain of their affiliates (“RSM Canada”). RSM Canada Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM Canada. RSM Canada LLP is the Canadian member firm of RSM International, a global network of independent audit, tax and consulting firms. Members of RSM Canada Alliance have access to RSM International resources through RSM Canada but are not member firms of RSM International. Visit rsmcanada.com/aboutus for more information regarding RSM Canada and RSM International. The RSM trademark is used under license by RSM Canada. RSM Canada Alliance products and services are proprietary to RSM Canada.

FCR a proud member of RSM Canada Alliance, a premier affiliation of independent accounting and consulting firms across North America. RSM Canada Alliance provides our firm with access to resources of RSM, the leading provider of audit, tax and consulting services focused on the middle market. RSM Canada LLP is a licensed CPA firm and the Canadian member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM Canada Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how FCR can assist you, please call us at 1 855 363 3526

Important Notice:

FCR will now redirect you to CCH Portal where your FCR Client Portal login is located.

Share This