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Taxation - Federal income tax - Business and property income - Accounting - Accrual accounting - Losses - Business loss

Thursday, August 18, 2016 @ 8:00 PM  


Appeal by Kruger Incorporated from a Tax Court decision allowing in part its appeal from reassessment. The appellant manufactured newsprint and other paper products. A significant portion of its receivables was denominated in US dollars, leading the appellant to buy and sell foreign currency option contracts to hedge its exposure to currency fluctuations. The appellant became one of the top non-banking purchasers of derivative products. In 2002, the Minister of National Revenue denied business losses of $91 million claimed by the appellant in the 1998 taxation year. The losses arose from dealing in foreign exchange options. At issue was the method used to compute income from dealing in foreign exchange options. The Tax Court rejected the appellant’s use of mark to market accrual accounting as the acceptable computation method and accepted the Minister’s contention that profit or loss could only be recognized when realized. The Tax Court accepted, in part, the appellant’s alternative argument that foreign exchange option contracts were inventory that could give rise to a recognizable loss based on year-end values. The appellant took issue with the Tax Court’s conclusion regarding the computation method. Both parties challenged the Tax Court’s findings regarding whether the contracts constituted inventory.

HELD: Appeal allowed. The Tax Court’s decision failed to adhere to the established framework of analysis set out in the Supreme Court of Canada decisions, Canderel and Ikea, by treating the realization principle as an overarching principle. There was no authority for the Tax Court’s proposition that the principle of realization applied to the exclusion of mark to market accounting unless the Act provided otherwise. The appellant prima facie established that mark to market accounting was an accurate reflection of its income based on evidence that mark to market method was consistent with well-accepted business principles, was GAAP’s preferred basis of accounting for foreign exchange option contracts and was consistent with FASB and international accounting practices. The evidence did not support a finding that the Minister discharged its onus of showing that realization procured a better picture of the appellant’s income. In the alternative, it was not open to the Tax Court to hold that any of the appellant’s foreign exchange option contracts constituted inventory as defined by s. 248(1) of the Income Tax Act, as none of the options to which the appellant was a party were held for sale or purchased for resale. The matter was referred for reconsideration and reassessment on the basis that the appellant was entitled to compute the income derived from its foreign exchange option contracts in accordance with the mark to market method of accounting.