MacDonald v. The Queen

MacDonald v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2017-08-08
Neutral citation
2017 TCC 157
File numbers
2013-4032(IT)G
Judges and Taxing Officers
Dominique Lafleur
Subjects
Income Tax Act
Decision Content
Docket: 2013-4032(IT)G
BETWEEN:
JAMES S.A. MACDONALD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on February 13, 14, 15 and 16, 2017, at Toronto, Ontario
Before: The Honourable Justice Dominique Lafleur
Appearances:
Counsel for the Appellant:
James Bunting
Elie Roth
Stephen S. Ruby
Counsel for the Respondent:
Suzanie Chua
___________________________________________________________________
JUDGMENT
The appeal from the reassessments made under the Income Tax Act for the 2004, 2005, 2006 and 2007 taxation years is allowed, with costs to the Appellant, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Signed at Montreal , Quebec, this 8th day of August 2017.
“Dominique Lafleur”
Lafleur J.
Citation: 2017 TCC 157
Date: 20170808
Docket: 2013-4032(IT)G
BETWEEN:
JAMES S.A. MACDONALD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lafleur J.
A. overview.
[1] This appeal concerns the determination of the proper income tax treatment of various Cash Settlement Payments (as defined below) made by the Appellant, Mr. James S.A. MacDonald, in partial and final settlement of a Forward Contract (as defined below) under the Income Tax Act, RSC, 1985, c. 1 (5th supp.), as amended (the “Act”), during the 2004, 2005 and 2006 taxation years. Mr. MacDonald treated the Cash Settlement Payments made pursuant to the Forward Contract totaling $9,956,837 as being on income account under subsection 9(1) of the Act and claimed business losses in the aggregate amount of $9,936,149. The Minister of National Revenue (the “Minister”) reassessed Mr. MacDonald on the basis that these payments were made on account of capital, and, therefore, resulted in capital losses. Also, as a result of the reassessment for the 2005 taxation year, the Minister reassessed Mr. MacDonald for the 2007 taxation year to delete a minimum tax carryforward credit on the basis that such carryforward was no longer available.
[2] The Appellant contended that the Forward Contract was an adventure or concern in the nature of trade, being a pure speculation. The Forward Contract was a bet against the price of the Bank of Nova Scotia (the “BNS”) common shares (the “BNS shares”). Furthermore, the Forward Contract could only be cash settled and did not involve the transfer of shares. Accordingly, any payment made under the Forward Contract was on income account and the resulting losses were business losses. It is only if the Forward Contract was considered a hedge of a capital asset that the Cash Settlement Payments and the resulting losses could be converted into a capital payment and capital losses for Mr. MacDonald. However, it is clear that Mr. MacDonald’s intention in entering into the Forward Contract was to profit in the short-term in the decline of the price of the BNS shares and was not to hedge his BNS shares. Furthermore, there are no links as to both timing and quantum between the Forward Contract and the BNS shares or any other capital assets owned by Mr. MacDonald. Accordingly, the Cash Settlement Payments were on income account and the resulting losses were business losses to Mr. MacDonald.
[3] The Respondent submitted that Mr. MacDonald entered into the Forward Contract to hedge the BNS shares held by him since the Forward Contract was sufficiently linked to the BNS shares, the Forward Contract being a partial same asset hedge. As the BNS shares are capital assets to Mr. MacDonald, the Cash Settlement Payments will also be considered as being made on account of capital, resulting in capital losses to Mr. MacDonald, within the meaning of sections 38, 39 and 40 of the Act. Furthermore, the Respondent submitted that the Cash Settlement Payments were not deductible on income account because they were capital expenditures within the meaning of paragraph 18(1)(b) of the Act.
B. the facts.
[4] By the time this appeal reached trial, the parties had come to an agreement on many of the relevant facts in a Partial Statement of Agreed Facts, attached as Appendix A to these Reasons for Judgment.
[5] Mr. MacDonald testified. He was a very honest and straightforward witness. I found him to be a credible witness and I do not doubt the truth of the facts he testified about.
[6] Each party also called an expert witness: for the Appellant, Mr. John Kurgan, a futures and commodities specialist at RBC Dominion Securities and for the Respondent, Mr. Peter Klein, Professor of Finance at the Beedie School of Business at Simon Fraser University. Both witnesses were qualified as experts in the areas of financial services, forward contracts, derivatives and hedging and their reports and rebuttal reports were filed with the Court as expert reports.
[7] Mr. MacDonald has over 40 years of capital markets and corporate finance experience, starting at the brokerage firm McLeod Young Weir (“MYW”) in 1969, and when MYW was purchased by the BNS in 1988, he continued his career at Scotia McLeod Inc. As a result of BNS acquisition of MYW in 1988, Mr. MacDonald acquired 183,333 common shares of BNS in exchange for shares that he held in MYW.
[8] In 1994, Mr. MacDonald invested in VFC Inc. (“VFC”), an automobile finance company that engaged in non-prime automotive credit financing. He was VFC’s Chairman and owner of 963,004 shares of VFC. In 2003, VFC shares were publicly offered. In 2006, the Toronto-Dominion Bank (“TD Bank”) acquired all the shares of VFC and Mr. MacDonald received approximately $13 million worth of common shares of TD Bank in exchange for his shares of VFC.
[9] In March 1997, Mr. MacDonald left Scotia McLeod Inc. and created Enterprise Capital Management Inc. (“ECM”), which managed funds for Canadian institutional investors and high net worth individuals and which raised and invested funds in a variety of companies.
[10] In the late 1990s, Mr. MacDonald anticipated, on the basis of his view of certain world financial events that the BNS shares he held could decline in value in the short term, despite his optimism about their long-term potential value. Such events included the 1997 Asian Debt Crisis, the collapse of the Thai Bhat, the October 1997 mini-crash of the New York Stock exchange, the Russian Debt Crisis in 1998 and the 1998 collapse of the Long Term Capital Management hedge fund. Mr. MacDonald’s negative short-term outlook stemmed from concerns he had about these adverse developments in international markets; in addition, in his view, BNS was the most internationally exposed to such events of all of the Canadian banks.
[11] Mr. MacDonald approached TD Securities Inc. (“TDSI”) to discuss a forward contract to speculate against the trading price of the BNS shares. Mr. MacDonald entered into a forward contract (the “Forward Contract”) with TDSI on the trade date of June 26, 1997, the terms of which were set out in a confirmation letter dated July 2, 1997, (the “Confirmation”), with a forward date of June 26, 2002, (the “Forward Date”). The Forward Contract could only be cash settled. There was no entitlement to elect physical settlement (i.e. delivery of BNS shares) of the Forward Contract. The cash settlement provision was very important to Mr. MacDonald as he had no intention of selling the BNS shares. The Confirmation contained optional early termination provisions pursuant to which Mr. MacDonald could elect to terminate the Forward Contract prior to the Forward Date. The Confirmation required a securities pledge agreement between Mr. MacDonald and TDSI as credit support for purposes of the Forward Contract. However, no copy of that agreement was produced at trial. Mr. MacDonald had testified that he did not have a copy of said document.
[12] Mr. MacDonald made cash settlement payments under the Forward Contract as follows: $2,204,065 in his 2004 taxation year, $5,855,329 in his 2005 taxation year and $1,897,442 in his 2006 taxation year (the “Cash Settlement Payments”). The Cash Settlement Payments were paid from Mr. MacDonald’s chequing account with TD Bank.
[13] Pursuant to the Confirmation:
(a) Mr. MacDonald agreed to pay TDSI the amount by which the “Reference Price” (the official closing price of the BNS shares on the Toronto Stock Exchange (“TSX”) on the Forward Date) exceeded the “Forward Price” (as defined in the Forward Contract as being $68.46), multiplied by the number of “Reference Shares”, being the number of BNS shares subject to the Forward Contract (165,000 BNS shares); and
(b) TDSI agreed to pay Mr. MacDonald the amount by which the Forward Price exceeded the Reference Price, multiplied by the number of Reference Shares.
[14] The Forward Contract was subsequently amended and extended several times to either adjust the Forward Price (to reflect changes to the quarterly dividend on the BNS shares) and the number of Reference Shares (to reflect a split of the shares and a stock dividend), or to extend the Forward Date and to substitute TDSI for TD Global Finance (In these reasons for judgment, I will refer to TDSI and/or TD Global Finance as TDSI). The Forward Contract was terminated on March 29, 2006.
[15] On June 6, 1997, TD Bank offered a credit facility to Mr. MacDonald which was accepted by the latter on July 7, 1997, (the “Loan”). Mr. MacDonald also entered into a securities pledge agreement with TD Bank (the “Securities Pledge Agreement”), pursuant to which he pledged 165,000 BNS shares and the Confirmation as collateral security for the Loan. Also, as collateral security for the Loan, Mr. MacDonald pledged to TD Bank all amounts which may become payable to him by TDSI pursuant to the Confirmation. The Loan made available up to $10,477,480, subject to a maximum of 95% of the spot price of the BNS shares multiplied by the number of BNS shares under the Securities Pledge Agreement. The Securities Pledge Agreement also refers to an Inter-Creditor Agreement between TD Bank and TDSI, as the pledged securities (the BNS shares, the Confirmation and amounts payable by TDSI under the Confirmation) would be pledged to both of TD Bank and TDSI.
[16] Mr. MacDonald borrowed $4,899,000 under the Loan in 1997, which proceeds were used for the purpose of investing in Enterprise Capital Limited Partnership (part of the group of ECM) and other various securities. The funds were borrowed before the taxation years under reassessment in this appeal, and substantially all of the borrowed funds had been repaid before the commencement of the relevant taxation years. On January 1, 2004, the balance outstanding under the Loan was $554,485. Mr. MacDonald testified that he considered the Loan terminated when it was fully repaid by him on November 5, 2004.
[17] Mr. MacDonald testified that he considered the Loan to be ancillary to the Forward Contract — he viewed the Loan as a “by-product” of the Forward Contract. He claimed that he entered into the Loan because it was offered to him on very favorable terms.
[18] Mr. MacDonald also testified that he felt that he was able to take advantage of a downturn in the market as well as of a downturn in the price of the BNS shares and that his intention was to achieve a profit on an anticipated decline in the value of the BNS shares based on “storm clouds” he saw on the investment horizon. He stated that his intention was not to hedge and he was very clear on that point.
[19] Mr. MacDonald explained during his testimony that not realizing a gain on the Forward Contract in or around 1998 when the market was down was, in hindsight, a major error and that he compounded the error by continuing to wait to settle under the Forward Contract.
[20] Mr. MacDonald explained that, during the relevant period, he had the financial latitude to absorb the losses arising under the Forward Contract. Mr. MacDonald testified that the aggregate income reported on his T1 personal tax returns from 2002 through 2006 was approximately $28.5 million, even after deducting any losses sustained under the Forward Contract.
[21] Mr. MacDonald testified that he did not sell his BNS shares to offset the losses arising under the Forward Contract and the BNS shares that he did sell during the relevant taxation years, were sold by him for the purpose of rebalancing his investment portfolio. After the acquisition of VFC by TD Bank, Mr. MacDonald acquired a significant shareholding in TD Bank. In order to reduce his position in Canadian financial institutions, Mr. MacDonald sold some of his BNS shares over time.
[22] Notwithstanding the sale of some BNS shares over the years, Mr. MacDonald testified that he maintained a positive long-term outlook with respect to BNS. He explained at trial that, presently, the BNS shares are his largest share investment, the “cornerstone” of his investment portfolio, amounting to approximately 15 percent of his total share portfolio. He has no intention of selling the BNS shares and intended to keep them indefinitely.
C. the issue.
[23] The issue in this appeal is whether the Cash Settlement Payments made by Mr. MacDonald under the Forward Contract during the 2004, 2005 and 2006 taxation years were on income account and resulted in business losses for Mr. MacDonald or whether said payments were on capital account and resulted in capital losses for Mr. MacDonald under the Act.
D. the position of the parties.
1. The Appellant’s Position.
[24] The Appellant submitted that I should first determine whether the Forward Contract was, in and of itself, an adventure or concern in the nature of trade as a speculative instrument. If I conclude that the Forward Contract was an adventure or concern in the nature of trade, then I have to determine whether the Forward Contract was sufficiently linked (both in terms of timing and quantum) with an underlying capital asset so as to convert the payments on income account made by Mr. MacDonald under the Forward Contract as payments on capital account, resulting in capital losses to Mr. MacDonald. If I conclude that the Forward Contract was not an adventure in the nature of trade, then, according to the Appellant, I should dismiss the appeal.
[25] According to the Appellant, the Forward Contract was an adventure or concern in the nature of trade and the Cash Settlement Payments were therefore fully deductible on income account for the purposes of the Act, under subsection 9(1). The Forward Contract, by itself, cannot be viewed as an income producing capital asset as it did not generate a current yield. The Forward Contract did not involve an exchange, sale or delivery of any BNS shares. Furthermore, the Forward Contract was a speculative instrument and gave rise to profit or loss solely by virtue of fluctuations in the value of the contract itself and more particularly, it could only give rise to gain or loss by virtue of the fluctuations in the price of the Reference Shares (that is the BNS shares) on its cash settlement. It is clear that the Forward Contract was itself the sole source of income. At the time Mr. MacDonald entered into the Forward Contract, it was uncertain whether the stock price of the Reference Shares would exceed or be exceeded by the Forward Price on the Forward Date. Mr. MacDonald’s sole purpose and intention in entering into the Forward Contract was to speculate on, and profit from, an anticipated decline in the trading price of the BNS shares.
[26] In order to succeed in this appeal, the Respondent must establish that the Forward Contract was a hedge against a capital asset, such that the Forward Contract is treated as a capital asset, with the result that any gains or losses resulting from its settlement will be on capital account. In this appeal, the requirements pertaining to a hedge are not made out as Mr. MacDonald had no intention to hedge when entering into the Forward Contract and there was no linkage between the Forward Contract and any capital assets owned by Mr. MacDonald, including the BNS shares, in terms of both quantum and timing. According to the Appellant, the Forward Contract did not hedge any capital asset and, therefore, the losses on income account were not converted into losses on capital account.
2. The Respondent’s Position.
[27] The Respondent took issue with the approach taken by the Appellant. According to the Respondent, as the Minister is taking the view and had reassessed on the basis that the Cash Settlement Payments were payments made on capital account since the Forward Contract was a hedge of the BNS Shares (which are capital assets to Mr. MacDonald), then my analysis should start with a discussion as to whether the Forward Contract was a hedge. If I answer in the affirmative, then I will have to determine the nature of the assets being hedged so as to qualify the Cash Settlement Payments, whether as payments made on income or on capital account. If I conclude in the negative, I will have to determine whether Mr. MacDonald was engaged in a business, which, by definition, under subsection 248(1) of the Act, includes an adventure or concern in the nature of trade. If I do conclude that Mr. MacDonald was engaged in a business, the Cash Settlement Payments will then be considered as payments made on income account resulting in business losses for Mr. MacDonald.
[28] According to the Respondent, the Forward Contract was not an adventure or concern in the nature of trade; the Forward Contract was “property” and “capital property” as defined under the Act.
[29] According to the Respondent, Mr. MacDonald’s primary intention in entering into the structured arrangement, including the Forward Contract, was “to lock-in an economic gain on the underlying BNS shares pledged and the Forward Contract, and to protect the value of the BNS shares”. By entering into the Forward Contract, Mr. MacDonald had locked-in a gain as if the BNS shares had been sold by fixing the price (the Forward Price) and by virtue of the Loan, he had gained access to funds similar to the amount that would have been obtained if the BNS shares had been sold in the spot market instead.
[30] Mr. MacDonald was exposed to no risk of loss from the structured arrangement and was not a speculator on the Forward Contract. According to the Respondent, Mr. MacDonald would have made a “multimillion-dollar profit” from his position under the Forward Contract from August 1997 to May 2000 as the world financial crisis grew and the BNS shares price fell; however, he did not act on it.
[31] Furthermore, Mr. MacDonald’s secondary intention was to benefit from the disparity flowing from the reporting of the losses on the Forward Contract on account of income and the reporting of the gains on the disposition of the BNS shares on account of capital.
[32] The Respondent took the position that Mr. MacDonald had hedged the BNS shares. The Forward Contract was a partial same asset hedge for Mr. MacDonald’s long-term investment in the BNS shares, i.e. a forward contract under which the underlying assets (or delivery assets) and the Reference Shares were the BNS shares. Consequently, the linkage between the BNS shares and the Forward Contract was clear. Since Mr. MacDonald reduced his overall exposure to price fluctuations in the BNS shares and the number of BNS shares comprising the delivery assets never exceeded the number of BNS shares owned by Mr. MacDonald, Mr. MacDonald had hedged the BNS shares.
[33] Furthermore, as the Forward Contract is a partial same asset hedge, there was no need for the original purchase of the BNS shares to be contemporaneous with the entering into of the Forward Contract. The Respondent also pointed to linkages between the Forward Contract, the Loan and the Securities Pledge Agreement, which I will review later in these reasons for judgment.
E. discussion.
1. The Legal Framework.
[34] Until 2013, the Act did not address directly the taxation of financial derivative instruments. Therefore, basic tax principles should apply as to the issue of whether payments made under a financial derivative instrument are on income or capital account and the case law will provide guidance as to how to apply the Act to that type of instrument.
[35] As mentioned above, the parties took differing approaches with respect to the appropriate legal framework that I should use for my analysis in this appeal. For the reasons below, I am of the view that the Appellant’s approach should be used as it is in accordance with the structure of the Act. Therefore, I should first determine whether the Forward Contract was, in and of itself, an adventure or concern in the nature of trade for Mr. MacDonald, so as to be a source of income that is a “business” under paragraph 3(a) of the Act. If I conclude that the Forward Contract was, in and of itself, an adventure or concern in the nature of trade for Mr. MacDonald, then the Cash Settlement Payments will be considered payments from a source, namely the Forward Contract, which was a business and will be on income account provided the Forward Contract was not a hedge of a capital asset, which later issue should be examined as a second step to my analysis. In my view, this approach is in accordance with the principles for ascertaining profit under subsection 9(1) of the Act developed by the Supreme Court of Canada in Canderel Ltd v Canada, [1998] 1 SCR 147, [1998] SCJ No 13 (QL) [Canderel], that “[i]n seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer’s profit for the given year” (para. 53).
[36] The basic rules for determining the income of a taxpayer are found in section 3 of the Act, the relevant part of it reads as follows:
3 Income for taxation year — The income of a taxpayer for a taxation year for the purposes of this Part is the taxpayer’s income for the year determined by the following rules:
(a) determine the total of all amounts each of which is the taxpayer’s income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada, including, without restricting the generality of the foregoing, the taxpayer’s income for the year from each office, employment, business and property,
(b) determine the amount, if any, by which
(i) the total of
(A) all of the taxpayer’s taxable capital gains for the year from dispositions of property other than listed personal property, and
. . .
(ii) the amount, if any, by which the taxpayer’s allowable capital losses for the year from dispositions of property other than listed personal property exceed the taxpayer’s allowable business investment losses for the year,
. . .
3 Revenu pour l’année d’imposition — Pour déterminer le revenu d’un contribuable pour une année d’imposition, pour l’application de la présente partie, les calculs suivants sont à effectuer :
a) le calcul du total des sommes qui constituent chacune le revenu du contribuable pour l’année (autre qu’un gain en capital imposable résultant de la disposition d’un bien) dont la source se situe au Canada ou à l’étranger, y compris, sans que soit limitée la portée générale de ce qui précède, le revenu tiré de chaque charge, emploi, entreprise et bien;
b) le calcul de l’excédent éventuel du montant visé au sous-alinéa (i) sur le montant visé au sous-alinéa (ii) :
(i) le total des montants suivants :
(A) ses gains en capital imposables pour l’année tirés de la disposition de biens, autres que des biens meubles déterminés,
[…]
(ii) l’excédent éventuel de ses pertes en capital déductibles pour l’année, résultant de la disposition de biens autres que des biens meubles déterminés sur les pertes déductibles au titre d’un placement d’entreprise pour l’année, subies par le contribuable;
[…]
[37] The Supreme Court of Canada explained in Friesen v Canada, [1995] 3 SCR 103 at 111, [1995] 2 CTC 369, 1995 CanLII 62 [Friesen] that section 3 of the Act:
. . . recognizes two basic categories of income: “ordinary income” from office, employment, business and property, all of which are included in s. 3(a), and income from a capital source, or capital gains which are covered by s. 3(b). The whole structure of the Income Tax Act reflects the basic distinction recognized in the Canadian tax system between income and capital gain.
[38] In accordance with paragraph 3(a) of the Act, income derived from a source that is a business, including an adventure or concern in the nature of trade, will be included in the income of a taxpayer under the Act. Therefore, gains and losses from the settlement of a forward contract will be considered on income account provided they are income from a source that is a business, including an adventure or concern in the nature of trade. On the other hand, gains and losses from the settlement of a forward contract will be considered on capital account provided they are income from a source that is a capital or capital property.
2. The Forward Contract: an adventure or concern in the nature of trade or capital property?
2.1 The Appellant’s position:
[39] According to the Appellant, the Forward Contract is the “quintessential adventure or concern in the nature of trade” as it is highly speculative in nature, involves great risks, was isolated and non-recurring and was not used by Mr. MacDonald to “lock-in” any gain on his BNS shares. The Forward Contract could only be profitable if the trading price of the BNS shares upon settlement was less than the Forward Price. When Mr. MacDonald entered into the Forward Contract, it was uncertain whether he would be required to make payments to TDSI or whether he would receive an amount from TDSI.
[40] Furthermore, the Forward Contract cannot be viewed as an income‑producing asset in the traditional sense, since it does not, by itself, generate a current yield; it will give rise to gain or loss by reference to the trading price of the BNS shares on the settlement date. The Forward Contract cannot be considered “property” or “capital property” because “it is a tree that bears no fruit”. On maturity of the Forward Contract, there is no exchange, sale or delivery of the BNS shares and there is no capital asset separate from it that is being bought or sold. The Forward Contract is the sole source of income for Mr. MacDonald. The BNS shares, being the Reference Shares under the Forward Contract, are not the source of income.
[41] Given the nature of the cash-settled Forward Contract and Mr. MacDonald’s stated intention at the time he entered into the Forward Contract that he expected to profit from an anticipated fall in the trading price of the BNS shares, the Forward Contract was “a pure speculation” or an adventure or concern in the nature of trade.
2.2 The Respondent’s position:
[42] According to the Respondent, a forward contract is “property” within the meaning of subsection 248(1) of the Act, a word so broadly defined that it includes a “right of any kind whatever”, and is “capital property” within the meaning of subsection 248(1) and section 54 of the Act. The Respondent cited Friesen, supra, a case decided by the Supreme Court of Canada (at para 42), for the proposition that there are only two classes of property under the Act, inventory and capital property, and argued that a derivative instrument can be either a capital property or inventory. According to the Respondent, the Forward Contract at issue in this appeal is capital property.
[43] The Forward Contract is not an adventure or concern in the nature of trade. The Respondent submitted that in order for there to be an adventure in the nature of trade, there must be a scheme for profit-making which does not include anticipated tax advantages, which was what Mr. MacDonald was trying to obtain (Canada v Loewen (CA), [1994] 3 FC 83 at 93, [1994] 2 CTC 75 [Loewen]).
[44] According to the Respondent, a series of facts do not establish that Mr. MacDonald had a scheme for profit-making; I will review these facts below.
[45] Furthermore, the Respondent pointed to the following factors that are relevant to determine whether a transaction is on income or capital account: i) the nature of the property sold; ii) the length of the period of ownership; iii) the frequency or number of similar transactions; iv) the work done to put the property into marketable condition during the ownership period; v) the circumstances responsible for the sale; vi) the motive at the time of acquisition and, if there was a secondary intention at the time of purchase, to resell (Belcourt Properties Inc v The Queen, 2014 TCC 208 at paras 30-31, 2014 DTC 1182).
2.3 Discussion.
[46] For the following reasons, I am of the view that the Forward Contract was, in and of itself, entered into by Mr. MacDonald as an adventure or concern in the nature of trade as a speculative instrument.
[47] A forward contract is a type of financial derivative instrument. The Supreme Court of Canada in Placer Dome Canada Ltd v Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 SCR 715, at para 30 [Placer Dome], generally describes a forward contract as “a contract that obligates one party to buy, and another party to sell, a specified amount of a particular asset at a specified price, on a given date in the future”. The Supreme Court states that the obligation under a forward contract is two-sided, that is both parties have an obligation to perform. The Supreme Court also notes that, as commonly understood under generally accepted accounting principles (“GAAP”), financial derivatives are contracts whose value is based on the value of an underlying asset, reference rate, or index (para 29).
[48] Similarly, Dr. Klein generally described a forward contract as an agreement between a seller and a buyer to exchange a certain number of units of a “Delivery Asset” at a future “Delivery Date” for a pre-agreed “Delivery Price”. He also explained that, in this case, it is evident that Mr. MacDonald was the “seller” under the Forward Contract notwithstanding the fact it is not certain until the date of settlement which party will be required to transfer economic value. In other words, until the spot price of the Reference Shares (i.e. the current market price) on the date of settlement was known, it was unclear whether Mr. MacDonald would pay TDSI or whether he would receive a payment from TDSI.
[49] As mentioned above, the definition of the word “business” in subsection 248(1) of the Act includes an “adventure or concern in the nature of trade”. However, that phrase is not defined in the Act and we must turn to the common law to ascertain its meaning.
[50] A “scheme for profit-making” is the first requirement for an adventure or concern in the nature of trade and must be present in the intention of the taxpayer. The courts have focused on the intention of the taxpayer at the time of entering into the transaction.
[51] In determining whether a transaction is an adventure or concern in the nature of trade, the Exchequer Court of Canada in MNR v James A Taylor, [1956] CTC 189, 56 DTC 1125 [Taylor], stated that all of the circumstances of the transaction must be considered and that no single criterion can be formulated in reaching this determination (Taylor, supra at 1139). In that case, the Exchequer Court of Canada noted that the nature and quantity of the subject matter was a relevant consideration as to whether a transaction is an adventure in the nature of trade; in addition, the fact that a transaction is isolated or unique is not a test as to whether it is an adventure in the nature of trade: indeed, it may be, on the contrary, “a very important factor” (Taylor, supra at 1137). The Exchequer Court cited with approval a statement of Lord Carmont in Reinhold (Commissioners of Inland Revenue v Reinhold, (1953) 34 TC 389) “that there are cases “where the commodity itself stamps the transaction as a trading venture” (Taylor, supra at 1139).
[52] In Canada Safeway Limited v Canada, 2008 FCA 24, 2008 DTC 6074 [Canada Safeway], the Federal Court of Appeal opined that although the courts have used various factors to determine whether a transaction is an adventure in the nature of trade or a capital transaction, the most determinative factor is the intention of the taxpayer at the time of acquiring the property and if that intention reveals a scheme for profit-making, then the transaction will be an adventure or concern in the nature of trade (para 43). In assessing whether a scheme for profit-making exists, the courts have to determine whether the taxpayer had “a legitimate intention of gaining a profit from the transaction” (Friesen, supra at para 16). However, if the taxpayer intended to hold the property for the purpose of producing income or to be used in the production of income, it will be considered a capital property (Canada Safeway, supra at para 78).
[53] The courts have consistently emphasized that adventures in the nature of trade are speculative trading ventures and they involve great risk (Continental Bank of Canada v Canada, [1998] 2 SCR 358, 98 DTC 6501; Aviva Canada Inc formerly CGU Group Canada Ltd v The Queen, 2006 TCC 57, [2006] GSTC 8).
[54] In Ethicon Sutures Ltd v The Queen, 85 DTC 5290 (FCTD), [1985] FCJ No 436 (QL) (FCTD), the Federal Court stated that “where the transaction is a speculation made in the hope of profit, it will be treated as an adventure in the nature of trade . . .” (page 5293).
[55] The Appellant referred this Court to the Canada Revenue Agency (the “CRA”) Interpretation Bulletin IT-459 (September 8, 1980) (now archived) as support for the proposition that all of the circumstances of a transaction must be considered when determining whether it is an adventure or concern in the nature of trade. In this document, the CRA reiterated the principal tests for determining whether a transaction is an adventure or concern in the nature of trade, which are derived from the case law:
i) whether the taxpayer dealt with the property acquired by him in the same way as a dealer in such property ordinarily would deal with it;
ii) whether the nature and the quantity of the property excludes the possibility that its sale was the realization of an investment or was otherwise of a capital nature, or that it could have been disposed of other than in a transaction of a trading nature; and
iii) whether the taxpayer’s intention as established or deduced, is consistent with other evidence pointing to a trading motivation.
[56] Applying the doctrine propounded in Canada Safeway, supra, to this case, the most important factor to consider answering the question as to whether the Forward Contract was, in and of itself, an adventure or concern in the nature of trade is the intention of Mr. MacDonald at the time of entering into the Forward Contract.
[57] Clearly, a forward contract can be used to hedge or to speculate (Placer Dome, supra at para 29). Thus, the type of derivative instrument used has no bearing on Mr. MacDonald’s intention. Further, it cannot be inferred from the terms and conditions of the Forward Contract, the Loan and the Securities Pledge Agreement that there was a speculative intention, or not. In other words, these agreements do not state that the purpose was to hedge or to speculate.
[58] The Respondent argued that Mr. MacDonald’s primary intention by entering into that structured arrangement, including the Forward Contract, was to lock-in an economic gain on the BNS shares pledged and the Forward Contract, and to protect the value of the BNS shares. He therefore was exposed to no risk of loss from the structured arrangement. Furthermore, according to the Respondent, Mr. MacDonald did not show a scheme for profit-making and did not act as a dealer or trader would act. I do not agree with the Respondent.
[59] I am of the view that Mr. MacDonald’s sole purpose and intention in entering into the Forward Contract was to speculate on and profit from, an anticipated decline in the trading price of the BNS shares; his testimony was credible and reliable, and he was himself a very credible witness. In addition, I am not satisfied that there was a change of intention over the years, even where Mr. MacDonald stated that he continued holding the Forward Contract because he wanted to cut his losses, since a change of intention must be clear and unequivocal (Edmund Peachey Ltd v The Queen, 79 DTC 5064 at 5067 (FCA), [1979] FCJ No 2 (QL) (FCA)).
[60] In order for there to be an adventure in the nature of trade, there must be a scheme for profit-making and I am of the view that a scheme for profit-making was present in this case. The facts showed that Mr. MacDonald had a legitimate intention of gaining a profit from the Forward Contract. When he entered into the Forward Contract, it was uncertain as to whether he would be required to make a payment to TDSI or whether he would receive an amount from TDSI. The Forward Contract afforded Mr. MacDonald an opportunity to speculate on the outcome that the price of the BNS Shares would drop in the short term and that he could profit from that anticipated drop. His testimony was uncontradicted and the surrounding facts supported his testimony.
[61] I agree with the following arguments raised by the Appellant. Mr. MacDonald entered into a Forward Contract that could only be cash settled. Hence, the Forward Contract did not involve an exchange, sale or delivery of any BNS shares. The Forward Contract was pure speculation since Mr. MacDonald had to deal with the Forward Contract to get income from it, i.e. he had to terminate it or partially terminate it to get any income; the Forward Contract did not, by itself, yield income. The Forward contract could only be profitable if the trading price of the BNS shares at the maturity date was lower than the Forward Price and only if Mr. MacDonald dealt with the Forward Contract, i.e. if he terminated it or partially terminated it. Furthermore, the Forward Contract itself stamps the transaction as a trading venture as it was highly speculative in nature, it involved great potential for risk and reward, it was isolated and non-recurring, and was not used to lock-in any gain in the BNS Shares. As to whether Mr. MacDonald would receive or be required to make payments under the Forward Contract was entirely dependent upon the future movement in the market price of the BNS Shares on the TSX.
[62] Although there were cross-references between the various agreements (the Forward Contract, the Loan, the Security Pledge Agreement), the evidence showed that Mr. MacDonald did not consider the Loan as being part of the Forward Contract. He considered the Loan to be a by-product of the Forward Contract, and testified that since the terms and conditions were so advantageous, he accepted the credit offered by TD Bank. The evidence showed that Mr. MacDonald treated the Loan and the Forward Contract as two separate instruments. Only a small percentage of the loan credit offered was borrowed by Mr. MacDonald. In addition, in November 2004, the Loan was repaid in totality; but the Forward Contract remained in place. The fact that Mr. MacDonald invested the amount borrowed in ECM and other publicly listed securities is not relevant with respect to that determination.
[63] What I have to examine is the intention of Mr. MacDonald at the time of entering into the Forward Contract as confirmed by the execution of the Confirmation. The Confirmation was executed on July 2, 1997; the Forward Contract has a trade date of June 26, 1997. I am of the view that, on balance, the evidence showed that Mr. MacDonald’s intention at the time of entering into the Forward Contract was to gain a profit by speculating that the market price of the BNS shares would drop in value because of the storm clouds he foresaw coming in the financial mark