The Federal Court of Appeal has held in the Kruger Inc. v.
Canada decision published yesterday, that Kruger Inc. was
entitled to use the mark-to-market method in computing its income
for federal income tax purposes. As a result, for income tax
purposes it was entitled to recognize an accrued year-end loss on
its book of foreign exchange option contracts.
Kruger is a manufacturer of newsprint and other paper products,
but the Court found that Kruger's option trading activities
– which consisted principally of writing over-the-counter
foreign exchange options on the U.S. dollar but also included the
purchase of option contracts – amounted to a separate
The Court of Appeal's conclusions rested principally on two
Supreme Court of Canada decisions:
Canderel, which was stated to stand for the
proposition that the requirement to compute income on a realization
basis (i.e., in the case of options, when they mature or are sold)
"can give way to other methods of computing income pursuant to
section 9...where these can be shown to provide a more accurate
picture of the taxpayer's income for the year;" and
Canadian General Electric, which was described as
finding that a taxpayer had the choice of recognizing
changes in the Canadian-dollar equivalent of its U.S.-dollar trade
payables on an accrual rather than realization basis.
The decision also relied on key factual findings:
the option valuations used by Kruger at year-end "were
"the broad recognition of mark to market accounting for
purposes of computing income from dealing in foreign exchange
options, and the uncontested evidence that banks, financial
institutions and mutual funds which engage in this activity report
their income on this basis with the CRA's approval."
This case may indicate that a taxpayer, which has derivatives or
other property or obligations acquired or incurred on income
(rather than capital) account, has the option to report its gains
or losses on those holdings on a mark-to-market rather than
realization basis for tax purposes if, under generally-accepted
accounting principles, it also prepares its financial statements on
a mark-to-market basis.
However, it is not clear that the Canada Revenue Agency will
accept that this is what the Kruger decision has
established. It likely will be concerned that taxpayers would
consider selectively adopting mark-to-market tax accounting
whenever they sustained significant accrued losses on their
derivatives book, or other trading positions that they have marked
to market for accounting purposes. The CRA is also cautious
about changing long-standing assessing practices except when these
have been clearly found to be incorrect.
What the CRA likely will accept is that financial institutions,
such as banks (which already are required to apply statutory
income-tax mark-to-market rules to most of their stock and bond and
equity and debt derivatives holdings) will continue to be able to
use mark-to-market tax accounting for their other derivatives
positions (which do not come within these statutory mark-to-market
rules). These financial institutions will now be on a more
secure footing than they were in the aftermath of a technical
interpretation issued by the CRA in 2012, in which it indicated
that it may no longer accommodate non-statutory mark-to-market tax
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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