What is a taxable income under the Canadian Federal Income Tax Act?

Under the Canadian Income Tax Act (the "ITA"),1 the concept of a source of income is fundamental: there can be no taxation without income under the ITA and, subject to some very narrow exceptions provided in the ITA, there can be no income without a source.2 Very generally, section 3 of the ITA provides the basis for the computation of income; the income of a taxpayer includes its income for the year from worldwide sources (inside or outside of Canada) such as income from employment, business and property,3 as well as its taxable capital gains.4 Although section 9 of the ITA states that income from a business or property is the taxpayer's profit from that business or property, the concept of "business" is not extensively defined in the ITA, and it is therefore jurisprudence that establishes in what situation a taxpayer is considered to have received income or loss from a business in a year.

Judicial authority has established that in order to receive income from a business, a taxpayer needs to undertake an activity in pursuit of profit.5 In the recent decision Canada v Paletta, 2022 FCA 86, this principle was challenged by the taxpayer on the alleged basis that the commerciality and non-personal nature of a transaction is sufficient. In its reasons, the Federal Court of Appeal (the "FCA") disagreed with the conclusions of the Tax Court of Canada and held that an activity with no intent of profit but with an exclusive intent to avoid tax6 cannot give rise to a source of business income under section 9 of the ITA, despite its appearance of commerciality. Despite the commerciality of a transaction being insufficient by itself, businesses should be mindful that losses arising from non-commercial activities might also not be deductible under section 3 of the ITA.

The facts before the FCA in Paletta were the following: for its taxation years 2000 to 2007, Mr. Paletta entered into numerous forward foreign exchange trades with several brokerage firms. Mr. Paletta entered these trades in pairs of offsetting forward contracts to buy and sell the same amount of foreign currency on different but proximate dates.7 By doing so and by taking advantage of currency rate fluctuations, one transaction in each pair would generate a loss while the other would generate an offsetting gain.8 Since Mr. Paletta executed the transactions carefully to realize the loss transaction before the end of each taxation year and the corresponding gain only in the following taxation year, and because Mr. Paletta repeated the strategy every year, Mr. Paletta deducted his losses and reduced his declared income each year. In this way Mr. Paletta attempted to defer paying income taxes indefinitely. Indeed, the losses that were generated in a taxation year were greater than both the gains from the gain transaction (which had been paired with a loss transaction closed in the prior year) and Mr. Paletta's income from other sources-in this way Mr. Paletta's declared losses steadily increased each year.9 Mr. Paletta used this strategy for himself, as well as for two corporations controlled or owned by him.10

In its reasons, the FCA reviewed the Supreme Court principle decision Stewart v Canada11 and the two-step test for identifying a source of business income. The FCA concluded that a source of income cannot be found without an intent to generate profit:12

Stewart teaches that, in the absence of a personal or hobby element, where courts are confronted with what appears to be a clearly commercial activity and the evidence is consistent with the view that the activity is conducted for profit, they need go no further to hold that a business or property source of income exists for purposes of the Act. However, where as is the case here, the evidence reveals that, despite the appearances of commerciality, the activity is not in fact conducted with a view to profit, a business or property source cannot be found to exist.

Then, the FCA contrasted such finding with the conclusion of the Supreme Court of Canada in the decision Walls v Canada,13 which applied the test of Stewart but added that a commercial activity pursued with an intent of profit did not cease to be a business for the purposes of the ITA just because of a simultaneous intent to avoid tax.14 Notwithstanding the conclusions of the court in Walls, the FCA in Paletta stressed that Walls does not state that an activity devoted exclusively to tax avoidance with an appearance of commerciality can be a business.15

In applying its findings to the situation of Mr. Paletta, and since Mr. Paletta did not pursue the transactions with any intent of profit (as he entered the transactions for the sole purpose of deferring taxation), the FCA concluded that the losses filed by Mr. Paletta were not income from a business. In coming to this conclusion, the FCA also established that Mr. Paletta was grossly negligent as despite receiving warnings, he was "indifferent or wilfully (sic) blind to the legal validity of his plan and that he was only concerned about fulfilling his desire to pay no tax"16. The FCA thus upheld the Minister's assessment of gross negligence penalties for the taxpayer's taxation years 2000 through 2006.


1. Income Tax Act, R.S.C. 1985, c. 1 (5th Supp) (the "ITA").

2. Canada v. Paletta, 2022 FCA 86, para 30 ("Paletta").

3. ITA, para 3 (a).

4. ITA, para 3(b).

5. Paletta, para 35.

6. By realizing a "target loss".

7. Paletta, paras 6 and 11.

8. Paletta, para 6.

9. Paletta, para 7.

10. Paletta, para 8.

11. Stewart v Canada, 2002 SCC 46 ("Stewart").

12. Paletta, para 36.

13. Walls v Canada, 2002 SCC 47 ("Walls").

14. Paletta, para 50.

15. Paletta, para 50.

16. Paletta, para 92.

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