Canada: Mark-to-market available to non-financial institutions

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Canada: Mark-to-market available to non-financial institutions

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Nancy Diep

In a recent decision by the Federal Court of Appeal (FCA), it was confirmed that the adoption of mark-to-market valuation is not restricted to financial institutions for the purposes of computing income for Canadian tax purposes.

The case involved Kruger Inc. (the taxpayer), a Canadian-based company that carries on a paper products business, with most of its production destined for the US. In order to manage its foreign exchange exposure, the taxpayer started in the 1980s to purchase and sell foreign currency option contracts. By the mid 1990s, the taxpayer had a team of specialised derivatives traders that managed the options and other hedges. In effect, the company had become a speculative trader in derivatives as a separate business and, in reporting its profit for tax purposes, it adopted mark-to-market accounting for its trading business.

The Tax Court of Canada found that taxpayers were subject to an overarching principle of taxation that, unless the Income Tax Act provided otherwise, profits and losses could only be recognised when "realised".

In overturning the lower court decision, the FCA resorted to first principles in posing the question of whether the taxpayer's method of accounting provided an accurate picture of its income for the year and found that there is nothing at law that excludes mark-to-market accounting if it achieves this objective. Once a taxpayer demonstrates that mark-to-market accounting provides this accurate picture, the onus is on the Crown (government) to demonstrate an alternative method that provides a "more accurate" picture, which it failed to do here.

As a final interesting matter, the FCA also addressed the question of whether the option contracts qualified as inventory. In the court's view, the contracts were not property held for sale, a key requirement in the meaning of inventory, and so constituted a separate category of property that is not capital property and not inventory, the impact of which still must be accounted for by a taxpayer.

Nancy Diep (nancy.diep@blakes.com), Calgary

Blake, Cassels & Graydon

Tel: +1 403 260 9779

Website: www.blakes.com

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