Chad v The King
In Chad v The King, the Tax Court of Canada addressed a tax dispute between the taxpayer, Robert Chad, and the Canada Revenue Agency (“CRA”) regarding Chad’s 2011 tax year. Chad had engaged in a series of foreign currency exchange transactions that lead to a $22 million dollar capital loss in 2011, followed by an offsetting $22 million dollar capital gain in 2012. The CRA disallowed Chad’s use of the capital loss on the basis that the transactions were a sham.
Background
Near the end of 2011 Chad employed a tax-deferral strategy involving forward contracts for foreign currency exchange in what is known as a saddle-trading strategy. Chad would purchase a short position on US dollars along with an equivalent long position. This meant that regardless of whether the value of the US dollar rose or fell, Chad would have an unrealized capital gain and a nearly equivalent capital loss. By selling his loss position in late 2011 and his gain position in early 2012 he could defer the paying taxes on any other capital gains he earned in 2011.
Chad hired a broker to make the trades and instructed them to aim for a loss of $22 million in 2011. The broker charged a fee of $240,000.
Key Issues
Were the trades shams?
The CRA argued that Chad’s misrepresented the legal rights he gained through these trades, and the losses should be disallowed as being derived from a sham.
Were the trades legally effective?
The CRA assumed that even if the trades were not shams, their underlying contracts were not legally effective and could not have been executed in the way Chad claimed.
Did the trades constitute a source of income?
In order to claim a capital loss for tax purposes, the loss must arise from a source of income. The CRA took the position that Chad’s foreign exchange trades did not legally constitute a source of income under the Income Tax Act.
Court Findings
The Court dismissed the first two of the CRA’s arguments. The contractual relationship behind the transactions was determined to fit what Chad had represented them as, and so there was no sham. Likewise, the Court heard expert evidence that the transactions were legally effected, and that they had been executed according to their contractual terms.
However, the Court found that the trades did not constitute a source of income under the Income Tax Act. While the Court found that the transactions were not personal in nature, they were not sufficiently commercial to be considered a source of income because they were undertaken without an intent to profit.
In making this determination, the Court looked to whether there were sufficient objective manifestations to support Chad’s subjective statements of his intent to profit. In particular, the Court focused on Chad’s correspondence with his broker and the steps he took to close out his position in early 2012. The evidence showed that Chad was never concerned with the fact that his position would not provide a gain greater than the $240,000 broker fee, and that he took steps to reduce the risk of his short and long positions doing much more than offsetting each other.
In the end, Chad’s trades ended in a net gain of $6,200, not nearly enough to profit when the broker fee is considered. The Court ruled that Chad’s intention had not been to profit, but rather to generate a $22 million loss in 2011, and as such the loss did not arise from a source of income.
Conclusion
The decision in Chad v The King is a cautionary tale for any taxpayer who engages in transactions for the sole purpose of deferring or offsetting their taxes. Taxpayers who wish to utilize such transactions in these ways should seek out the advice of a tax lawyer before setting their plan in motion.
If you have any concerns regarding your own tax affairs, speak to a qualified tax lawyer today. We can provide advice tailored to your specific circumstances and assist with a range of services from tax planning to CRA tax disputes.
***Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
Matthew Pollock
