Supreme Court Defines Test For Characterizing Derivatives Transactions

On March 13, 2020, the Supreme Court of Canada released its decision in MacDonald v Canada¹ which provides important guidance in determining whether a financial derivative is on income or capital account for the purposes of the Income Tax Act (Canada).

The issue was whether the taxpayer could deduct, as income losses, the cash settlement payments he made under a forward contract. This turned on whether the purpose of the forward contract was to hedge a financial risk or to speculate. If the forward contract were a hedge, gains or losses from the forward contract would derive their character from the underlying asset hedged. Conversely, if the forward contract were a speculation, the gains or losses would be on income account.