Published: April 28, 2025
INTRODUCTION: Businesses using artificial tax plans without considering business realities may face unintended consequences.
The March 2025 case of Chad V King 2024 TCC 142 emphasizes the need for taxpayers to ensure that their business-oriented tax plans are alive to business realities. In Chad, the tax court refused deductions of the taxpayer’s expenses and losses because they arose from trading activities that were not sufficiently commercial.
The tax court made an objective assessment of all the evidence presented by the taxpayer and found that the taxpayer had no intent to make profits from the trading activities. As a result, the court held that the income arising from the trading activities was not a source of income for tax purposes under the Income Tax Act. Therefore, losses and expenses incurred from the trades cannot be used to offset income for tax purposes.
The decision in Chad was accurate in the opinion of our expert Canadian tax lawyers. The tax plan was so artificial and tax-focused that it ignored business realities, i.e., the primary goal of every business is to make a profit. The GAAR, which was held inapplicable in Chad, also has an economic substance consideration; this further underscores the need for tax plans to be alive to business realities.
We will begin this article by reviewing the facts in Chad; we will provide details of the tax court’s decision and their legal significance; we will offer justifications in support of the court’s decision in Chad. As is customary with our articles, we will provide the reader with Pro Tax Tips and Frequently Asked Questions arising from the article. Our Pro Tax Tips for this blog will be on the GAAR.
FACTS OF THE CASE IN CHAD V THE KING.
Chad was a businessman with diverse business interests; his primary focus was in oil and gas. Chad entered into a straddle trading strategy for trade in foreign exchange (FX) forward contracts. He hired an FX broker, Timothy Hodgins (TH), who, along with his father, owned a Canadian brokerage business, HFX Markets Ltd (HFX).
HFX had a revenue-splitting arrangement with a London-based FX brokerage firm called Velocity. HFX also had an ‘earn out’ clause, which allowed it to own up to 5% of Velocity shares.
Before the trades began, Chad provided TH with a target loss amount of $22M for 2011. All 34 trades carried out by TH on behalf of Chad for 2011 and 2012 had Velocity as the counterparty. The trades were carried out in USD on an over-the-counter basis, rather than an institutional exchange.
The trade involved one long and one short position. Upon TH’s recommendation, Chad closed out the loss position on the trade and realized a loss of $22,017,400 in 2011. In the first quarter of 2012, Chad closed out the gain positions for which he realized gains in similar amounts in 2012. However, the gains exceeded the losses by $6200.
Chad claimed the losses and used them to offset income from his other businesses in 2011. The remainder of the losses were carried over to offset Chad’s income for 2013 and 2014. Chad also deducted the sum of $166,666.67 from his taxable income as brokerage fees it paid to Velocity for its services in 2011.
The CRA reassessed Chad’s 2011 tax returns and refused Chad’s deduction of the losses and fees. As a result, Chad appealed to the Tax Court of Canada (TCC). In defence of its position at the TCC, the CRA argued that Chad’s transactions: were a sham, were not legally effective, were not a source of income for tax purposes, were made before their value dates, were reported using improper accounting methods; and that the GAAR should be applicable.
The Canadian tax litigation lawyer for Chad opposed all the CRA arguments. In addition, Chad explained that the purpose of his FX trading activities was to speculate, profit, gain market access, hedge, learn, develop tools, strategies and concepts which could also be used in his other business concerns, engage in tax planning, and to defer income from 2011 to 2012.
JUDGMENT OF THE TCC IN CHAD V THE KING
The TCC dismissed Chad’s appeal. Although the TCC affirmed most of Chad’s oppositions to the CRA arguments, it however agreed with the CRA that Chad’s FX trades were not a source of income. As a result, the losses and expenses arising from such trades cannot be used to offset Chad’s taxable income.
DETAILS OF THE TCC’S JUDGMENT IN CHAD V THE KING
The TCC held as follows:
- Chad’s FX transactions were not a sham, because the actual contractual relationship was not different from what Chad and Velocity presented them to be.
- Chad’s FX transactions were legally effective, because they were executed in accordance with their contractual terms.
- The values in Chad’s FX contracts were transferred on the dates stipulated therein.
However, in dismissing Chad’s appeal, the TCC explained that Chad’s FX trades were not a source of income for tax purposes. This was because the evidence did not objectively show that the trades were made with an intent to profit. The trades did not even show any efforts to produce a greater gain to cover the brokerage fees paid by Chad to Velocity, which was a significant expense.
The focus of the trades was merely to generate a $22M loss; this explains why Chad’s long and short positions in the straddle strategy were simply offsetting each other in order to achieve this loss. Therefore, the income generated from such transactions was not business or property income recognized for tax purposes.
The court further held that, although the transactions were not personal in nature, they were ‘not sufficiently commercial.’ The TCC, therefore, joined the CRA in refusing Chad’s deductions of losses and expenses generated as a result of the trade.
Since Chad’s FX activities were found not to be a source of income for tax purposes, the TCC considered it unnecessary to decide the other issues in the appeal regarding:
- The propriety of the accounting method used to report the transactions,
- The GAAR.
LEGAL SIGNIFICANCE OF CHAD V THE KING
Chad’s case exemplifies the need for taxpayers to pay attention to reasons and theories explaining their tax plans, and to review these reasons and theories with experienced Canadian tax lawyers. This is because when the tax plans are up for review, the taxpayer’s defence of these plans is mostly factual.
This will require the taxpayer to present evidence in court to explain the tax plans with reasons and theories behind the plans. In Chad v the King, the tax structure was presented in a manner that took it out of the realm of a commercial endeavour. As a result, losses and expenses incurred by the taxpayer were held to be incapable of offsetting any income for tax purposes.
JUSTIFICATIONS FOR THE TCC’S DECISION IN CHAD V THE KING
Justifications for the TCC’s Part-Concurrence with Chad’s Appeal Submissions
The TCC rightly concurred with part of Chad’s submissions in opposition to the CRA arguments in the Appeal. As a result, the court found that Chad’s transactions were not a sham, were legally effective, and value was duly transferred.
First, the TCC rightly decided that a transaction is a sham where the relevant parties present their legal rights and obligations in a manner different from what the parties truly know them to be.
This was consistent with its earlier decision in Cameco Corporation v. The Queen (2018 TCC 195). The facts relied on by the TCC to support this forgoing conclusion also made it implausible that the transaction would be a sham, i.e. TH could not set the prices for the trades; the prices were set by Velocity, who dealt at arm’s length with TH, as indicated in the paragraph below; Velocity also dealt with TH in the same manner as its other clients.
The court also relied on the expert testimony of Mr. Bird as regards the reputation of Velocity in the financial market, which includes: being majorly owned by a reputable Australian Bank, being a global securities brokerage firm, and being authorized by regulators in many markets.
Secondly, the TCC was accurate when it held that a transaction is legally effective where it is a real transaction that is valid and enforceable. It further explained that in the case of a contract, there has to be offer and acceptance; consideration; and intention to create legal relations. Offer, acceptance and consideration were evident from the facts.
With respect to the intention, the TCC rightly posited that Chad and Velocity entered legal relations for the purpose of FX trades and truly carried out the trades. In reaching this conclusion, the TCC rightly considered facts which depicted the genuine independence of TH and agents of Velocity, i.e. they dealt at arms-length with each other; they did not have access to each other’s information; they were separated from each other; and they even competed with each other.
However, the TCC should have also supported this conclusion with the expert testimony of U. Wystup: that although the transactions between TH and Velocity were on an over-the-counter basis, they were reflective of the market conditions, with real risks of loss and gains. This adds to the reality and genuineness of the transactions.
Thirdly, it was a matter of course for the TCC to conclude that, since Chad’s transactions were legally effective, it follows that such contracts were in accordance with their terms. Moreover, value was truly transferred on the dates stipulated in the contracts, as the TCC rightly deduced, mostly from the documentary evidence before it.
The TCC was therefore accurate in accepting Chad’s contentions on the above forgoing issues.
Justifications for the TCC’s Dismissal Of Chad’s Appeal
Tax planning is the right of taxpayers. Taxpayers are entitled to plan their affairs in order to minimize their tax liabilities. The case of Chad shows that the reasons for your tax plan are equally as important as the plan itself. Taxpayers have a duty to understand their tax plans, review them with a qualified Canadian tax lawyer, and be able to sufficiently defend them when called upon to do so.
When a tax plan becomes too artificial that it ignores business realities, such a plan may lead to unintended results. In Chad’s case, the plan failed the ‘source of income’ test as a result. Generally speaking, for a transaction to constitute a source of business or property income for tax purposes, there has to be an intention to profit from that transaction. This intention must be objectively established by the evidence. See Stewart v. The Queen, [2002] 2 S.C.R. 645, 2002 SCC 46.
Chad’s transactions were clearly not undertaken with an intent to profit. The TCC rightly made this finding through accurate, objective inferences from the evidence provided by Chad.
In Chad’s correspondence with Velocity, Chad did not show an intent to make enough profit to cover the cost of the brokerage fees to Velocity, which totalled $240,000 for both 2011 and 2012. This brokerage fee sum was too significant to have gone unnoticed. This was also the finding of the TCC. Chad was, instead, more focused on reducing risks by ensuring that his long and short positions were offsetting each other. In the end, Chad ended up with a mere profit of $6,200, which was nothing compared to the deficit created by the brokerage fees.
An explanation for Chad’s non-profit mindset is even evident from the facts. The facts show that Chad was interested in achieving a target loss of $22M. Chad paid the brokerage fees to Velocity, essentially to achieve this loss. It was therefore reasonable for the TCC to conclude that Chad’s transactions were more interested in creating losses than making profits. The TCC stated verbatim as follows:
“Although Mr. Chad, when testifying, asserted that, in participating in the Trades, he intended to pursue a profit, the contemporaneous documentary evidence indicates that he and Mr. Hodgins were focused on achieving the agreed-upon target loss (as revised), and that, once that loss had been realized, the risks of the Trades were strongly and effectively hedged, so as to keep the profit/loss amount in a relatively neutral position. In other words, despite the appearances of commerciality, the FX Activities were not, in fact, conducted with a view to profit. Hence, I do not consider the FX Activities to have been “clearly commercial.” See Para 168.
In explaining the rationale behind the deductibility of expenses, the TCC rightly explained that “profit” is a net concept, which presupposes the deduction of expenses. As the FX activities have been held not to constitute a business, because they were not undertaken with an intent to profit and were not clearly commercial, it therefore presupposes that expenses incurred as a result were not deductible. This explanation of the TCC is founded on the basic explanation of what constitutes a “profit” and is, therefore, clearly irrefutable. See also paragraph 18(1)(a) of the Income Tax Act.
PRO TAX TIPS: What is GAAR, and when is it applicable?
GAAR means General Anti-avoidance Rule. It is a blanket provision contained in Section 245 of the Income Tax Act. Its aim is mainly to deny benefits to abusive tax avoidance transactions. These are transactions that comply with the specific provisions of the Income Tax Act or even treaties, but do not accord with the purpose of those provisions.
One such benefit is tax deferral or reduction, as in Chad’s case. The TCC, however, held that the GAAR did not apply to Chad’s transactions. This is because Chad’s transaction did not even comply with specific provisions of the Income Tax Act regarding what constitutes a source of income for tax purposes.
An Avoidance Transaction is any transaction or series of transactions that result in a tax benefit, unless one of the main purposes for carrying out that transaction is not to obtain a tax benefit. See S 245 (3) of the Income Tax Act.
For an avoidance transaction to be considered abusive, one of the principal factors to be considered is whether the transaction(s) is significantly lacking in economic substance. This consideration, like its U.S. equivalent, aims to discourage artificial transactions created primarily for tax purposes and to encourage transactions with genuine economic and commercial purposes.
Where the GAAR successfully applies to a transaction, the resulting tax benefit is denied, and the taxpayer is essentially put back in the same position as though such abusive tax avoidance had not been carried out. Penalties are generally levied for such offending transaction(s).
In order to ensure that your tax planning activities do not contravene the GAAR or its penalty clauses, it is encouraged that you seek advice from an experienced tax professional. Our top Canadian tax lawyers are available to help you.
Frequently Asked Questions (FAQs)
What accounting method should I use to report my income for tax purposes?
The calculation of income for tax purposes is a legal issue. Taxpayers should use accounting methods that best disclose their financial position as long as such accounting method(s) do not contravene the provisions of the Income Tax Act or applicable laws, case law, and well-accepted accounting principles. Please feel free to reach out to our top Canadian tax lawyers for guidance as it relates to your particular situation.
When am I permitted to carry over my losses?
Taxpayers have the ability to carry over their losses incurred in a year to offset their taxable income in both previous and future years, subject to certain limitations. Such losses could be business, capital, investment, etc.
Read our previous articles to ascertain if your losses are eligible for carryover. We are available if you need further guidance on your specific situation.
Is every loss or expense incurred in a business or property transaction deductible to offset income?
Losses or expenses incurred in business or property transactions can only be deductible where they were incurred for the purpose of gaining income from the business or properties.
Section 18(1)(a) provides that “no deduction shall be made in respect of an outlay or expense except to the extent that it was made or incurred… for the purpose of gaining or producing income from the business or property.”
Where a transaction is not considered a source of business and property income, it follows that fees and expenses incurred in earning such income will not be deductible to offset taxpayers’ incomes from other recognized sources of income.
Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
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