Tax Court finds gain on hedge to protect balance sheet equity was a capital gain

In the CRA’s long-standing view, proceeds realized on a hedge contract cannot be on capital account if there is no sale (or proposed sale) of the underlying item being hedged.  Such could be the case if a hedge is entered into to protect the consolidated balance sheet equity of a corporate group.   In George Weston Limited v. The Queen, 2015 TCC 42, the Tax Court of Canada said that the CRA’s view has no legal basis (paragraph 97).  The correct principle is this: proceeds realized from a hedge will be on capital account if the item being hedged is a capital item.  In George Weston, a public company entered into swaps to stabilize (hedge) the value of the group’s investment in US business assets, which was exposed to a currency risk in the company’s consolidated balance sheet (paragraph 77).  As such, the swaps hedged a capital investment (paragraph 89).  Furthermore, the swaps were terminated not to profit from the derivatives market, but rather because the risk exposure had decreased (paragraph 90).  Accordingly, the $317 million gain on termination of the swaps was a capital gain, not ordinary business income.