Citation: 2009 TCC 127
Date: 20090519
Docket: 2007-4612(IT)I
BETWEEN:
GÉRARD GOULET,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Bédard J.
[1]
In 2002 and 2003, the
appellant purchased notes and commercial papers (debt obligations) at a
discount on the secondary market.
The appellant held these debt obligations for periods ranging from 27 to 90
days. The debt obligations did not accumulate interest. However, the rate of
return for each obligation was clearly established, thus enabling
the appellant to know his rate of return. I note right away that the appellant
did not demonstrate that the rate of return was higher than the market rate.
The debt obligations were repaid by their issuers on time in 2003. In his
income tax return for the 2003 taxation year, the appellant treated the
difference between the redemption prices of the debt obligations and their
purchase prices (in this case, $30,164) as capital gain. The Minister of
National Revenue (the Minister) reassessed the appellant’s return for the 2003
taxation year concluding that the difference between the redemption prices of
the debt obligations and their purchase prices constituted interest instead. That
is the reason for this appeal.
Respondent’s
position
[2]
The respondent
basically maintains that the return on the debt obligations must be treated as
interest income pursuant to subsections 12(4) and 12(9) of the Income
Tax Act (the Act) and subsections 7000(1) and 7000(2) of the
Income Tax Regulations (the Regulations).
Appellant’s
position
[3]
The relevant parts of
the appellant’s written submissions merit citing.
START OF WRITTEN ARGUMENT
[Translation]
Your Honour:
The respondent cannot base himself on
paragraph 7000(1)(a) or on subsection 12(9) of the Income
Tax Act, because they do no apply in the commercial paper context.
Subsection 12(4) mentioned in Ms. Tardif’s argument does not apply
either, since it is related to subsection 12(9) and only gives more details on
applying it.
The provisions that apply are rather the
following:
(a) Division B: Computation of Income, Subdivision c: Taxable
Capital Gains and Allowable Capital Losses;
(b) section 38: meaning of taxable capital gains and allowable
capital losses;
(c) paragraph 39(1)(a): meaning of capital gain and capital loss;
(d) subsection 39(3): gain in respect of purchase of bonds, etc., by
issuer;
(a) the amount, if any, by which the amount for which the
obligation was issued by the taxpayer exceeds the purchase price paid or agreed
to be paid by the taxpayer for the obligation shall be deemed to be a capital
gain of the taxpayer for the taxation year from the disposition of a capital
property, and
(b) the amount, if any, by which the purchase price paid or
agreed to be paid by the taxpayer for the obligation exceeds the greater of the
principal amount of the obligation and the amount for which it was issued by
the taxpayer shall be deemed to be a capital loss of the taxpayer for the
taxation year from the disposition of a capital property,
(e) subsection 39(6): Definition of “Canadian security”.
It is true that, for a taxpayer, it is not
easy to determine the tax treatment of these obligations. Interpretation
Bulletin IT‑114 2.1.4, enclosed in Appendix 1, mentions this
fact.
[Translation]
The Income Tax Act has few provisions
concerning the tax treatment of discounts and premiums on debt obligations.
What should we be referring to in
situations like this, Your Honour?
I believe that the appellant did well to
base himself on the information he had received from the Canada Revenue Agency
staff. It was based on this information that the income was treated as capital
gain, especially since the financial institution did not issue an information
slip (T5 or other).
Even the Canada Revenue Agency was unable to
confirm in its draft assessment what provision of the Act the appellant could
refer to, stating only that the appellant must apply the generally accepted
accounting principles. Moreover, Danielle Cloutier, the reviewing officer,
admitted to the Court in her testimony that she had no training in taxation.
In addition, the appellant considers the fact
that he has been using the same tax treatment or practice from year to year to
be a method accepted by the Department. Interpretation Bulletin IT-479R,
paragraph 25(c), enclosed in Appendix 2, states that
. . . the Department will accept reporting of gains and losses
on capital account provided this practice is followed consistently from year to
year.
It is very important to also consider the
riskiness of these investments, which results in a higher rate of return.
Taking into account that the obligations are unsecured, we cannot consider the
discount as being the same as interest. I refer you to the test established by
Lord Greene in Lomax v. Dixon & Son, Ltd (Appendix 3):
. . . the high rate of interest is in part
attributable to the capital risk.
Interpretation Bulletin IT-114 2.1.4.3
(Appendix 1) states the following:
[Translation]
Thus, in the context of an obligation being
issued on the secondary market, if it is admitted that there was no discount at
the time the obligation was first issued and if it does not comply with
regulatory provisions, the discount will not be treated as interest, but rather
as income of a business or capital gain depending on whether or not the buyer
is an investor.
With respect to law, Valérie Tardif found no
case law on subsection 12(9), and in the one case that does refer to it, O’Neil
v. Minister of National Revenue (Appendix 4), Justice Lamarre Proulx
found that subsection 12(9) and section 7000 do not apply to short‑term
debt obligations, which is the case that concerns us:
Subsection 12(9) and Regulation 7000 invoked
by counsel for the Respondent in the Reply, though not of application here, as
these sections would apply for an investment instrument of a long duration and
here the instrument had a six-month life, confirm however that instruments with
no stated interest are deemed to be carrying on a yearly interest calculated in
a prescribed manner.
As for Justice Dussault’s decision in Gestion
Guy Ménard, which Ms. Tardif refers to, regretfully, it does not discuss
the same kind of obligation at all. Commercial papers cannot be compared with
Treasury bills or banker’s acceptances.
A Treasury bill of the Government of Canada
is a debt obligation issued by the Canadian government that offers a high
level of security with respect to capital and income.
A banker’s acceptance is a bill issued to a
client, the capital and interest of which is guaranteed by the bank.
A commercial paper is a short-term unsecured
obligation issued by financial or non-financial institutions, usually at a
discount.
Furthermore, the appellant is quite familiar
with Treasury bills and banker’s acceptances and has always declared the income
from those as interest.
Ms. Tardif is also referring us to
McCarthy Tétrault’s comments, but that document cannot be accepted because it
does not apply to this case pursuant to the Income Tax Act.
I would also submit to you, Your Honour, a
document enclosed in Appendix 5 taken from the Collection fiscale du
Québec in October 2006, using the search terms: gain en capital –
intérêts [capital gain – interest]. In section 2.3.2.4 of this
document, Escompte ou prime sur l’achat d’une obligation [discount or
premium on the purchase of an obligation], paragraph (3), [Translation] “the Revenue Canada test”
is proposed as the method for determining the nature of the discount or premium
on a debt obligation. If we apply that test to this case, we would notice that
we cannot answer “yes” to the questions in (b) and (c). Based on this, we can
conclude that a discount must be treated as capital gain.
Your Honour, I would also cite a comment you
made during Ms. Tardif’s argument. I consider it very important for
deciding on the tax treatment of an obligation when the issuing company goes
bankrupt and the taxpayer collects nothing.
[Translation]
How would you have treated the loss?
Of course this would result in capital loss.
The Department does not permit that this loss be deducted from other income at
100%. Should we not then consider the treatment of losses when assessing the
opposite case? I think so. In the acts and regulations, the Department
recognizes that debt or other kinds of obligations treated as capital gain must
also be treated as capital loss.
If we also look at the current subprime
lending crisis, it clearly demonstrates the fragility of these investments,
which are completely unsecured and can be considered as capital losses.
In support of my argument, I enclose in
Appendix 6 a letter of compliance from the Ministère du revenu du Québec
from a related case. It informed the respondent that her tax returns for the
years concerned were in compliance with the tax legislation in effect.
Your Honour, I do not believe that the
respondent has clearly demonstrated that the return on the
unsecured debt obligations should be added to the appellant’s income in the
form of interest. There were several hesitations and suppositions in
Ms. Tardif’s argument:
[Translation]
Yes, subsection 12(4) applies somewhat, so to
speak.
I found no case law on subsection 12(9) and
section 7000, but for those . . . in those, what is at issue are not debt
obligations.
The Court must instead base its decision on
section 38, paragraphs 39(1)(a), 39(3)(a) and 39(3)(b)
and subsection 39(6) of the Income Tax Act.
Consequently, I believe that the appellant
was justified in treating his return as capital gain for the above reasons and
because of the reasonable doubt created by the documents, bulletins and case
law.
Statutory
provisions
[4]
The relevant provisions
of the Act and Regulations are as follows:
Income Tax Act
12. (1) Income inclusions – There
shall be included in computing the income of a taxpayer for a taxation year as
income from a business or property such of the following amounts as are
applicable:
. . .
(c) Interest – subject to
subsections (3) and (4.1), any amount received or receivable by the taxpayer in
the year (depending on the method regularly followed by the taxpayer in
computing the taxpayer’s income) as, on account of, in lieu of payment of or in
satisfaction of, interest to the extent that the interest was not included in
computing the taxpayer’s income for a preceding taxation year;
(4) Interest from investment
contract – Subject to
subsection 12(4.1), where in a taxation year a taxpayer (other than a taxpayer
to whom subsection 12(3) applies) holds an interest in an investment contract
on any anniversary day of the contract, there shall be included in computing
the taxpayer’s income for the year the interest that accrued to the taxpayer to
the end of that day with respect to the investment contract, to the extent that
the interest was not otherwise included in computing the taxpayer’s income for
the year or any preceding taxation year.
(9) Deemed accrual – For the purposes of subsections 12(3), 12(4) and 12(11)
and 20(14) and 20(21), where a taxpayer acquires an interest in a prescribed
debt obligation, an amount determined in prescribed manner shall be deemed to
accrue to the taxpayer as interest on the obligation in each taxation year
during which the taxpayer holds the interest in the obligation.
(11) Definitions – In this section,
“anniversary day” of an investment contract means
(a) the day that is one year after the day immediately
preceding the date of issue of the contract,
(b) the day that occurs at every successive one year interval
from the day determined under paragraph (a), and
(c) the
day on which the contract was disposed of;
“investment contract”, in
relation to a taxpayer, means any debt obligation other than
(a) a salary deferral arrangement or a plan or arrangement
that, but for any of paragraphs (a), (b) and (d) to (l)
of the definition “salary deferral arrangement” in subsection 248(1), would be
a salary deferral arrangement,
(b) a retirement compensation arrangement or a plan or
arrangement that, but for any of paragraphs (a), (b), (d)
and (f) to (n) of the definition “retirement compensation
arrangement” in subsection 248(1), would be a retirement compensation
arrangement,
(c) an employee benefit plan or a plan or arrangement that, but
for any of paragraphs (a) to (e) of the definition “employee
benefit plan” in subsection 248(1), would be an employee benefit plan,
(d) a foreign retirement arrangement,
(e) an income bond,
(f) an income debenture,
(g) a small business development bond,
(h) a small business bond,
(i) an obligation in respect of which the taxpayer has
(otherwise than because of subsection 12(4)) at periodic intervals of not more
than one year, included, in computing the taxpayer’s income throughout the
period in which the taxpayer held an interest in the obligation, the income
accrued thereon for such intervals,
(j) an obligation in respect of a net income stabilization
account,
(k) an indexed debt obligation, and
(l) a prescribed contract.
Income Tax
Regulations
7000. (1) [prescribed debt
obligation] – For the purpose of subsection 12(9) of the Act, each of the
following debt obligations (other than a debt obligation that is an indexed
debt obligation) in respect of which a taxpayer has at any time acquired an
interest is a prescribed debt obligation:
(a) a particular debt obligation in respect of which no
interest is stipulated to be payable in respect of its principal amount,
. . .
and, for the purposes of this subsection, a debt obligation
includes, for greater certainty, all of the issuer’s obligations to pay
principal and interest under that obligation.
(2) [interest on a prescribed debt
obligation] – For the purposes of subsection 12(9) of the Act, the amount
determined in prescribed manner that is deemed to accrue to a taxpayer as
interest on a prescribed debt obligation in each taxation year during which he
holds an interest in the obligation is,
(a) in the case of a prescribed debt obligation described in
paragraph (1)(a), the amount of interest that would be determined in
respect thereof if interest thereon for that year were computed on a compound
interest basis using the maximum of all rates each of which is a rate computed
(i) in respect of each possible
circumstance under which an interest of the taxpayer in the obligation could
mature or be surrendered or retracted, and
(ii) using assumptions concerning the
interest rate and compounding period that will result in a present value, at
the date of purchase of the interest, of all the maximum payments thereunder,
equal to the cost thereof to the taxpayer;
. . .
(5) [computation of interest] – For the purposes of making the computations referred to in
paragraphs (2)(a), (b), (c) and (c.1), the
compounding period shall not exceed one year and any interest rate used shall
be constant from the time of acquisition or issue, as the case may be, until
the time of maturity, surrender or retraction.
Analysis
and conclusion
[5]
Based on the above
statutory provisions, a taxpayer who holds a prescribed debt obligation as set
out in subsection 7000(1) of the Regulations must compute the interest
accrued in the manner prescribed in subsection 7000(2) of the Regulations
and include this interest in computing his annual income pursuant to
subsection 12(4) of the Act.
[6]
Subsection 12(9)
of the Act sets out that, when a taxpayer acquires an interest in a prescribed
debt obligation, an amount determined in
the prescribed manner is deemed to accrue to the taxpayer as interest on the
obligation in each taxation year during which the taxpayer holds the interest
in the obligation. The prescribed debt obligations described in
subsection 12(9) of the Act include “a particular debt obligation in
respect of which no interest is stipulated to be payable in respect of its
principal amount”. Subsection 7000(2)
of the Regulations sets out the method for computing the interest accrued on
prescribed debt obligations for the purposes of subsection 12(9) of the
Act. More specifically, paragraph 7000(2)(a) of the Regulations
sets out the method for computing the presumed interest on “a particular debt obligation in respect of which no
interest is stipulated to be payable in respect of its principal amount” for
the purposes of subsection 12(9) of the Act. The method for computing the
interest accrued set out in paragraph 7000(2)(a) of the Regulations makes it possible to
compute the interest accrued daily during the time that the taxpayer holds an
interest in a particular debt obligation
in respect of which no interest is stipulated to be payable in respect of its
principal amount. Consequently, in my view, it is wrong to be claiming that the
provisions in subsections 12(4) and 12(9) of the Act apply only to
long-term prescribed debt obligations. I note right away that
subsections 12(9) of the Act and 7000(2) of the Regulations do not
stipulate that their provisions apply only to taxpayers who hold prescribed
debt obligations that were acquired at the time of their issue. In other words,
I am of the opinion that subsections 12(9) of the Act and 7000(2) of the
Regulations also apply to taxpayers holding prescribed debt obligations
acquired on the secondary market. Moreover, the following comments from the
Canada Tax Service on the application of subsection 12(9) of the Act to
prescribed debt obligations acquired on the secondary market are very
convincing:
Where such an instrument is purchased by a
second or subsequent purchaser in a secondary market transaction, the amount of
the original issue discount itself is disregarded and the rule operates so as
to accrue over the period until maturity the difference between the price paid
for the instrument and its value at maturity, again on the basis of an
effective interest calculation utilizing annual or more frequent compounding.
[7]
In addition,
subsection 12(4) of the Act obligates a taxpayer who holds an interest in an “investment contract” (defined in
subsection 12(11) of the Act) on any “anniversary day” of the contract
(also defined in subsection 12(11) of the Act) to include in computing his
income for the year the interest that accrued to him pursuant to subsection
12(9) of the Act to the end of that day. According to subsection 12(11) of
the Act, an “investment contract” is any debt obligation other than those set
out in that subsection. Furthermore, subsection 12(11) of the Act defines
“anniversary day” of an investment contract as any of the following days:
(a) the day
that is one year after the day immediately preceding the date of issue of the
contract,
(b) the day
that occurs at every successive one year interval from the day determined under
paragraph (a), and
(c)
the day on which the contract was disposed of.
[8]
In this case, the debt
obligations at issue are prescribed debt obligations because they are particular debt obligations in respect of which no
interest is stipulated to be payable in respect of their principal amount. They
are also “investment contracts” under subsection 12(11) of the Act, since they
are not one of the exempted obligations set out in that subsection.
Consequently, the Minister was correct to treat the return on these debt obligations
($30,164 in this case) as interest pursuant to
subsections 12(4) and 12(9) of the Act and
7000(1) and 7000(2) of the Regulations.
[9]
The fact that debt
obligations are riskier investments does not, in my opinion, change the
application of or override subsections 12(4) and 12(9) of the
Act and 7000(1) and 7000(2) of the Regulations. I note that
the appellant did not establish that the rate of return for the debt
obligations at issue was higher than the market rate. As a result, Lord
Greene’s comments in Lomax
do not apply to this case. As for Interpretation Bulletin IT‑114, which
the appellant referred to several times, not only do interpretation bulletins
not have the force of law, but also that particular bulletin was cancelled on
June 10, 1994.
[10]
In conclusion, even if
subsections 12(4) and 12(9) of the Act and
subsections 7000(1) and 7000(2) of the Regulations did not apply
to the debt obligations at issue, in my view, based on the case law dealing with
interest, the return on the obligations (in this case $30,164) should be
included in computing the appellant’s income for the 2003 taxation year in
the form of interest in accordance with paragraph 12(1)(c) of the Act.
[11]
For these reasons, the
appeal is dismissed.
Signed at Ottawa, Canada, on
this 19th day of May 2009.
“Paul Bédard”
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