REASONS
FOR JUDGMENT
Pizzitelli J.
[1]
The Appellant, a Nova Scotia unlimited liability
Company, appeals a reassessment denying interest deductions in respect of its 2002
taxation year totalling $10,094,856 on loans from a parent corporation used to
acquire additional common shares in a U.S. wholly-owned subsidiary. The
interest claimed and denied was in respect of interest paid for the period from
March 28, 2002 to November 3, 2002 ( the “Period”
). The Minister of National Revenue (the “Minister”) disallowed
the interest deduction pursuant to subparagraph 20(1)(c)(i) of the Income
Tax Act (the “Act”) on the basis that
the funds borrowed were not used for the purposes of earning income from a
business or property; namely from a U.S. subsidiary’s shares acquired with the
borrowed funds.
[2]
Most of the relevant facts are not in dispute. A
chronology of transactions started with Wendy’s International Inc. (“Wendy’s”), the ultimate parent of the group loaning
$234,000,000 Cdn. ($147,654,000 US) to its U.S. subsidiary, Delcan Inc. (“Delcan”) before March 18, 2002 at an interest rate
not to exceed 7 percent. Delcan in turn loaned the full amount to the
Appellant on March 18, 2002 at a rate of 7.125 percent pursuant to a loan
agreement and subsequently assigned this loan receivable to another affiliate
in the group. The Appellant in turn used the full amount of the loan from
Delcan to purchase 1,840 additional common shares in its already wholly-owned
U.S. subsidiary, Tim Donut U.S. Limited, Inc. (“Tim’s
U.S.”) on March 26, 2002 which in turn made an interest‑free loan
to Wendy’s the next day, on March 27, 2002 evidenced by a Promissory Note dated
as of that date (the “Note”). A schematic
drawing of these transactions was entered as Exhibit R-1. In short, monies that
started from Wendy’s was loaned out at interest and found its way back to
Wendy’s interest free through these series of transactions. The evidence is
that the Note was originally intended to be on an interest bearing basis
according to planning memorandums entered into evidence, although no rate was
specified, but that due to concerns an interest bearing note would have on state
taxes in the U.S. and concerns with the Thin Capitalization and Foreign Accrual
Property Income Rules in Canada under the Act, it was decided the loan
would proceed on a non‑interest basis until the matter was sorted out.
[3]
Sometime in June of 2012, following a revised
plan evidenced in May of 2012, Tim’s U.S. incorporated a new U.S. subsidiary,
Buzz Co., which later changed its name to TD US Finance Co. (“Tim’s Finance”). Tim’s U.S. assigned the Note to Buzz
Co. as payment for its shares in Buzz Co. and Buzz Co. then issued a Demand for
Payment on the Note to Wendy’s which repaid the Note in full by issuing a new promissory
note to Buzz Co. on November 4, 2002 (the “New Note”)
for the same full amount bearing an interest rate of 4.75 percent, thus
effectively replacing the non-interest bearing loan with a new interest bearing
one. The delay in effecting these plan changes was explained by the
preoccupation of the parties of the group in purchasing the interests of one of
the group’s founders.
[4]
It should be noted that the Canada Revenue
Agency (“CRA”) has in effect denied the
Appellant the deduction of interest paid on its loan from Delcan during the
Period, which coincides with the time the Appellant’s US subsidiary loaned the
money back to Wendy’s on an interest free basis pursuant to the Note. Once the
loan back to Wendy’s was effectively repaid and replaced with an interest
bearing loan evidenced by the New Note, the Minister allowed interest
deductibility from that date onwards.
[5]
Before proceeding on a further discussion of
facts not agreed to or whose affects are disputed, I will briefly discuss the position
of the parties and the provisions of the Act in play here as well as to
give needed context to this dispute.
The Appellant’s Position
[6]
The Appellant takes the position that the
purchase of common shares by the Appellant in Tim’s U.S., the property it
acquired from the proceeds of its borrowings from Delcan, is a garden variety
transaction that satisfies the test in subparagraph 20(1)(c)(i) and that the “use” of the Appellant as “borrower” is what must be
looked at, not the use that Tim’s U.S., the subsidiary, made of the funds
invested in it which it accuses the Crown of wrongfully considering. In essence
says the Appellant, the act of purchasing shares that capitalizes its
subsidiary to allow it to acquire capital assets and operate its business for
the Appellant’s ultimate benefit and payment of future dividends is sufficient,
regardless of whether Tim’s U.S. actually earned income from the new capital
injection. The Appellant argues there is evidence that Tim’s U.S had a 10 year
plan to significantly expand its U.S. operations for income earning reasons and
in fact ultimately did resulting in substantial future dividends paid to the
Appellant starting in 2007, thus demonstrating an income earning purpose to the
purchase of the shares.
[7]
Notwithstanding this, the Appellant says that
even if the Minister is correct in looking at what use the Appellant’s
subsidiary made of the funds, there is ample evidence that the monies lent by Tim’s
U.S. to Wendy’s were indirectly available for Tim’s U.S. use when needed
through the groups internal funding mechanisms in place, thus satisfying such
indirect purpose test in any event through what the Appellant termed to be “exceptional circumstances”.
[8]
Finally argues the Appellant, even if the
Minister succeeds in its position that the purposes of the loan was to
facilitate the making of an interest free loan to Wendy’s, it argues such
purpose was not the sole purpose as alleged by the Respondent and that the
additional purpose of earning ultimate dividend income is sufficient to meet
the purpose test.
The Respondent’s
Position
[9]
The Respondent’s takes the position that the
transactions undertaken by the Appellant are nothing more than a series of
predetermined steps to lend money to Wendy’s interest free while at the same
time giving it an interest expense and that the Appellant had no purpose of
earning income from investing in Tim’s U.S. shares at the time of the initial
loan evidenced by the Note. In any event says the Respondent, the interest
deducted by the Appellant would not be a reasonable expense under paragraph
20(1)(c) of the Act in the circumstances.
The Law
[10]
Subsection 20(1) reads as follows:
(1) Deductions
permitted in computing income from business or property. Notwithstanding paragraphs 18(1)(a), (b) and (h),
in computing a taxpayer's income for a taxation year from a business or
property, there may be deducted such of the following amounts as are wholly
applicable to that source or such part of the following amounts as may
reasonably be regarded as applicable thereto:
…
(c) Interest - an amount paid in the year or payable in respect of the year
(depending on the method regularly followed by the taxpayer in computing the
taxpayer's income), pursuant to a legal obligation to pay interest on
(i) borrowed money used for the purpose of earning income from
a business or property (other than borrowed money used to acquire property the
income from which would be exempt or to acquire a life insurance policy),
…
or a reasonable
amount in respect thereof, whichever is lesser;
[11]
The Supreme Court of Canada in Shell Canada
Ltd. v The Queen [1999] 3 SCR 622 held at page 637 that paragraph 20(1)(c) has four elements:
(1) the amount must be paid in the year or be payable in the year in
which it is sought to be deducted;
(2) the amount must be paid pursuant to a legal obligation to pay
interest on borrowed money;
(3) the borrowed money must be used for the purpose of earning
non-exempt income from a business or property; and
(4) the amount must be reasonable, as assessed by reference to the first
three requirements.
[12]
There is no dispute between the parties that the
two requisite elements described in Shell Canada in (1) and (2) above
have been met. The Appellant borrowed the money pursuant to a loan agreement
and agreed to pay interest at a rate of 7.125 percent to the borrower, Delcan
and did pay the interest.
[13]
The only dispute is whether the $234,000,000
expressed in Canadian funds borrowed from Delcan was used by the Appellant for
the purpose of earning income from the common shares it acquired in Tim’s U.S.
and whether the amount of interest was reasonable; namely whether the requisite
elements describe in Shell Canada in (3) and (4) above have been met.
Analysis
[14]
There is clearly confusion between the parties
position regarding the relevant analysis of the third requisite element in subparagraph
20(1)(c)(i) as referred to in Shell Canada above which requires that “the borrowed money must be used for the purpose of earning
non-exempt income from a business or property;”.
[15]
It is clear the provision requires us to first
identify the use of the borrowed money and then its purpose. There is no
dispute by either party that the direct use of the borrowed money must first be
ascertained as required by the Supreme Court in Singleton v The Queen, 2001
SCC 61, [2001] 2 S.C.R. 1046, at paragraph 26, where Major J. stated:
26 Only the third element is at issue in this appeal: the
borrowed money must be used for the purpose of earning non-exempt income from a
business. The Shell case confirmed that the focus of the inquiry is not
on the purpose of the borrowing per se, but is on the taxpayer’s purpose
in using the money. McLachlin J. agreed with Dickson, C.J. in Bronfman Trust
that the inquiry must be centered on the use to which the taxpayer put the
borrowed funds. …
[16]
It is also clear that the only issue in Singleton,
as the Respondent has pointed out, was on the “use”
of the borrowed funds. There was no dispute as to the purpose portion of the
requirement. That is the context of Singleton. Singleton did not
have to decide if the purpose test was also met, thus why the focus of the inquiry
was only on the “use” component. The borrowed
funds, once injected into the law partnership, had an income earning purpose;
namely to earn income from the law firm. There was no argument as to another
purpose, unlike the case at hand.
[17]
In my view the Appellant confuses the use and
purpose analyses of the requirement. Frankly, the wording of the Respondent’s
assumption in paragraph 14(m) of its Amended Reply gives some reason for such
confusion where it is stated:
m) at the time that the investment in additional common
shares in Tim U.S. was made, the appellant’s sole purpose for investing in new
common shares and sole use for the funds borrowed from Delcan was to arrange
for funds to be available to Wendy’s at zero interest while generating an
interest expense in the hands of the appellant;
[18]
In such assumption the Respondent appears to
both be acknowledging that the funds were used to acquire the shares and
arrange the questioned loan to Wendy’s. However, it is also clear that the
Respondent also assumed in its Amended Reply and confirmed in argument at trial
that the use of the funds by the Appellant was to acquire shares in Tim’s U.S. Specifically,
in clause 14(g)(iv) of the Amended Reply the Respondent assumes;
(iv) on or about March 26, 2002 the appellant used the proceeds
of the Loan to acquire additional common shares of its wholly owned U.S.
subsidiary, Tim U.S.;
[19]
There is no dispute as to the direct use of the
borrowed funds so no issue of tracing the funds to the use in applying the “use” test arises as in the Bronfman Trust v The
Queen, [1987] 1 S.C.R. 32 case. The only issue in dispute is the “purpose”. In effect, the only question that must be
answered here is whether the common shares were acquired for the purpose of
earning non-exempt income.
[20]
In Ludco Enterprises Ltd. et al v The Queen,
2001 SCC 62, [2001] 2 SCR 1082, Iacobucci J. clearly considered the Shell Canada
and Bronfman Trust decisions and their focus of inquiry as to the “use” factor and concluded in paragraph 45 that “… the
law relating to the matter of the taxpayer’s “purpose”
was not fully elaborated on in that case”.
[21]
At par 46, Iacobucci J. distinguishes Singleton
as well:
46 In
the case at bar, and in contrast to Singleton, supra, there is no
dispute as to the particular use that the borrowed funds were put to: they were
directly used to purchase shares in the Companies. Rather, the focus of the inquiry
is on whether the taxpayers’ purpose in so using the funds was to earn income
within the meaning of s. 20(1)(c)(i). Consequently, in the present appeal,
the Court is asked for the first time to explicate the law on two of the
central concepts in s. 20(1)(c)(i): “purpose” and “income”.
[22]
In this case, like Ludco, there is no
dispute the funds were used to purchase shares and likewise the focus of our inquiry
must be on whether there was an income-earning purpose in acquiring those
shares as earlier stated.
[23]
It must be noted and there is no dispute between
the parties that Ludco also made it clear that it is not necessary that
the sole purpose must be to earn non‑exempt income and that such purpose
may also be an ancillary purpose. In fact here the Appellant argues that if the
Court finds the investment in shares was not to earn dividend income as its
main purpose, it was at least an ancillary one. The Respondent’s position is
that the Appellant’s sole purpose for investing in the new common shares was to
arrange for funds to be available to Wendy’s at zero percent interest while
generating an interest expense in the hands of the Appellant, and hence there was
no other purpose.
[24]
The Supreme Court informs us in Ludco as
to the appropriate test for determining the purpose for interest deductibility
under subparagraph 20(1)(c)(i) at paragraphs 54 and 55:
54 Having
determined that an ancillary purpose to earn income can provide the requisite
purpose for interest deductibility, the question still remains as to how courts
should go about identifying whether the requisite purpose or earning income is
present. What standard should be applied? In the interpretation of the Act, as
in other areas of law, where purpose and intention behind actions is to be
ascertained, courts should objectively determine the nature of the purpose,
guided by both subjective and objective manifestations of purpose: … In the
result, the requisite test to determine the purpose for interest deductibility
under s. 20(1)(c)(i) is whether, considering all the circumstances,
the taxpayer had a reasonable expectation of income at the time the investment
was made.
55 Reasonable
expectation accords with the language of purpose in the section and provides an
objective standard, apart from the taxpayer’s subjective intention, which by
itself is relevant but not conclusive. It also avoids many of the pitfalls of
the other tests advanced and furthers the policy objective of the interest
deductibility provision aimed at capital accumulation and investment, as
discussed in the next section of these reasons.
[25]
It is clear from Ludco that the test must
be applied at the time the investment is made, namely at the date the Appellant
acquired the shares in Tim’s U.S., and furthermore that “all the circumstances must be considered”.
[26]
The language of “all the
circumstances must be considered” is very broad. In my view, such
language cannot be consistent with any position that would suggest the use of
the funds by the subsidiary or other members of the group cannot be considered
nor that any series of transactions related to the direct investment cannot be
considered. While Singleton made it clear that there was no room to
consider a series of transactions in determining the “use”
of the funds for the “use” test components, i.e.
that the direct use is the test that must be ascertained, the determination of
the “purpose” for buying the shares does not
preclude looking at the indirect use of the funds or any other relevant factor.
All circumstances must be considered. In this regard, it seems that the
Respondent’s reference to “use” in paragraph 14(m) of
the Amended Reply above discussed accords with this premise.
[27]
Moreover, Ludco makes it clear in
paragraphs 57 to 63 when discerning what is meant by “income”
that subparagraph 20(1)(c)(i) “refers to income
generally, that is an amount that would come into income for taxation purposes,
not just net income”. This clearly contemplates in my view that some
types of income, such as capital gains or even dividend income, may often be
derived from indirect uses of the money invested in shares of a corporation
that owns subsidiaries or has investments in other corporations like the case
at hand. Major J. in Ludco in fact goes on in paragraph 63 thereof
to discuss that the object of the section is “… create
an incentive to accumulate capital with the potential to produce income by
allowing taxpayers to deduct interest costs associated with its acquisition”
and thus concludes that the taxpayer need only have a reasonable expectation of
creating “gross income” instead of net income.
These arguments clearly support an argument that monies borrowed for the
purposes of creating wealth indirectly would fall within the purpose of the
section.
[28]
As the Appellant himself has pointed out in
argument, Canadian Helicopters Ltd. v The Queen, 2002 FCA 30, 2002 DTC
6805, a decision of the Federal Court of Appeal, allowed interest deductibility
on borrowings of that taxpayer who used the proceeds of the borrowing to
advance an interest-loan to its parent and who in turn did the same to its
parent to fund the acquisition of another company. The Court held that the
appellant’s ability to earn management fees from the acquired company met the
purpose test. This is entirely consistent with the principles of Ludco
above described that allows the Court to look at all circumstances including
the ultimate use of the borrowed funds to establish an income-earning purpose,
even in the context of a series of transactions.
[29]
The Appellant also suggests that the Court
should not treat the Appellant and Tim’s U.S. or its subsidiary Tim’s Finance
(Buzz Co.) as the same taxpayer who borrowed the funds in deference to the principle
of respecting their individual existence or not piercing the corporate veil and
relies on the Federal Court of Appeal’s decision in The Queen v Merban
Capital Corp., [1989] FCJ No. 712, 89 DTC 5404. Frankly, there is no
dispute here that it is the Appellant and not any of its subsidiaries who
borrowed the funds in this matter so such decision has little relevance to the
matter at hand. In Merban the Court found the subsidiaries were the
borrower and in essence the taxpayer there could not deduct interest incurred
by it as a guarantor. In any event, the Supreme Court of Canada has addressed
the tests as to “use” and “purpose” since the 1989 decision in Merban
through Bronfman Trust, Singleton and Ludco as above
discussed and it is clear that for the “purpose”
test in paragraph 20(1)(c), the use of the funds by the borrower subsidiaries
can be considered as part of all the circumstances.
[30]
I now turn my attention to analyzing the
evidence pertaining to the circumstances of this case.
[31]
Can it be said that the Appellant had the reasonable
expectation to earn income; either immediate or future dividend income or even
increased capital gains as a result of the purchase of shares at the time of
such purchase? I simply cannot agree this was a reasonable expectation of the Appellant
at the time of such purchase for the following reasons:
1. The
Appellant was already the sole shareholder of Tim’s U.S. at the time of
purchase of additional shares. The evidence is clear that Tim’s U.S. had lost
substantial monies in the previous 4 years prior to the purchase date. The
evidence is that the losses went from $12,000,000 in 1999, to $8,000,000 in
2000 to $4,000,000 in 2001 to $480,000 in 2002. Regardless of the obviously
reversing trend which the Appellant points to, it is pretty clear Tim’s U.S.
was not in a position financially to pay any immediate or short term dividends
at the time of purchase of shares. This is particularly relevant when one
considers that the loan evidence by the Note was only intended to be
outstanding for a short period of time and was in fact only outstanding for
about 7 months. There was also no history of payment of past dividends,
obviously due to past losses at least in part.
2. The
evidence of the Appellant’s own witnesses, namely P.H, the former CEO and T.M.,
the former CFO confirmed that the group had a policy of no returns on
investments, i.e. dividends, until all capital expenditures were funded. The
evidence from these witnesses and the 10 year plan submitted into evidence
suggest at least a plan for substantial capital investments to increase the
number of stores in the U.S. over the next 10 years. The net income projected
from such increased stores shown on the plan for 2003 to 2010 are not projected
to exceed the increase in capital expenditures for any years during that
period, let alone in total so there is no indication of any monies being
available for dividends during that period in light of the stated policy.
3. The 10
year plan itself has a line item for dividends to be paid and zero dividends
were planned.
4. Notwithstanding
that the Appellant has lead evidence showing dividends were in fact paid in
2007 to 2012, ranging from $100,000 per year from 2007 to 2009, $1,000,000 for
each of 2010 and 2011 and $500,000 in 2012, the evidence is also that in 2006
the Tim Hortons group was spun out of the Wendy’s group and so a different
ownership matrix applied that was not part of the circumstances at the time of
the investment and no evidence was lead to suggest this was in the cards at the
time of investing in the shares in 2002. If it was, one would think the
projections on dividends in the 10 year plan would have showed it.
5. There is
no mention of any potential for dividends to be paid in any of the planning
memorandums of J.G., in any of the resolutions of the directors of the
Appellant or Tim’s U.S. or Tim’s Finance (Buzz Co.) discussed in more detail
later or anywhere else, let alone in the 10 year plan previously discussed.
6. The
Appellant was already the sole shareholder of Tim’s U.S. at the time of
purchasing additional shares in March, 2002. Whatever quantative income
earning capacity or benefit it had per se in its capacity as sole owner
did not change as a result of its new investment in Tim’s U.S. unless it can be
demonstrated that the new investment could be expected to create or increase
the chances for dividends or at least an increase in the value of its Tim’s
U.S. shares. The fact the funds used to buy the new shares were immediately
loaned to Wendy’s without interest for about 7 months after which funds
were paid back in full suggests no obvious expectation that those funds created
or were expected to create any income for Tim’s U.S. so as to increase its
ability to pay dividends or increase the value of its shares for the future income
benefit of the Appellant.
7. The
funds loaned to Wendy’s on an interest free basis were also intended to be a
short term temporary loan at the time of its advance. The Appellant’s own
witnesses testified, as earlier mentioned, that they were aware the loan
evidenced by the Note had to be reorganized and replaced and evidence from the
planning memorandum of J.G., the tax advisor to the group indicates a revised
plan as early as May 2002 that was put into effect resulting in the repayment
of the Note in full in November of 2002, with delays explained due to the
group’s preoccupation with other matters, including the repurchase of the
shares of one of the Tim Horton’s group initial founders. The testimony
explaining why there were delays in implementing the revised plan suggests it
was the intention to loan funds out for an even shorter period of time. The testimony
of the Appellant’s witnesses also confirmed that they knew of the potential tax
problems above mentioned prior to the initial loan advance under the Note and
that it had to be fixed thus the revised memorandum and repayment of the Note.
8. There is
no credible evidence any portion of the funds invested in Tim’s U.S. were used
or intended to be used for any other purpose other than to loan monies to
Wendy’s on an interest free basis at the time of the investment in Tim’s U.S.
shares. Notwithstanding the Appellant pointing to the Director’s Resolution of
the Appellant dated March 8, 2002 that monies be used to purchase the shares in
Tim’s U.S. were expected was to be used to repay debt by Tim’s U.S. and fund
future capital expenditures, thus supporting an argument the purpose of the
funds was to create wealth through the accumulation of capital for the
subsidiary and thus indirectly for it, it is clear no repayment of debt was
made and no direct capital expenditures were made as all the funds were lent to
Wendy’s. In fact, the Resolution of the Board of Directors of Tim’s U.S. dated
the same date as the Appellant’s Director’s Resolution refers to a current
indebtedness of the subsidiary to Wendy’s of $50,000 and authorizes the
company, “upon receipt of the aforesaid capital
contribution” to repay accounts payable to Wendy’s up to the amount of
the capital contribution and to lend any remaining amounts to Wendy’s at such
interest rate (including without interest). The capital contribution far
exceeded the amount of the stated indebtedness to Wendy’s yet none was paid. No
mention is even made of a capital expenditure. Interesting enough, the CEO of
the Appellant, P.H. was a director of Tim’s U.S. and attended both meetings as
did a few other directors or invitees of both meetings. Notwithstanding both
companies being represented by many of the same people at meetings held at the
same day and time, no funds were used to pay any indebtedness of Tim’s U.S. to
Wendy’s nor used for capital expenditures. The only logical conclusion I can
draw from this is that all the members of the group intended and were aware all
the money was going back to Wendy’s.
I should also
like to add that I give little weight to the Appellant’s argument that
subsection 89(3) of the Companies Act of Nova Scotia requires the Court
to treat the proceedings reflected in the Minutes of the Directors of the
Appellant as true. The provision provides that:
Until the contrary is proved, every
general meeting of the company or meeting of directors or managers in respect
of proceedings whereof minutes have been so made shall be deemed to have been
duly held and convened, and all proceedings had thereat to have been duly had,
and all appointments of directors, managers or liquidators shall be deemed to
be valid.
There is no
dispute as to the directors meeting of the Appellant evidenced by the above
mentioned Resolution dated March 8, 2002 having been duly held and convened.
There is however clear evidence that the funds were indeed not used by Tim’s
U.S. to repay capital or fund future capital expenditures as stated in the
Resolution so the contrary has been proven in my view.
I also take note
of the fact that while the share subscription was on March 26, 2002 the Note
from Wendy’s dated March 27, 2002 has a schedule attached which shows almost
two-thirds of the loan to Wendy’s (i.e. US 96,000,000 being the Canadian
dollar equivalent of $152,000,000) was advanced to it prior to March 26, 2002
with the balance on March 27, 2002; all suggesting most of the subscription
funds were never even intended to be expended through Tim’s U.S., regardless of
the inconsistent purposes stated for the ultimate use of those funds.
9. One of
the Appellant’s witness, one M.K, who joined the group in 2005 and thus did not
have first-hand knowledge of the transactions in issue, testified she reviewed
the computer data records obtained and archived from the PeopleSoft system used
by the Wendy’s group after the Tim Horton’s group was spun out of the Wendy’s
group in 2006 and found evidence that capital expenditures were made in late
2002 to acquire and build a new U.S. location in Newark, Ohio that was approved
by Tim’s U.S. Real Estate Acquisition Committee (“REAC”)
in February, 2002. Her evidence is that the location was completed sometime in
December, 2002. There is no evidence these payments were made from the monies
advanced through the Note or otherwise, although the Appellant, through the
same witness, lead evidence that another affiliated corporation in the Group,
T.H.D. Donut (Delaware), Inc. (“THDD”), the U.S.
Franchisor, was the cheque writing entity for Tim’s U.S., as well as other U.S.
entities, that would have expended all amounts and recorded them in a journal
as an increase in inter‑company advances. Likewise, all amounts received
by THDD as rents on behalf of Tim’s U.S. would be recorded as a reduction to
inter-company balances. In essence her testimony is that a total of $821,305
was expended on the Newark, Ohio store between September 15 and December 27, 2002
and that such inter-company advances were reconciled at a later date. She
testified that to the extent THDD did not have the funds from its streams of
franchise royalties as franchisor, that Wendy’s would advance those funds to it
to meet its cheque writing obligations; the obvious suggestions being that capital
expenditures were made on behalf of Tim’s U.S. in 2002 and that Wendy’s
advanced those funds ultimately through THDD thus demonstrating the monies
loaned to Wendy’s from Tim’s U.S. did find their way back when needed.
With respect to
the Appellant, what evidence is there that any of the funds from the loan
represented by the Note found its way to Tim’s U.S. instead of from the
internal sources of THDD which had an income stream as the U.S. Franchisor or
even partly from Tim’s U.S. rental income stream? There was no evidence of same
or that any amount in the inter-company loan accounts between Wendy’s and THDD,
or THDD and Tim’s U.S. for that matter, related to the specific store as there
is no evidence as to when the bills were even paid. The problem I have is that such
evidence is simply not conclusive on its own. The bigger problem I have is that
such evidence is directly contrary to the documentary evidence contained in the
Joint Book of Documents entered into evidence on consent as Exhibit A-1, which
at Tab 6 contains a resolution of Buzz Co., (later renamed Tim’s Finance)
authorizing that a demand for repayment of the Note be made and that on
November 4, 2002 the Demand for Payment, being Tab 7 of Exhibit A-1 was made,
the last paragraph of which reads:
NOW THEREFORE, the Lender hereby demands
payment on November 4, 2002 of U.S. $147,654,000, being the full principal
amount payable under the Note.
Demand for
Payment was satisfied by Wendy’s on November 4, 2002 by the issuance of a new
debt obligation for the same amount to bear interest previously described as
the New Note.
The Demand for Payment
of 100 percent of the original amount lent to Wendy’s pursuant to the Note and
the actual repayment of 100 percent of that amount, seven months later, is
evidence enough that there were no off setting amounts claimed against Tim’s
U.S. as a result of any inter-company loan reconciliations.
Frankly, the Appellant’s
attempts to suggest the proceeds of the original Note were somehow in play
through the cheque writing structure of the group utilizing THDD and
reconciliation of inter‑company accounts appears nothing more than smoke
and mirrors.
I might also add
that the Appellant’s attempt to show repayments of capital by Tim’s Finance to
Tim’s U.S. in September of 2003 of $50,000 and in 2004 to 2006, through the
evidence of M.K. is of no assistance. Nor is the evidence from the 2005 tax
return of Tim’s U.S. entered into evidence by the Appellant evidencing an
increase in capital expenditures of about $39,000,000 over the previous year,
which M.K. testified she helped prepare but which are unsigned and for which no
evidence was tendered to prove they were actually filed or why they even had to
be filed when the evidence of the same witness is that for U.S. tax purposes Tim’s
U.S. was consolidated within Wendy’s returns. These repayments or capital
expenditures fall within the life of the New Note, not the original Note which
was extinguished almost a year beforehand.
It also follows
that such structure cannot support any special circumstances exception that
would warrant the granting of interest deductibility within the meaning the
Appellant alleges was created in Bronfman Trust. In fact, I do not take Bronfman
Trust to create an exceptional circumstances test that allows deductibility
of interest where the court looks at an ineligible indirect use of the funds
and grants a deduction of interest in special circumstances as it is clear to
me Dickson C.J. was actually referring to looking at the indirect use of funds
as part of focusing on the “purpose” test, not the
“use” test. At page 54, the former Chief Justice
stated:
Even if there
are exceptional circumstances in which, on a real appreciation of a taxpayer’s
transactions, it might be appropriate to allow the taxpayer to deduct interest
on funds borrowed for an ineligible use because of an indirect effect on the
taxpayer’s income-earning capacity, I am satisfied that those circumstances are
not presented in the case before us. It seems to me that, at the very least,
the taxpayer must satisfy the Court that his or her bona fide purpose
in using the funds was to earn income. (Emphasis added.)
In Bronfman
Trust, the Court held that the borrowing of funds to pay a capital
allocation to a trust beneficiary had no direct income earning nature or use.
In Bronfman Trust as in Singleton, the focus of the analyses was
on the use, not the purpose and Bronfman Trust can be distinguished on that
basis and the reference to exceptional circumstances are obiter dictum. Bronfman
Trust cannot be said to create any exceptional circumstances exception test,
although in fairness, the learned Justice certainly kept the door open to such
possibility, but in light of Ludco, it seems that a consideration of
indirect use of funds and the indirect benefit or income it may create for the
taxpayer is now clearly relevant after finding an eligible use, but only for
the purpose of analyzing the purpose test. In any event, in the case at hand,
the Appellant has an eligible direct use, namely, the purchase of common shares
so there is no need to consider an exceptional circumstances exception in the
context of an ineligible use.
10. Finally, I
would like to comment on the Appellant’s contention that it always had the
subjective intention to earn income from its purchase of the said shares
because the group plan had always been for Tim’s U.S. to charge interest on its
loan to Wendy’s. If interest had been charged, we would not be here today. Oddly,
the Appellant argues and thus implicitly agrees that the indirect use of the
invested funds is a factor to consider.
While the
evidence of the Appellant’s former CEO, P.H. and its tax advisor, J.G. clearly
indicated that the Note was initially intended to be interest bearing, the
evidence is somewhat ambivalent as to that intent. As seen earlier, in the Minutes
of the Board of Director’s meeting of Tim’s U.S. dated March 8, 2002,
authorizing the loan to Wendy’s, it is clear that the funds could be loaned to
Wendy’s “at such interest rate (including without
interest) as may be acceptable to any one or more of the officers of the
Company.” Clearly, when the loan was authorized, the parties indicated a
possible intention to loan it interest free. What is also clear is that any intention
to charge interest clearly changed at the time the loan was made since the Note
was in fact non-interest bearing. The evidence is also clear from such
aforesaid witnesses that the charging of interest created potential tax
problems with State taxes, and the Thin Capitalization and Foreign Accrual
Property provisions of the Act and that they were aware at the time of
the loan that the plan would have to be changed but needed to go ahead. The
loan could have been delayed until these issues were addressed to the
satisfaction of the Appellant but was not. No explanation has ever been offered
as to why the loan proceeded in any event or why it needed to go ahead. What is
clear is that the loan did proceed on an interest free basis as reflected in
the Note and I can only assume that any tax concerns were not sufficient to
delay the transaction and that getting money to Wendy’s was the overriding
concern. I am not convinced there was any subjective intention at the time of
the loan to charge interest and that objectively, the opposite appears true.
[32]
In analyzing all the evidence pertaining to the
circumstances of this case, I simply cannot find that the Appellant had any
reasonable expectation of earning non-exempt income of any kind, directly or
indirectly, at the time of its purchase of additional shares in Tim’s U.S. on
or about March 26, 2002.The evidence clearly and unambiguously only points to
the sole purpose of the borrowed funds as being to facilitate an interest free
loan to Wendy’s while creating an interest deduction for the Appellant.
Accordingly, there is no need for me to consider the Respondent’s other
argument that the interest in question would not be reasonable under the
provision in issue.
[33]
The appeal is dismissed with costs to the
Respondent. If either party is not satisfied with this cost order, they may
make submissions as to costs within 45 days for my consideration.
Signed at Ottawa,
Canada, this 6th day of March 2015.
“F.J. Pizzitelli”