The taxpayer financed its inventory of used automobiles held for resale through unsecured loans of $2 million (for a total of $6 million) from its shareholders, who were the three respective holding companies for the three Gervais brothers. When the ARQ reviewed the deductibility of the loan interest of 10% p.a., the taxpayer provided a very brief letter from Desjardins stating that for an unsecured “cash flow” loan the interest rate in 2015 would fall in the range of 9% to 12%, and then a more detailed letter from its accountants (Deloitte) that, based on Moody’s metrics, concluded that an interest rate for such loans should fall in the range of 7.89% to 12.39%. The ARQ reassessed to deny the claimed interest in excess of 7.89%, having regard to the Quebec equivalent of ITA s. 67 (TA s. 420), but without having formed any opinion that 7.89% was a reasonable rate of interest.
Before reversing the decision below to confirm these reassessments, the Court of Appeal stated (at para. 13, TaxInterpretations translation):
The appellant was not required to make out a prima facie case that the 7.89% rate was unreasonable but, rather, that the assumption, on which the respondent relied in assessing it, that the 10% interest rate deducted from its income for the taxation years in issue was not "reasonable in the circumstances," … was prima facie … unsound.
After canvassing authorities on the concept of a reasonable deduction, including (at para. 29) the statement in Gabco that this was a question of whether “no reasonable business man would have contracted to pay such an amount having only the business consideration of the appellant in mind,” and (at para. 31) that in Petro-Canada that “[t]here may be circumstances in which a decision to pay more than fair market value for something is a reasonable decision,” and then stated (at paras. 53-54):
[I]n this case interest at the 10% rate deducted by the appellant is literally in the middle of the range of reasonable rates established by Deloitte's accountants, that is, between 7.89%, the rate used by the respondent to assess it, and 12.39%, this range having been established by considering, among other things, rates for unsecured loans. This rate of 10% also appears to be consistent with the range of 9% to 12% that Mr. Giguère testified to for the purpose of unsecured financing of vehicle inventories … .
After indicating that a statement in Mohammad, that there are difficulties in rejecting amounts that fall between two extremes, as “entirely applicable,” the Court indicated its conclusion (at para. 54) that:
[T]he respondent does not demonstrated by a preponderance of the evidence that it has resolved this problem and has failed to demonstrate by a preponderance of the evidence that the 10% interest rate was unreasonable within the meaning of TA section 420.