Trans-Prairie Pipelines Ltd. v. MNR, 70 DTC 6351, [1970] CTC 537 (Ex Ct)

JACKETT, P.:—This is an appeal from a Judgment of the Tax Appeal Board dismissing an appeal by the appellant from its assessments under Part I of the Income Tax Act for the 1956, 1957, 1958 and 1959 taxation years. In respect of each year, there is a question as to whether the respondent was right in disallowing four-sevenths of the interest payable by the appellant in the year on a bond issue, the appellant having claimed to deduct, in computing its income for the year, the whole of such interest under Section 11(1) (c) of the Income Tax Act as being interest on "‘borrowed money used for the purpose of earning income’’ from the appellant’s business. In addition, in respect of the 1956 taxation year, there is a question as to whether the respondent was right in disallowing the deduction, under Section 11(1) (eb) (11), In computing the appellant’s income for the year, of four- sevenths of expenses incurred in that year in the floating of the bond issue in question.

The parties are in agreement that, if the appellant succeeds on the interest question, it also succeeds on the question that arises under Section 11(1) (cb) and that, if the appellant fails on the interest question, it also fails on the question under Section 11(1) (cb). I shall, therefore, say nothing further with reference to the question that arises under Section 11(1) (eb).

There is really no dispute as to the relevant facts.* [1]

The appellant’s business is building and operating pipelines. When the appellant started business in 1954, it raised the capital required for that business by two share issues. The money so raised consisted of

Part of this money was disbursed for the appellant’s pipelines and other capital assets and the rest became its circulating capital. In 1956, the appellant investigated the possibility of raising further capital for expansion by way of bond issues and learned that one of the first steps that it would have to take was to redeem its preferred shares and substitute borrowed capital for the capital that had been subscribed for such preferred shares.! [2] Accordingly, in 1956, the appellant redeemed its preferred shares and, to do so, paid $700,000 to the holders of those shares. At the same time, it borrowed $700,000 from the Great West Life Assurance Company by way of a bond issue and raised a further $300,000 by issuing additional common shares. In the course of carrying out these transactions, the preferred Shares were redeemed by using the $300,000 obtained by the new issue of common shares and $400,000 out of the $700,000 received on the floating of the bond issue.

In these circumstances, the question arises as to whether the appellant is entitled to a deduction, in computing its income for 1956 and subsequent years, of the whole or only part of the interest payable on such bonds by virtue of Section 11(1) (c) of the Income Tax Act, which reads as follows:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his 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 a reasonable amount in respect thereof, whichever i is the lesser;

The respondent has disallowed the deduction of four-sevenths of the amount of such interest for each of the years in question on the ground that $400,000 out of the $700,000 borrowed by the bond issue was used to redeem preferred shares and was not, therefore, used "‘for the purpose of earning income’ ‘ from the business. In this conclusion, the respondent has been upheld by the Tax Appeal Board.

The alternative view is that, prior to the transactions in question, the capital being used for the purpose of earning income from the appellant’s business was the $700,000 subscribed by the preferred shareholders and the $140,006 subscribed by the common shareholders, and that, after those transactions, the money subscribed by the preferred shareholders had been withdrawn and what the appellant was using in its business to earn income was the $440,006 subscribed by common shareholders and the $700,000 of borrowed money. This, in my view, is a correct appreciation of the matter.

It follows that, in my view, the whole of the $700,000 of borrowed money was being used by the appellant in its business for the purpose of earning income from the business; and that is my view even though, from another point of view, and in a different sense, some $400,000 of the $700,000 was in fact paid on the redemption of the preferred shares.* [3]

The difficulty arises from the fact that, in ordinary parlance, when one talks of the use of money in a business to earn income, one is referring to the mass of capital dedicated to that business, through all the different forms through which it passes while it remains in the business, and, when one talks of using money to acquire property or to pay a debt, one is referring to using money to make a particular payment as a result of which the payer no longer has that money, t [4]

When a business person has borrowed money to use in a business, he is, according to the ordinary use of language, using that borrowed money in his business to earn income therefrom even though part of it has been converted into bricks and mortar’’ and part of it was paid out during the first year for inventory and by way of salaries. Indeed, except in very unusual circumstances, he is using that borrowed money in his business to earn income until the loan matures and is paid off. By contrast, the actual money borrowed will, according to the ordinary use of language, have been "‘used’’ to acquire plant and machinery and to pay running expenses and will, in fact, have completely ceased to belong to the business man once it has been so used.

It would not, of course, be completely absurd to attribute the latter sense to the words ‘‘money used’’ where they first appear in Section 11(1) (c) (1). Whether or not interest is deductible on borrowed money during each year of the life of a loan would then depend upon whether the first. expenditure of the money after being borrowed was an expenditure for the purpose of the business. That test would, in most cases, produce the right result. However, in my view, such an interpretation is not only not in accordance with the ordinary sense of the words as used in the context but it results in a rule that is not sound in principle. For example, a parent company such as the appellant company in D.W.S. Corporation v. M.N.R., [1968] 2 Ex. C.R. 44; [1968] C.T.C. 65 (affirmed Can. S.C.), having raised some borrowed capital, could use it on one occasion to acquire inventory for its business and could then, when it comes back in the ordinary course of trade, put it at the disposal of a subsidiary for the balance of the term of the loan, and charge the interest as an expense of the parent’s business; If, on the other hand, the words “money used for the purpose of earning income in a business” are given their ordinary sense in this context of interest on borrowed capital, the obviously sensible result achieved in the D.W.S. case would flow whether borrowed capital was turned over to a related company without ever being used in the borrower’s business or was turned over to a related company after being so used for a limited time. Surely, what must have been intended by Section 11(1)(c) was that the interest should be deductible for the years in which the borrowed capital was employed in the business rather than that it should be deductible for the life of a loan as long as its first use was in the business.* [5]

The facts of the present appeal provide an even more striking illustration of the inappropriateness of the meaning of the words money used for the purpose of earning income from a business ’ ’ that is relied on by the respondent. Prior to the 1956 transactions, the appellant’s capital used in its business consisted in part of $700,000 subscribed by preferred shareholders. As a result of those transactions, the $700,000 had been repaid to those shareholders and the appellant had borrowed $700,000 which, as a practical matter of business common sense, went to fill the hole left by redemption of the $700,000 preferred. Yet, according to the view relied on by the respondent, for the purpose of this provision concerning interest on borrowed capital, $400,000 of the borrowed money cannot be regarded as being used to earn income from the business.

The appeal will be allowed with costs and the assessments under appeal will be referred back to the respondent for reassessment on the basis that the whole of the $700,000 borrowed from the Great West Life Assurance Company was during the

years 1956, 1957, 1958 and 1959: borrowed money used for the purpose of earning income from thé appellant’s business within the meaning of Section 11(1) (e) and Section 11(1) (eb) of the Income Tax Act. -