Redclay Holdings Ltd. v. The Queen, 96 DTC 1207, [1996] 2 CTC 2347 (TCC)

Rip J.T.C.C.: — Redclay Holdings Limited (“Redclay”) appeals from an income tax assessment of its 1988 taxation year and determinations of losses by the Minister of National Revenue (“Minister”) in respect of its 1986 and 1987 taxation years. The issues to be decided in these appeals are:

a) firstly, whether amounts of unpaid interest deducted by the appellant in computing its income for its 1983, 1984 and 1985 taxation years and which amounts of interest remained unpaid in its 1986, 1987 and 1988 taxation years, respectively, were properly added back into the income of the appellant for the latter years by the Minister pursuant to paragraph 78(1 )(a) of the Income Tax Act (“Act”); and

b) secondly, whether the amounts of unpaid interest deducted in computing the appellant’s losses for 1985, [1] 1986, 1987 and 1988 represent amounts payable in respect of those years within the meaning of paragraph 20(1 )(c) of the Act.

FACTS TS

The parties filed the following Agreed Statement of Facts:

1. The Appellant was incorporated under the laws of Ontario on May 31, 1982, and at all material times herein carried on the business of exploring for, developing and mining mineral resources in Canada.

2. Blackclay Holdings Limited (“Blackclay”) was incorporated under the laws of Ontario on November 4, 1982, and at all material times herein carried on the business of acquiring and holding debt obligations which it purchased from the Bank of Montreal.

3. At all material times herein all of the outstanding shares of the Appellant and Blackclay were owned by the Kuwait Investment Office, which is a branch of the Ministry of Finance of the Government of the State of Kuwait.

4. Highmont Mining Company (“Highmont”) is a partnership that was formed under the laws of the Province of British Columbia on March 20, 1981 between Teck Corporation (“Teck”) and HV Mining Limited Partnership (“HV”). At all material times herein the business of Highmont was the exploration, development and mining of mineral resources in the Highland Valley region of British Columbia. At all material times herein the Appellant and Blackclay dealt at arm’s length with the Bank of Montreal, Teck, HV and Marc Rich and Co. AG (“Marc Rich”).

5. The mining activities of Highmont were financed by partner capital contributions and borrowings from financial institutions and customers. Before the Appellant became a partner in Highmont, each of Teck and HV had borrowed money (the “Project Loans”) from the Bank of Montreal under a term loan facility to finance their capital contributions to Highmont. Each had granted security for the repayment of its Project Loan by means of a charge on its interest in the Highmont assets. Highmont had also borrowed money from a customer, Marc Rich, that purchased substantial volumes of copper concentrates from Highmont upon terms which were evidenced by debentures (the “Copper Debentures”) containing a specific covenant to pay interest on the principal amount thereof and accumulated unpaid interest. The indebtedness of Highmont under the Copper Debentures, and security therefor, were subordinate to the obligations of the partners of Highmont under the Project Loans. Furthermore, the terms and conditions of the Copper Debentures limited the right of the holder to enforce the payment of principal and interest due thereunder to 50 per cent of Available Cash Flow, as defined.

6. On June 30, 1982 Redclay purchased a 29.999 percent interest in Highmont from Teck, in consideration of the assumption of an equivalent share of the obligations of Teck under the Project Loans, the Copper Debentures and the other obligations of Highmont. On the same date, Blackclay purchased from Bank of Montreal 30 percent of the amount receivable by the Bank of Montreal from Teck under the Project Loans, in consideration of the payment of cash and an assignment of a proportionate share of the Bank’s rights under the Project Loans.

7. As a consequence of the foregoing transactions, Redclay became indebted directly to Blackclay in respect of the Project Loans assumed by Redclay.

8. As the result of declining revenues attributable to depressed prices for copper and molybdenum, Highmont suspended its mining operations in 1984, planning to recommence operations when product prices had risen to a level sufficient to support the expenditures necessary to sustain operations. During the suspension of activities, representatives of Highmont entered into negotiations with Highland Valley Copper partnership (“Highland Valley”) regarding the prospect of conducting the Highmont mining activities in partnership with Highland Valley, which was also engaged in mining operations in the Highland Valley region of British Columbia. The partners of Highmont dealt at arm’s length with the partners of Highland Valley at all material times. These negotiations culminated in the sale by Highmont of substantially all of its assets to Highland Valley in consideration of a partnership interest in Highland Valley. This transaction closed on January 20, 1988 and Highland Valley has continually conducted mining operations from that date to the present time.

9. In computing its income for the 1983, 1984 and 1985 taxation years, the Appellant deducted interest payable in respect of the Project Loans that it assumed on the acquisition of its interest in Highmont from Teck. The Appellant did no pay such interest, owing to the fact that its revenues from Highmont were insufficient to enable it to pay same.

10. Blackclay, which at all material times did not deal at arm’s length with the Appellant, included in computing its income pursuant to paragraph 12(1 )(c) of the Income Tax Act the interest described in Fact 9 which was receivable by it from the Appellant, and deducted in computing its income pursuant to paragraph 20(1 )(p) of the Income Tax Act an equivalent amount as a bad debt. The Minister of National Revenue allowed the bad debt deductions so claimed by Blackclay for the reason that he was satisfied that the Appellant did not have, in the taxation years in question, the financial ability to pay such interest.

11. Each of Highmont, the Appellant and Blackclay computed its income for purposes of the Income Tax Act on the accrual basis at all material times.

12. In each of its 1986, 1987 and 1988 taxation years, the Appellant reported non-capital losses as follows and the Minister of National Revenue reassessed the Appellant’s non-capital losses as follows:

Taxation Year Non-Capital Loss		Non-Capital Loss
	Reported	Reassessed
1986	($ 5.861.268)	($4.279.676)
1987	(5.395.528)	(2.270,838)
1988	(5.404.818)	261.682

The non-capital losses reported by the Appellant resulted mainly from:

- the deduction by the Appellant of the interest payable to Blackclay on the Project Loans described in paragraph 9; and

- the deduction by the Appellant of its 29.999 per cent share of the losses of Highmont, the computation of which included deductions claimed by Highmont for interest under the terms of the Copper Debentures described in paragraph 5.

13. From 1988 when Highmont first became a partner in Highland Valley to the present time, Highland Valley continuously has carried on the business of producing and selling copper and molybdenum. Highmont has received from Highland Valley revenues totalling $56,362,925, of which the Appellant’s share (29.999 per cent) is $16,979,579 as shown on Schedule “A” attached hereto. [2]

14. Counsel to the parties agree to dispense with the requirement to identify and put one another to the strict proof of, and hereby consent to the admission into evidence of, any of the documents contained in the Appellant’s List of Documents in this appeal, other than the document at Tab 20.

Appellant’s counsel also read into evidence portions of the transcript of the examination for discovery of Darren McNeil, an officer of the respondent. Mr. McNeil agreed that the general purpose of Interpretation Bulletins is to assist taxpayers in planning their affairs and provide taxpayers and their advisers with guidance in computing income and filing tax returns. He said the goal of paragraph 12(a) in Bulletin IT-109R, dated March 25, 1981, [3] headed “Problems involving Section 78”, was to explain when the Minister would not apply section 78.

McNeil declared that whether the deduction of a bad debt reserve (paragraph 20(1 )(p)) necessarily qualifies as a tax avoidance scheme “would depend on the circumstances” of each case. On the facts of this appeal, he said, “there isn’t necessarily a tax avoidance scheme” but a benefit was enjoyed in that the interest expense claimed by Redclay was not “offset” by the inclusion of interest in the income of the creditor “after the deductions of the bad debt expense”. McNeil added that “the Department doesn’t necessarily have to prove that a tax avoidance scheme exists, but merely that it’s appropriate in the circumstances to apply section 78 ...”. McNeil agreed that in reassessing Redclay, he equated a tax avoidance scheme with the benefit he perceived was enjoyed by Redclay and Blackclay Holdings Limited (“Blackclay”), even though Redclay was financially unable to pay interest.

McNeil’s also acknowledged that when he disallowed interest expenses claimed by Redclay he was not aware of the full extent of the sale of the assets between the old and new partnerships. He learned Highmont Mining Company (“Highmont”) received cash distributions from Highland Valley Copper (“Highland Valley”) only after reviewing documentation subsequently provided by appellant’s counsel.

STATUTORY PROVISIONS

Subsection 78(1) provides:

Where an amount in respect of a deductible outlay or expense that was Owing by a taxpayer to a person with whom the taxpayer was not dealing at arm’s length at the time the outlay or expense was incurred and at the end of the second taxation year following the taxation year in which the outlay or expense was incurred, is unpaid at the end of that second taxation year, either

(a) the amount so unpaid shall be included in computing the taxpayer’s income for the third taxation year following the taxation year in which the outlay or expense was incurred, or

(b) where the taxpayer and that person have filed an agreement in prescribed form on or before the day on or before which the taxpayer is required by section 150 to file the taxpayer’s return of income for the third succeeding taxation year, for the purposes of this Act the following rules apply:

(i) the amount so unpaid shall be deemed to have been paid by the taxpayer and received by that person on the first day of that third taxation year, and section 153, except subsection 153(3), is applicable to the extent that it would apply if that amount were being paid to that person by the taxpayer, and

(ii) that person shall be deemed to have made a loan to the taxpayer on the first day of that third taxation year in an amount equal to the amount so unpaid minus the amount, if any, deducted or withheld therefrom by the taxpayer on account of that person’s tax for that third taxation year.

Paragraph 18(l)(a) reads: [4]

In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

Subsection 20(1) provides:

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) 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),

(ii) an amount payable for property acquired for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy),

or a reasonable amount in respect thereof, whichever is the lesser;

SUBMISSIONS

I. Subsection 78(1) Issue - Project Loans

Subsection 78(1) provides that where a taxpayer (“debtor”) incurs a deductible outlay or expense which is payable to a person (“creditor”) with whom it is not dealing at arm’s length, and the actual payment of the debt is not made before the end of the second taxation year after the year in which it was incurred, then the amount unpaid is to be included in the debtor’s income in the third taxation year after the outlay or expense was incurred. The debtor and the creditor may avoid the inclusion of the unpaid amount in the debtor’s income by filing an agreement with Revenue Canada on the prescribed form in accordance with paragraph 78(1 )(b).

(a) Appellant’s Submissions

A problem with subsection 78(1) is that if the creditor and debtor do not file the agreement, the amount added to the debtor’s income in the third taxation year may not be deducted again even if subsequently paid. Appellant’s counsel, Mr. Ewens, called this an “absurd result” which ought to be rejected in favour of one that is in harmony with the scheme of the entire Act. Cases such as Minister of National Revenue v. Mid-West Abrasive Co., [1973] C.T.C. 548, 73 D.T.C. 5429 (F.C.T.D.) emphasize that a taxpayer may deduct interest only in respect of the taxation year during which the borrowed money is used by the taxpayer. Paragraph 20(1 )(c) permits Redclay to deduct the interest expense, states counsel; the reversal by paragraph 78(1 )(a) of the interest expense is contrary to the scheme of the Act.

In counsel’s view, subsection 78(1), when read in its entirety and within the scheme of the Act as a whole, applies only where a non- arm’s length debtor computes its income on the accrual basis and has incurred a deductible outlay or expense owing to a creditor with whom it does not deal at arm’s length, where the creditor is subject to tax on the cash basis (or is a non-resident of Canada who incurs tax liability in this country under the withholding provisions of Part XIII only on amounts paid or credited to him). Subsection 78(1) focuses on deductible expenses of the debtor that have not actually been paid to the non-arm’s length creditor. Counsel stated that the object and purpose of paragraph 78(1 )(a) is to reverse the debtor’s deduction of an expense where the non-arm’s length creditor has not incurred a tax liability that results from its receipt of payment of the expense within the prescribed time period. The only significance under the Act of a taxpayer not having received an item of revenue arises where receipt is the basis of the taxpayer’s liability, for example, the creditor is on a cash basis of reporting income. Counsel submitted the position of a non-arm’s length creditor whose tax liability is not based on receipt of the deductible item is not intended to be affected by subsection 78(1). Blackclay is an accrual basis taxpayer and is required to include interest in its income as interest becomes receivable by it. According to counsel section 78 has no application whatever to Redclay, as a matter of applying the correct statutory interpretation of subsection 78(1).

Paragraph 78(1 )(b) uses words like “unpaid”, “paid” and “received” and deems the unpaid amount to be paid and received. These words, stated counsel, contemplate a situation where a creditor computes income on a cash basis. Subsection 78(1) does not police paragraph 20(1 )(c).

Counsel said further support for his position is found in paragraph 78(1)(b). The deeming of the unpaid amount to be paid by the debtor and received by the creditor, counsel argued, could have significance and tax relevance only where the non-arm’s length creditor computes its income on the cash basis or is a non-resident. The facts in this appeal serve as an excellent example, Mr. Ewens declared, of a circumstance for the appropriate application of the “words in context” principle that Estey J. applied in Stubart Investments Ltd. v. R., [1984] S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305.

Mr. Ewens also referred to Revenue Canada’s administrative policy, set forth in paragraph 12(b) of Bulletin IT-109R, not to apply section 78 to add back an amount to the income of a debtor where both the debtor and creditor compute their incomes on the accrual basis. The provisions of Interpretation Bulletin IT-109R are not contrary to law but only reinforce the interpretation of section 78, counsel insisted. The Minister ought to be admonished for not treating the appellant as he said he would in the Interpretation Bulletin. There was nothing artificial between Redclay and Blackclay.

I agree with counsel that the combination of Redclay not paying interest and Blackclay claiming a reserve was not part of a tax avoidance scheme. Redclay did not pay interest because its revenues from Highmont were insufficient to enable it to pay the interest. Blackclay claimed a reserve because it was of the view the debts became bad in the relevant years. The respondent did not allege in her pleadings this transaction was part of a tax avoidance scheme and the evidence of Darren McNeil was that Revenue Canada did not assess on the basis a tax avoidance scheme was present. To equate a tax avoidance scheme in the circumstances at bar with a purported tax benefit enjoyed by a taxpayer is quite a stretch which I am not prepared to accept. If Redclay had been debtor of a creditor with whom it acted at arm’s length, subsection 78(1) would be irrelevant. The fact a creditor and debtor do not deal at arm’s length does not necessarily make the transaction they enter into part of a tax avoidance scheme. Indeed, Revenue Canada does not pretend that every claim by a non-arm’s length creditor of a bad debt reserve constitutes a tax avoidance scheme.

Counsel stated Redclay’s inability to pay interest on its indebtedness to Blackclay was due to the depressed metal prices encountered with the Highmont mine, culminating in its operations being suspended. The appellant derived no benefit. Revenue Canada, according to counsel, is attempting to preclude his client from enjoying some kind of administrative treatment because otherwise, in Revenue Canada’s view, the appellant would derive a tax advantage.

Once Revenue Canada established a policy that not every claim of a bad debt reserve by a non-arm’s length creditor constitutes a tax avoidance scheme, counsel declared, the fisc is obliged to carefully analyze the circumstances that it encounters on an audit of non-arm’s length taxpayers who report income on the accrual basis, where one has claimed a doubtful debt reserve or a bad debt reserve. Revenue Canada’s responsibility, he added, is to determine whether the deduction of the reserve was claimed in accordance with the underlying intent and object and spirit of paragraph 20(1 )(1) or (p). Blackclay, by claiming the bad debt reserve, acted as any arm’s length creditor would have acted in the circumstances. The scheme of the Act should be applied consistently to situations where a creditor does not deal at arm’s length with a debtor and where the creditor does deal at arm’s length, where otherwise the facts are the same. It might well be, concluded counsel, that Blackclay’s deduction of a bad debt reserve may eventually be reversed in the future if, as and when cash flow is generated from the Highland Valley partnership and the appellant is in a position to make payment.

Counsel relied on the Reasons for Judgment in Riddell v. Minister of National Revenue (sub nom. Riddell v. Canada), [1995] 2 C.T.C. 434, (sub nom. Riddell v. R.), 95 D.T.C. 5530 (F.C.T.D.), in particular at page 441 (D.T.C. 5533), for the proposition that when the Minister establishes a policy of treating taxpayers in the same position as the appellant in a particular manner, it is not open to him to exercise his discretionary power to not apply that policy to the appellant. The Minister may not exercise his discretion arbitrarily and capriciously by failing to apply it to the appellant in the same manner as to other taxpayers. Even if the Minister has erred in interpreting the law, the courts should sanction the administrative treatment by the Minister’s department, counsel submitted.

(b) Respondent’s Submissions

There is no question, said respondent’s counsel, Mr. Plourde, that:

(a) the amount of interest was a deductible expense which

(b) was owing by Redclay to a person with whom it does not deal at arm’s length, Blackclay, at the time the interest expense was incurred and at the end of the second taxation year following the year the interest was incurred, and

(c) the interest had not been paid at the end of that second taxation year.

Once conditions (a), (b) and (c) are met, then, according to subsection 78(1) there are two possible consequences: (i) either the amount of interest is included in the debtor’s income in the third taxation year, or (ii) the debtor and creditor agree the amount of interest is deemed to have been paid and received.

Subsection 78(1), respondent’s counsel submitted, puts a break on computing income on an accrual basis when the debtor and creditor do not deal at arm’s length. Revenue Canada will apply subsection 78(1) when the creditor claims a reserve for a bad debt or a doubtful debt. A non-arm’s length relationship requires a payment by a debtor to a creditor within a reasonable time, he reasoned.

Respondent’s counsel argued subsection 78(1) is clear and free from doubt. Once its conditions are met, subsection 78(1) comes into play. One should not find ambiguity where none exists.

IT Paragraph 20(1 )(c) Issue - Copper Debentures

Paragraph 20(1 )(c) permits a taxpayer, in computing his income, to deduct interest payable in respect of the year on borrowed money used for the purpose of earning income from a business or property.

Each Copper Debenture provided that the indebtedness evidenced by it was subordinated to obligations of the Highmont partners under the Project Loans [5] which prohibited payment on account of principal of or interest on the debenture until the term loan repayment date. The holders of the Copper Debentures were “not entitled to payment in respect thereof except, in the aggregate, to the extent of 50 per cent of available cash flow… . ”

A Restated Sales Agreement between Teck Corporation (“Teck”) and Marc Rich and Co. AG (“Marc Rich”) provided for loans by Marc Rich for the benefit of the Highmont project. Clause 12(g) of the Agreement described, inter alia, the terms of repayment:

(iv) Repayment of the loans and interest thereon shall be effected only after repayment in full of the Term Loan Debt and all interest and other charges in respect thereof and shall be repaid quarterly, two months after the end of each calendar quarter, but only out of 50 per cent of Net Cash Flow of Teck. In the event that 50 per cent of Net Cash Flow of Teck shall not be sufficient to repay the loans made by Buyer to Teck hereunder, then Buyer shall not be entitled to repayment of any such deficiency.

(vi) Payments out of 50 per cent of Net Cash Flow of Teck shall be applied firstly to accumulated interest, if any; secondly to current interest, if any; and thirdly to principal.

Highmont did not have sufficient cash flow during the taxation years under appeal to pay any of the interest on its Copper Debentures that was owing to Marc Rich.

(a) Appellant’s Submissions

The appellant submits that Highmont had an obligation to pay interest on the Copper Debentures, the only uncertainty being the time when payment would be made. The existence of the obligation to pay the interest was certain. The interest on the limited recourse debt constituted interest “payable” by Highmont whether or not actually paid in the year. If I understand counsel correctly, he argued paragraph 20(1 )(c) requires that a taxpayer be legally obligated to pay interest on borrowed money in respect of the year in which the taxpayer seeks to deduct the interest; paragraph 20(1 )(c) does not require that the interest be paid - or payable - in the year the deduction is sought.

Here too the appellant relies in no small part on statements published by Revenue Canada. In January 1991, a Technical Interpretation expressed the view that:

it would generally be very difficult to conclude that interest paid or payable on a limited recourse or non-recourse loan would not be interest paid or payable pursuant to a legal obligation on the basis that the security for the loan might not be sufficient to cover the principal and interest payable on the due date. [6]

A year later, at the Canadian Tax Foundation’s Corporate Management Tax Conference, Revenue Canada Round Table discussion, Revenue Canada was asked (question 9) whether interest paid or payable on limited recourse debt is deductible pursuant to paragraph 20(1 )(c). The response was:

There is no direct answer because it is always a question of fact as to whether there is a legal obligation to pay interest. Note the Department has not said there is no legal obligation just because the lender has limited recourse in the case of default, ie. limited recourse in and of itself doesn’t result in a finding that there is no legal obligation.

Counsel also referred to new rules proposed by the Minister of Finance to apply generally to “tax shelter investments” and to limited partnerships and general partnerships with inactive partners. [7] The tax shelter proposals dealt with limited recourse debt incurred by investors in tax shelters. Their general impact, said Mr. Ewens, is to defer the entitlement to deduct interest on limited recourse debt until the interest is actually paid. In counsel’s view the introduction of the draft legislation makes it clear that the Department of Finance believes that without this change in the law, interest payable on limited recourse debt is deductible. Counsel relied on King Rentals Limited v. R. (sub nom. King Rentals Ltd. v. Canada) [1995] 2 C.T.C. 2612, 96 D.T.C. 1132; [1995] T.C.J. No. 790, at paragraph 7, in support of this submission.

Counsel also argued that the scheme of the Act requires an adjustment to a taxpayer’s income in the year in which a taxpayer’s obligation to pay, for example, interest, is settled or extinguished without full payment having been made by the taxpayer. An example of the scheme is found in section 80. The courts have held that accounts for a taxation year, once closed, cannot be reopened because of subsequent events. So if interest has been deducted on the basis of an amount legally owing at the end of a year, that year’s accounts cannot be adjusted to reflect an amount subsequently forgiven: The British Mexican Petroleum Co. v. Commissioners of Inland Revenue (sub nom. British Mexican Petroleum Co. v. Jackson), (1931) 16 Tax Cas. 570 (U.K.H.L.); George T. Davie & Sons Ltd. v. Minister of National Revenue, [1954] C.T.C. 124, 54 D.T.C. 1045 (Exch.); and J.D. Stirling Ltd. v. Minister of National Revenue, [1969] C.T.C. 418, 69 D.T.C. 5259 (Exch.). Consequently, counsel stated, interest payable by Highmont is deductible in computing its income in the year in respect of such interest accrued. If, in a subsequent year, Marc Rich forgives Highmont any portion of such interest, section 80 would apply. However, until Highmont knows that it will not be legally required to pay any of the accrued and unpaid interest under the Copper Debentures it is entitled to deduct such interest: Fonthill Lumber Limited v. R., [1981] C.T.C. 406, 81 D.T.C. 5333 (F.C.T.D.).

Mr. Ewens cited several cases which he found to be helpful in determining whether an amount is payable in law when the obligation to pay is a limited recourse one, or where the timing for the making of the payment is dependent upon the occurrence of some act or event.

In Pioneer Designs Corp. v. Minister of National Revenue, [1990] 2 C.T.C. 2446, 91 D.T.C. 293, the directors of the appellant passed a series of resolutions that bonuses be paid to directors. In the first resolution bonuses were to be paid in a lump sum and in a second resolution the bonus was declared in precise amounts without specifying dates of payments. The trial judge found “there was a real expectation by the directors that bonuses [would] be paid during the following taxation year”. The directors did not want to constrain the appellant’s corporation to pay the bonuses on a specific date and some flexibility was built into the procedure for paying bonuses to take into account the corporation’s working capital requirements. One of the Minister’s arguments was that the payments of the bonuses were contingent upon the appellant having the requisite funds to pay them and was contrary to the provisions of paragraph 18(l)(e). Garon T.C.J. held the second set of resolutions “were not in any way conditional but rather couched in absolute terms” (page 2456 (D.T.C. 300)). My colleague dismissed the Minister’s argument that the liability to pay the bonuses depended on the appellant’s cash flow since “in a sense, all obligations dealing with the payment of money depend on the debtor having the necessary funds to meet his obligations” (page 2456 (D.T.C. 301)). The obligation to pay the bonuses in Pioneer Designs was not to be dependent on the availability of funds but was a legally binding obligation.

In Mid-West Abrasive, supra, the appellant agreed “interest will be paid if requested”, but “not in excess of 6 per cent on the promissory notes”, which, it was agreed by counsel meant “but not in excess of 6 per cent per annum”. The Minister’s position was that if the notes had provided for a definite rate of interest without the requirement of a request for payment of the interest, the taxpayer, would have been permitted to claim the interest deduction in each year the obligation to pay interest arose or not at all. The liability to pay interest arises only after the request for interest was made. Sweet D.J., rejecting the Minister’s position, stated, at page 556 (D.T.C. 5435):

It is my view that when the respondent executed the promissory notes containing ‘interest will be paid if requested, but not in excess of 6 per cent’ liability for interest was created. The request for interest did not create the liability. The respondent assumed liability for interest and committed itself in respect of interest when it signed and delivered the notes. The lender might not have invoked its rights under that commitment and would not have invoked its rights if it did not request interest. The lender’s omission to make the request would merely be a waiver of its rights and a forgiveness of the respondent’s liability for interest which existed from the beginning. If and when the request is made it would merely be indicative of the time the borrower’s already existing liability for interest is to be discharged by payment.

Counsel argued that it is reasonable to infer that Marc Rich expected the interest and principal under the Copper Debentures would be repaid. Applying the reasoning adopted in Mid-West Abrasive, counsel submitted the existence of sufficient cash flow in Highmont did not create the liability in Highmont to pay interest on the Copper Debentures. The liability was created when those debentures were executed and delivered. Counsel added that the annual compounding of interest provided for in the debentures would be meaningless unless the parties intended that simple interest be payable throughout the term of the debentures.

Counsel relied on the reasoning of the House of Lords in Reed (Inspector of Taxes) v. Young, [1986] W.L.R. 649, cited in Signum Communications Inc. v. R., [1988] 2 C.T.C. 239; 88 D.T.C. 6427 (F.C.T.D.); aff d. (sub nom. Signum Communications Inc. v. Canada), [1991] 2 C.T.C. 31, (sub nom. R. v. Signum Communications Inc.) 91 D.T.C. 5360 (F.C.A.) in support of his submission that one cannot question if the Highmont partnership had a legal obligation to pay interest under the Copper Debentures by whether, at the end of a particular fiscal year, it had sufficient cash flow to make payment in the year of the interest owing; the liability of Highmont to pay that interest existed from the time the debentures were executed and delivered.

The Supreme Court of United States decision in Commissioner of Internal Revenue v. Tufts, (1983) 461 U.S. 300 was cited by appellant’s counsel for the proposition that a non-recourse loan is a true loan. The only difference between a mortgage loan in which the mortgage has no recourse against the borrower and one in the borrower is personally liable is that the mortgagee’s remedy is limited to foreclosing on the securing property. The effect of non-recourse loan is to shift from the borrower to the lender any personal loss caused by the devaluation of the property. The recourse of a creditor against the debtor is for the interest and the capital of the debt. The creditor’s recourse may be limited by agreement between the creditor and debtor; under the terms of the Copper Debentures, the creditor’s recourse is limited to 50 per cent of available cash flow in the year. However, counsel stated, the existence of cash flow is not a condition precedent to the liability but forms the source from which the creditor may recover the liability for interest and compound interest. Over time, for example, the simple and compound interest on the Copper Debentures may aggregate $500,000. There may exist a cash flow, 50 per cent of which is $300,000. The creditor, Marc Rich, may recover the $300,000 but the debtor remains liable for $200,000. A real, as opposed to contingent, debt continues to exist. This is not, counsel insisted, the type of obligation present in Mandel v. R., [1978] C.T.C. 780, 78 D.T.C. 6518.

Mr. Ewens distinguished the facts at bar from that in J.L. Guay Ltée v. Minister of National Revenue , [1971] C.T.C. 686, 71 D.T.C. 5423 where the Minister disallowed the deduction of amounts of holdbacks on construction contracts which were only payable 35 days after issuance of a certificate of the architects and engineers. Noël A.C.J. upheld the assessment on the basis it was far from certain the amounts of the holdbacks would be paid in full. The amounts withheld were not only uncertain as to quantum but would not be even due or payable if the architects and engineers did not issue a certificate. The amount was not payable because the liability was uncertain. In the appeal at bar, counsel declared, the liability was certain; interest was accrued in each year.

In Mandel, supra, the balance of the purchase price of a motion picture was to be paid out of proceeds of the distribution of the motion picture. The Federal Court of Appeal held the liability to pay the balance of the purchase price was a contingent liability since the taxpayer would be liable for payment only if an event occurred (i.e. the film was profitable) which was by no means certain. Counsel submitted that Redclay’s obligation to pay interest is contained in an Agreement which provided for the compounding of the interest, if not paid in the year. There is a difference, he said, between uncertainty as to an obligation’s existence and uncertainty when the creditor will recover. In Redclay’s appeals, only the latter uncertainty is present; there is no doubt that Redclay was liable to pay interest before the existence of cash flow: Perini Estate v. R., [1982] C.T.C. 74, 82 D.T.C. 6080 (F.C.A.).

Counsel concluded that Highmont has received substantial distributions of cash flow from Highland Valley. The Minister’s official, McNeil, at the time the losses were calculated by Revenue Canada, was not aware of the full extent of the sale of assets between the old and new partnerships or of the operation of the new partnership. The appellant is entitled to deduct its expenses, including all interest expenses with respect to the years in appeal, against its future years’ income. At some point, counsel cautioned, provided revenue distribu tions are sufficient, Highmont may have repaid its entire interest indebtedness to Marc Rich, but its only entitlement to deduct such interest exists in those fiscal years when it used the funds borrowed under the Copper Debentures, namely the years which are the subject of these appeals.

(b) Respondent’s Submissions

Mr. Plourde stated that payment of interest under the Copper Debentures was subject to available cash flow. In clause 12 of the Restated Sales Agreement Marc Rich undertook to support loans to Teck but, except for an adjustment, Teck was not required to repay the loans except as provided in subclause 12(g)(iv), that is, out of cash flow. In counsel’s view the interest in issue was payable only to the extent there was cash flow available in the year. If there was no cash flow, Highmont had no obligation to pay interest.

The availability of cash flow was an uncertain event. If there was no cash flow in the year, counsel declared, Highmont was under no obligation to repay any of the loan or any interest. The availability of cash flow was a condition that had to be fulfilled before interest was payable on the debentures. In other words, the obligation to pay Marc Rich out of cash flow in the years in appeal was no different than the obligation to pay the balance of purchase price out of distribution proceeds in Mandel, supra; the obligations of both Highmont and Mr. Mandel were contingent on the happening of an uncertain event.

Since there was no cash flow in 1986, 1987 and 1988, stated counsel, Redclay was not liable for the payment of interest in those years and, pursuant to paragraph 20(1 )(c) of the Act, the amounts of interest are not deductible in computing Redclay’s income for those years. In Perini, supra, the taxpayer, the creditor, received amounts as “interest” on the balance of purchase price unascertained at the date of closing of the transaction, but determinable in accordance with the future earnings of the company, the shares of which were purchased. The Minister included these amounts of “interest” in the taxpayer’s income. The Federal Court of Appeal found that while the agreement created a contingent liability to pay the purchase price, that liability became absolute with retroactive effect to make the interest an ascertainable amount of compensation for the delayed receipt by the taxpayer of the total purchase price.

In the appeal at bar the amounts of interest payable under the Copper Debentures in each year in appeal had not been ascertained in the particular year. The reasoning in Perini does not assist the appellant. At best, counsel suggested, Redclay may be obligated to pay an amount of interest in the future, but such future obligation is not an expense payable in a current year: R. v. Burnco Industries, [1984] C.T.C. 337, 84 D.T.C. 6348 (F.C.A.).

Mr. Plourde also submitted that the issue of forgiveness of debt by the creditor is not relevant to the facts at bar. For a debt to be forgiven, he said, a debt must first exist and in the 1985, 1986, 1987 and 1988 Highmont was not liable for payment of any debt under the Copper Debentures. He also argued the term limited recourse debt refers to security that is provided for payment of a debt and has nothing to do with the payment of interest.

Analysis

Paragraph 78(I )( a)

Recently the Supreme Court of Canada again considered the proper interpretation of taxing provisions in the light of the basic structure of the Canadian taxation scheme which is established in the Act (Friesen v. R., [1995] 3 S.C.R. 103, [1995] 2 C.T.C. 369, 95 D.T.C. 5551) and reiterated the correct approach in interpreting sections of the Act is set out by Estey J. in Stubart, supra, page 578 (C.T.C. 316, D.T.C. 6323): apply the plain meaning rule. Estey J. at page 578 (C.T.C. 316, D.T.C. 6323) relied on the following passage of E.A. Driedger, Construction of Statutes (2nd ed. 1983), at page 87:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

In Antosko v. Minister of National Revenue (sub nom. Canada v. Antosko), [1994] 2 S.C.R. 312, [1994] 2 C.T.C. 25, (sub nom. Antosko v. R.) 94 D.T.C. 6314 Iacobucci J. stated, at pages 326-27 (C.T.C. 3, D.T.C. 6320), that:

While it is true that the courts must view discrete sections of the Income Tax Act in light of the other provisions of the Act and of the purpose of the legislation, and that they must analyze a given transaction in the context of economic and commercial reality, such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed: Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, at page 194; see also Symes v. Canada, [1993] 4 S.C.R. 695.

Major J. writing for the majority of the Court in Friesen, at page 373 (D.T.C. 5553), accepted the following comments on the Antosko case in Professor P.W. Hogg’s views Notes on Income Tax (3rd ed. 1994). Section 22.3 “Strict and purposive interpretation”, at page 22:12:

It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court’s view of the object and purpose of the provision ... [The Antosko case] is simply a recognition that “object and purpose” can play only a limited role in the interpretation of a statute that is as precise and detailed as the Income Tax Act. When a provision is couched in specific language that admits of no doubt or ambiguity in its application to the facts, then the provision must be applied regardless of its object and purpose. Only when the statutory language admits of some doubt or ambiguity in its application to the facts is it useful to resort to the object and purpose of the provision.

It is settled, then, that the plain meaning of the relevant section of the Act is to prevail. [8]

Paragraph 78(1 )(a) is unambiguous: where a creditor and debtor do not deal at arm’s length and an amount in respect of a deductible outlay or expense by the debtor is not paid to the creditor before the end of the second taxation year following the taxation year in which the outlay or expense was incurred, the debtor is to include that amount in its income in the third taxation year following the taxation year in which the expense or outlay was incurred. The deductions by Redclay in computing its income for each of 1983, 1984 and 1985 remain valid deductions. Because a non-arm’s length relationship exists between creditor and debtor, the Act requires the debtor to actually pay the debt within a certain time notwithstanding both the creditor and debtor account for income on an accrual basis.

Except if the debtor and creditor file the agreement provided for in paragraph 78(1 )(b), the creditor is unaffected by subsection 78(1). In the case at bar, for example, the parties admit the Minister allowed the bad debt deduction claimed by Blackclay. It is obvious the disallowance of the interest as an expense to Redclay combined with a failure to file the agreement provided for in paragraph 78(1 )(b) result in a one-sided adjustment to the tax treatment of the interest amount accrued. [9] However I do not agree with appellant’s counsel that subsection 78(1) applies only to situations where a debtor computes its income on the accrual basis and has incurred a deductible outlay or expense owing to a creditor with whom the debtor does not deal at arm’s length, where the creditor is subject to tax on a cash basis. The words of the provision are clear. It may well be that where a creditor and debtor do not deal at arm’s length, the purpose of subsection 78(1) simply ensures that the debtor pay to the creditor the amount it deducted in the year within a limited time or the amount previously deducted will be added to its income in a subsequent year.

Subsection 78(1) deals with a particular relationship, that of parties not dealing at arm’s length. The Act contains more than a few provisions where special rules apply to transactions between parties not dealing at arm’s length. For example, subparagraph 39(1 )(c)(iv) a capital loss realized by a corporation on a disposition of a debt owing to it by another corporation with which it does not deal at arm’s length will not be a business investment loss; subsection 69(1) deems the consideration of transaction between persons not dealing at arm’s length to be fair market value of the subject of the transaction. Parliament has assumed that persons who do not deal with each other at arm’s length do not have opposing interests and may tolerate situations that parties who deal at arm’s length would not tolerate. The Act sometimes takes transactions between persons not at arm’s length out of the normal scheme of the Act. Subsection 78(1) is such a provision.

Paragraph 78(1 )(a) does not suggest any words that are not specifically expressed in that provision. Parliament did not distinguish between debtors or creditors who report income on an accrual or cash basis. I hesitate in reading in such words when the words of subsection 78(1) are clear and plain and where

the legal and practical effect of what transpired is undisputed: Antosko, supra, pages 326-27.

I agree with counsel for the appellant that: if the appellant pays the amount of the debt in a future year, it will not be permitted to deduct that amount in the year of payment since the debt was not made or incurred in the year of the payment (paragraph 20(1 )(c)). However, the inability of the appellant to deduct after 1985 any debt incurred in 1983, 1984 and 1985 does not affect the operation of subsection 78(1).

Administrative Policy

Much of Mr. Ewens’ submission concerned the failure of the Department of National Revenue to carry out its administrative policy set forth in paragraph 12(a) of Bulletin IT-109R in assessing Redclay under section 78. Paragraph 12(a) provided the Department would not invoke section 78 where circumstances were not part of a tax avoidance scheme. I agreed with counsel circumstances in the appeal at bar did not suggest a tax avoidance scheme.

Bulletins are not authoritative sources for interpreting tax statutes since “an interpretation is not law until so interpreted by a Court of competent jurisdiction”: Cattanach J. in Southside Car Market Ltd. v. R., [1982] C.T.C. 214, 82 D.T.C. 6179, [1982] 2 F.C. 755, at page 223 (D.T.C. 6186, F.C. 770) quoted with approval in Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, [1988] 2 C.T.C. 294, 87 N.R. 300 at pages 195-96 (C.T.C. 305, N.R. 323) per Wilson J.

In Vaillancourt c. R., [1991] 2 C.T.C. 42, 91 D.T.C. 5408, Décary J.A., stated, at page 48 (D.T.C. 5412):

It is well settled that Interpretation Bulletins only represent the opinion of the Department of National Revenue, do not bind either the Minister, the taxpayer or the courts....

Décary J.A. added, at page 48 (D.T.C. 5412):

Having said that, I note that the courts are having increasing recourse to such Bulletins and they appear quite willing to see an ambiguity in the statute — as a reason for using them — when the interpretation given in a Bulletin squarely contradicts the interpretation suggested by the Department in a given case or allows the interpretation put forward by the taxpayer. When a taxpayer engages in business activity in response to an expressed inducement by the Government and the legality of that activity is confirmed in an Interpretation Bulletin, it is only fair to seek the meaning of the legislation in question in that bulletin also.

If the words of a provision of the Act are ambiguous or capable of being interpreted in more than one way, I may refer to the Department’s administrative policy for clarification: Harel v. Quebec (Deputy Minister of Revenue), [1978] 1 S.C.R. 851, [1977] C.T.C. 441, 77 D.T.C. 5438 at page 858 (C.T.C. 443, D.T.C. 5442). See also Novegjick v. R., [1983] 1 S.C.R. 29, [1983] C.T.C. 20, 83 D.T.C. 5041, at page 37 (C.T.C. 24, D.T.C. 5044). This is so in particular when the policy is favourable to a taxpayer.

Since about 1971 the Department of National Revenue has published Interpretation Bulletins describing its views how provisions in the Act ought to be interpreted. Before Revenue Canada issued these Bulletins its assessing policy was set out in an Assessing Guide available only to its officials, but also in the possession of people who previously may have been employed by Revenue Canada. The publication of the Bulletins widened the circulation of assessing policy to all those who were interested. Knowledge of Revenue Canada’s assessing practice permitted taxpayers to construct transactions that, they hoped, would not offend Revenue Canada.

The importance of the Minister in publicizing her administrative practice cannot be overstated. An economy functions better when citizens have some degree of certainty how the fisc will react to economic activity. Many provisions of the Act have not been considered by the courts. Certainly, fact situations vary with each transaction and where a court has interpreted a provision with respect to a set of facts, that interpretation may not necessarily apply to totally different facts in another transaction. In addition, the wording of a provision may be ambiguous, capable of more than one meaning or have a wholly unintended effect from that contemplated by a reasonable person. In such cases, and perhaps others, the Minister has correctly adopted a practice of applying a provision of the Act in a certain way. The publication of the practice by Revenue Canada allows taxpayers the opportunity to plan transactions if not with complete comfort, then with a reasonable expectation of how Revenue Canada will treat the transaction. It is beneficial to all - the taxing authority and the taxpayers - when the administrator of the Act applies an announced policy consistently and fairly. If the Minister changes his view when or how a provision ought to be applied such change in policy ought to be quickly publicized and not have a retroactive effect.

Subsection 220(1) of the Act sets forth the Minister’s duty under the Act:

The Minister shall administer and enforce this Act and control and supervise all persons employed to carry out or enforce this Act and the Deputy Minister of National Revenue for Taxation may exercise all the powers and perform the duties of the Minister under this Act.

Any policy developed and implemented by the Minister in administering the Act must be in accordance with the provisions of the Act itself. Where a provision the Minister views to be ambiguous or capable of more than one meaning has not been interpreted by a court of competent jurisdiction, the Minister, in forming a policy, must apply rules of interpretation set out by the courts in cases such as Stubart Investments, supra, Antosko, supra, and Friesen, supra. The Minister exercises his discretionary power to apply the provisions of the Act, not to apply administrative policy. If the Minister determines that an administrative policy is contrary to the provisions of the Act, he may not apply that policy. Administrative policy must comply with the Act and the Minister must apply that policy in a fair and even handed manner as described in Riddell, supra.

I have concluded the meaning of subsection 78(1) is unambiguous: it means what it says. The object sought by Parliament reinforces this interpretation and

it is not necessary for me to examine the Department’s administrative policy: Vaillancourt, supra, page 679. Paragraph 12(a) of Bulletin IT-109R does not interpret paragraph 78(1 )(a) as much as it describes the Minister’s assessing policy in a given set of circumstances. Where an assessment is found to be a good assessment in law, a taxpayer cannot succeed in challenging in Court the bona fides of the assessment on the grounds it was made contrary to the administrative policy of the Department. [10] The appellant’s complaint is with the Department, not the Courts.

Paragraph 20(1 )(c) [12]

The appellant’s submission is that Highmont clearly had an obligation to pay interest to Marc Rich; the only uncertainty was the time payment would be made. The respondent’s position is that in the relevant years in appeal no amount was payable “in respect of” such year pursuant to an obligation to pay interest on borrowed money used for the purpose of earning income in accordance with paragraph 20(1 )(c) of the Act.

The word “payable” means a sum of money that is to be paid or is falling due [11] or “qui doit être payé”. The word “payable” has also been described as a sum of money when someone is obliged to pay it. [13]

For purposes of paragraph 20(1 )(c), an amount of interest must be payable in respect of the year pursuant to a legal obligation to pay it. An obligation to pay may be contingent on a particular event, future and uncertain, or a condition taking place and the amount of interest would be payable in the year when the event takes place or the condition is satisfied; the amount of interest would be deductible in that year, not the year in which the interest may be eventually paid.

In the appeal at bar, the holders of the Copper Debentures were “entitled to payment...to the extent of 50 per cent of available cash flow...”. In Mandel, supra, the balance of the purchase price was to be paid out of revenues.

Appellant’s counsel is correct: Highmont had an obligation to pay principal and interest under the Copper Debentures. However, Highmont was not obligated to pay any amount of principal and interest in its 1986, 1987 and 1988 fiscal years. A debt existed; Highmont may have owed money to the creditors in the years in appeal but the interest was not yet payable. If the creditors asked Highmont for payment of the interest in those years, Highmont’s reply would be “We owe you interest but we don’t have to pay you yet. There has been no cash flow”, and Highmont would be correct. Therefore how can the partners in Highmont deduct any amount? The amount of interest Highmont was obliged to pay in those years to the holders of the debentures was not known; Highmont was not liable for payment of an ascertained amount of interest. Highmont was obligated to pay interest in each year but the amount of the interest payable in the year could not be quantified because there was no cash flow. It is an amount that is quantified or ascertained in the year that is payable in the year and is deductible in computing income for that year for tax purposes. As in Mandel, Highmont was not liable to pay merely on the expiration of a period of time or on the happening of an event that was certain, or even likely to occur. There was no reasonable certainty at any time in 1986, 1987 and 1988 cash would flow from Highmont in the year. Highmont’s liability was subject to an obligation to pay the interest if, but only if, an event occurred which was by no means certain to occur in the year: Mandel, supra, page 6521. Indeed, Highmont had suspended its mining operations in 1984. Highmont’s obligation was contingent on the happening of an uncertain event. If Highmont never reopened its mining operations, it would not be liable to the debenture holders for interest, simple or compounded. In 1986, 1987 and 1988 there was no certainty as to the amount of interest payable or if any amount would be payable in the particular year: see Samuel F. Investments Ltd. v. Minister of National Revenue, [1988] 1 C.T.C. 2181, 88 D.T.C. 1106 at 2184 (D.T.C. 1108). The creditors did not forgive Highmont payment of the amount of interest in the year. Interest was not paid in the year because it was not payable in the year. The unpaid interest was not deductible in these years even though at some future time these amounts of interest may become payable. The cases of Young, supra, Tufts, supra, and Guay, supra, do not assist the appellant.

The facts in this appeal are quite different from those in Mid- West Abrasive, supra, and Pioneer Designs, supra. In the former case the payment of interest was at the discretion of the creditor and was not conditional on an contingent event or an uncertainty. In the latter case, the appellant’s working capital was sufficient to pay the bonuses.

Here, again, the appellant raised the argument of the Minister’s administrative policy and public pronouncements. My comments with respect to these representations are set out in my discussion concerning the paragraph 78(1 )(a) issue: administrative policy must be subject to the provisions of the Act. There is no ambiguity in paragraph 20(1 )(c): the amount must be payable in respect of the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.

The appeals are dismissed with costs. Appeals dismisssed.