The Queen v. Bank of Nova Scotia, 81 DTC 5115, [1981] CTC 162 (FCA)

Heald, J:—This is an appeal from a judgment of the Trial Division which allowed the respondent’s appeal from a reassessment for income tax in respect of the respondent’s 1972 fiscal year which ended on October 31, 1972. The Trial Division judgment referred the matter back to the Minister of Na- tional Revenue for reassessment of respondent’s foreign tax credit of £179,596 for taxes paid to the United Kingdom (UK) for that year, by using the weighted average exchange rate of $2.52122 Canadian dollars to the pound sterling.

The issue in the appeal is whether, for purposes of paragraph 126(2)(a) of the Income Tax Act, 1952, c 148, as amended, and Article 21(2) of the Canada-United Kingdom Income Tax Agreement,* the UK income tax which was imposed on the respondent in respect of the income from its branches in the UK for the 1972 taxation year should be translated into Canadian funds:

(a) at the weighted average rate of exchange prevailing in the 1972 taxation year as contended by the respondent and accepted by the learned trial judge, or

(b) at the rate of exchange prevailing on January 1, 1974 when the UK income tax was paid, as contended by the appellant.

An agreed statement of facts was filed at the trial (Appeal Book pages 141 to 144 incl) from which the following circumstances emerge:

The law of the United Kingdom during the relevant period imposed tax on the respondent based on the amount of business transacted there during its 1972 fiscal year but only required such tax to become payable 14 months thereafter, ie, on January 1, 1974. The entire UK tax due and payable was accordingly paid by the respondent on January 1, 1974, except for the sum of £15,209 which had been withheld at source during the period, in respect of interest on certain UK bonds.

*Those provisions read as follows:

“126. . . .

(2) Where a taxpayer who was resident in Canada at any time in a taxation year carried on business in the year in a country other than Canada, he may deduct from the tax for the year otherwise payable under this Part by him an amount not exceeding the least of

(a) such part of the aggregate of the business-income tax paid by him for the year in respect of businesses carried on by him in that country and his foreign- tax as the taxpayer may claim,

(b) the amount determined under subsection (2.1) for the year in respect of businesses carried on by him in that country, and

(c) the amount by which

(i) the tax for the year otherwise payable under this Part by him

exceeds

(ii) the amount or the aggregate of amounts, as the case may be, deducted under subsection (1) by him from the tax for the year otherwise payable under this Part.”

Article 21(2)

“Subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada (which shall not affect the general principle hereof), United Kingdom tax payable in respect of income from sources within the United Kingdom shall be deducted from any Canadian tax payable in respect of that income. Where such income is a dividend paid before 6 April, 1966, by a company which is a resident of the United Kingdom, the deduction shall take into account any United Kingdom income tax appropriate to the dividend.”

The net profits of each of respondent’s seven UK branches for each quarter of its 1972 fiscal year were taken into the respondent’s income in Canada at the end of the quarter in Canadian funds determined by translating sterling into Canadian funds at the exchange rate prevailing at the end of the quarter. The net profits for each quarter which remained, after deducting a provision for estimated UK taxes, were remitted to Canada and converted into Canadian funds at the end of the quarter. The said estimate for UK taxes was retained in sterling in the UK, as required by the policies of the Bank of England and was permitted to be used by the respondent in its UK business until the UK taxes were paid.

The learned trial judge details at pages 155 and 156 of the Appeal Book the practical difference which results on the facts of this case, depending on whether the approach of the appellant or the respondent is adopted:

For Canadian taxation purposes the foreign currency profits and losses obviously must be expressed in terms of Canadian currency. Due to the constantly fluctuating foreign exchange situation, where there is an accounting for profits and losses on an accrual basis of accounting for a given fiscal period, it would be impossible to translate each entry as it occurs into Canadian funds in accordance with the prevailing rate of exchange existing at that time. It is therefore not only common accounting practice and good sense but it is a practice fully accepted and recognized by the defendant, that an average rate of exchange known as the weighted average of the rates prevailing during the period in question is used to translate into Canadian funds, at the end of the period the foreign profits realized and the losses incurred during that period. In the case at Bar, it is common ground that the weighted average figure of currency exchange for the fiscal period ending the 31st of October, 1972, was 2.52122 Canadian dollars to the pound sterling. Therefore, if that figure is used, the credit for £179,596 amounts to $452,794. On the other hand, if the rate of exchange existing on the date of payment is used, namely, 2.3131 for the £15,209 withheld at source and 2.2954 for the balance of the tax paid on the 1st of January, 1974, the resulting tax credit would only be $412,514. The difference between the two figures amounts to $40,280.

Then, after a comprehensive review of the factual situation, the evidence adduced, and the arguments of opposing counsel, he concludes (Appeal Book pp 168 to 171 incl):

On the assumption that the foreign tax must be paid and not merely be payable before the right to a tax credit for same arises, I arrive at the following conclusions based on the above facts, expert opinion and considerations:

1. That both the law and generally accepted good accounting practice require that the plaintiff carry out its accounting on an accrual basis, as in fact it did during the year in issue.

2. That generally accepted good accounting practices do not apply only to the calculation of profits and losses under section 9 of the Income Tax Act but to all matters of account unless there exists some statutory impediment to the application of those practices.

3. That generally accepted good accounting practice would normally require the unpaid United Kingdom taxes, which accrued in 1972, to be carried in the books of the plaintiff for that year and until payment at the weighted average rate of exchange for 1972.

4. That there exists no specific provision in the Income Tax Act itself, which would require the credit in pounds sterling to be translated into Canadian dollars according to the rate of exchange existing at the date of actual payment, nor would the translation in accordance with the weighted average rate in effect for the year during which the liability for the foreign tax was incurred, offend against the general scheme or purpose of the Act nor any of its specific provisions.

5. That no double taxation would be involved if the exchange rate at time of payment were used.

6. That neither method of calculation is basically unfair to either party nor more likely than the other to work to the disadvantage of anyone since the rate of exchange may always vary either way.

7. The procedural anomaly which would appear to prevent a foreign tax liability paid after the ninety-day period for appeal has expired, from being claimed as a tax credit, is of no assistance to the plaintiff.

8. That the following considerations, although not in any way compelling, would, if anything, tend to favour the weighted average rate of the fiscal year in question being used:

(a) It is more logical and simpler for the taxpayer (and especially a corporate taxpayer who must account to its shareholders) who is accounting on an accrual basis, to carry in his tax returns as well as in his general financial statements the same yardstick for tax liabilities and tax credits as for formal profits and losses before taxes.

(b) It is more consistent that the same measure be applicable to subparagraphs (a) and (b) of section 126(1), than to have two different methods of calculating tax credits in the same section.

(c) Except for section 127(1) pertaining to certain provincial logging tax credits, the credit under section 126(1 )(a) is the only one in the Income Tax Act where a credit must be allocated to a specific taxation year which is not necessarily the year of payment of the amount.

9. When section 126(1)(a) is considered by itself or in isolation and without taking into account normal accounting practices or any other factors, it would seem to be more natural and normal to calculate the value of the tax in Canadian dollars at the rate of exchange in effect at the date of payment, although there is nothing in the sections which actually requires this.

Notwithstanding paragraph 9 above, because of considerations 1, 2, 3, 4 and 8, I would find that the translation into Canadian dollars should be carried out in accordance with the weighted average rate of exchange in effect for the taxation period in question.

Should I be in error in finding that this principle applies to all foreign tax credit cases, then, I would find that, in the particular circumstances of this case, because United Kingdom law requires that the tax be set aside in sterling during the taxation year when it accrued and be kept in sterling until ultimate payment in sterling, the weighted average rate of foreign exchange should apply in any event.

III — Finding

I therefore conclude that whether the right to a credit arises at the time when the United Kingdom tax accrues and becomes payable or whether it arises only when the tax is actually paid the credit must in both cases be calculated by translating the amount of tax payable in sterling into Canadian dollars in accordance with the weighted average rate of exchange prevailing during the taxation year under consideration.

Since it is not necessary for me to decide the question of when the right to the tax credit for United Kingdom taxes actually arises in order to dispose of the litigation between the parties, I am deliberately refraining from doing so.

Counsel for the appellant submits first, that the learned trial judge erred in failing to hold that, pursuant to paragraph 126(2)(a), the right to the tax credit conferred thereby, only arises upon actual payment of the foreign business income tax and in failing to hold that such tax credit should be computed on the basis of the rate of exchange prevailing at the date of actual payment. Appellant’s further submission was that the learned trial judge erred further in concluding that the tax credit under subsection 126(2) was “a matter of commercial and taxation accounting” since, in counsel’s view, by paragraph 126(2)(a), Parliament had specifically directed that the right to such tax credit could only arise upon actual payment of the foreign business income tax which, in his view, necessitated the use of the cash method as distinct from the accrual method for purposes of computing such tax credit.

Dealing now with the first submission of counsel for the appellant, I am unable to agree with his view of this matter. It is my opinion that the respondent’s liability for UK income taxes for the 1972 taxation year arose in 1972 since that is the year when the income creating the liability was earned, even though by UK law, the tax was not required to be paid until some fourteen months later. I consider that the liability for the UK tax attached to the respondent at fiscal year-end, namely, October 31, 1972. To adopt the appellant’s view would necessarily require that the amount of the tax credit be calculated using the rate of exchange prevailing on the date of payment. On the facts of this case, that date would be January 1, 1974. However, in order to test the validity of this submission, it is interesting to pose a different factual situation. Conceivably, in some situations and with some taxpayers, the amount of the tax liability and, consequently, the amount of the UK tax credit could become known at year-end or a few days thereafter. If, again, one were to assume a year-end of October 31, 1972, and a taxpayer who decided to prepay the UK tax in November or December of 1972, or sometime in 1973, then the appellant’s submission as to date of calculation produces rather strange results. Because the tax credit would be based on the date of payment of the tax, it would fluctuate in accordance with the daily fluctuations of the rate of exchange. If the appellant is correct, the amount of UK tax credit would have changed almost daily during the period from October 31, 1972 to January 1, 1974, depending on when the UK tax was paid. I do not believe that Parliament intended such a result — namely, that the amount of tax credit should be affected by variations in the rate of foreign exchange. In my view, Parliament clearly intended, in enacting subsection 126(2)(a) to relieve against double taxation by providing for a tax credit based on the amount of tax payable for a taxation year, by a Canadian resident, on income earned in a foreign country in that taxation year, regardless of when, by the law of that foreign country, the foreign tax was required to be paid. Similarly, I am unable to agree with the second submission of appellant’s counsel that it was a necessary inference, from the language used by Parliament in paragraph 126(2)(a), that the cash method, as distinct from the accrual method, was to be used in computing the tax credit. In this regard, based on the evidence before him, the learned trial judge held:

1. That both the law and generally accepted good accounting practice required the respondent to carry out its accounting on an accrual basis as in fact was done in the 1972 fiscal and taxation year.

2. That generally accepted good accounting practices apply not only to the calculation of profits and losses under section 9 of the Income Tax Act but, as well, to all matters of accounting unless there exists some statutory impediment to the application of those practices.

3. That generally accepted good accounting practice would normally require the unpaid UK taxes, which accrued in 1972, to be carried in respondent’s book for that year and until payment, at the weighted average rate of exchange for 1972.

4. That there is no specific provision in the Income Tax Act requiring the credit in pounds sterling to be translated into Canadian dollars at the rate of exchange on January 1, 1974, the date of actual payment, nor would the translation in accordance with the weighted average rate for 1972 offend against the general scheme or purpose of the Act nor any of its specific provisions.

In my view, based on the evidence before him, and applying the relevant statutory provisions to that evidence, the learned trial judge was justified in making those findings and in reaching those conclusions.

I am fortified in my view of this matter because of another unusual and unjust result which could flow from the interpretation urged upon us by counsel for the appellant. The Canadian Income Tax Act requires a Canadian corporation to file its tax return for a taxation year, within six months from the end of that year (in this case, the return was required to be filed on or before April 30, 1973). If the appellant is right, since the respondent could not determine its foreign tax credit until January 1, 1974, it would be unable to file its tax return accurately claiming the foreign tax credit within the six month period set out in the statute. It should also be noted that there is no provision in the Act for reassessment in respect of the foreign tax credits. On the other hand, the respondent’s method would permit the taxpayer to compute the foreign tax method when its accounts are prepared following the year-end thus enabling the taxpayer to estimate its tax and file its return as required under the Act. In my view, where possible, the provisions of the Act should be interpreted in such a way as to enable a taxpayer to compute its tax and comply with the statute within the time constraints imposed thereby. Since, in my view, the language of the section does not foreclose such an interpretation, it should be adopted in this case.

Counsel for both parties made reference to the provisions of Article 21(2) of the Canada-United Kingdom Income Tax Agreement quoted supra. Both counsel agreed that there was no inconsistency between Article 21(2) of the Agreement and subsection 126(2) of the Act. I agree with respondent’s counsel that neither provision specifies the basis for translation of the UK income tax to Canadian funds and that both provisions make it clear that the UK tax to be deducted by the respondent from its Canadian tax otherwise payable for the 1972 taxation year is the UK tax on its UK source income for that year.

Both counsel submitted a number of authorities in support of their position but I do not find those authorities to be directly applicable to the issue to be decided here. There is, however, one English case to which we were referred that I find helpful to some extent, namely the case of Greig (Inspector of Taxes) v Ashton, [1956 1 W.L.R. 1056. In that case, a taxpayer resident in the UK in 1946 paid some $24,000 to the US tax authorities in respect of her earnings as a writer there. In 1950 she was repaid approximately $12,000 by the US in respect of tax overpaid. In 1946 the rate of exchange was $4 to the pound sterling but by 1950 the rate of exchange had fallen to $2.80 to the pound. As in the case at bar, she was entitled, pursuant to the UK-US Tax Convention and under the UK Income Tax Act, to a credit against any UK taxes payable in respect of US income which had been taxed there. The applicable section of the UK Income Tax Act provided as follows:

Para. 2(1) — Subject to the provisions of this schedule, where, under the arrangement, credit is to be allowed against any of the United Kingdom taxes chargeable in respect of any income, the amount of the United Kingdom taxes so chargeable shall be reduced by the amount of the credit.

The Crown contended that the alteration in the rate of exchange when the credit was repaid should be taken into account when the taxpayer’s credit under the Convention was adjusted by reason of the repayment of tax in 1950. Mr Justice Harman, of the Chancery Division, held that the payment of US tax in 1946 and the repayment in 1950 was one transaction, and the fact that, owing to the delay by the US fiscal authorities, there had been an alteration in the rate of exchange was irrelevant, and the Crown was not entitled to take it into account in the computation of the taxpayer’s credit in respect of tax paid by her in the US. At p 1061 of the report, Mr Justice Harman stated:

The fact that the United States authorities were slow about repaying or that the exchange had altered in the meanwhile, so that when they repaid her the amount repaid was worth more to her in pounds, seems to me, when one looks at it carefully, to be entirely irrelevant. I do not think that it has anything to do with the Crown at all. The money might have been repaid earlier and left in the United States and the same profit would have been made, which is not a profit which the Crown could tax. It is a mere accident, in my judgment, and the special commissioners were quite right in upholding the taxpayer’s contention, and the Crown’s contention in this case is wrong.

But I reject the Crown’s contention because the alteration in the rate of exchange is purely an outside circumstance which has nothing to do with the liability for tax nor the way in which the Convention ought to be related to the law.

I adopt the reasoning in that case as being equally applicable to the case at bar. The exchange fluctuations in 1972, 1973 and 1974 are, in my view, irrelevant circumstances in so far as the computation of respondent’s tax credit under subsection 126(2) is concerned. The purpose and intent of subsection 126(2) is to provide to the taxpayer relief against double taxation in respect of liability for tax in a foreign country. The rate of exchange is purely an outside circumstance which has nothing to do with the liability for tax.

Accordingly, and for all of the foregoing reasons, I have concluded that the appeal should be dismissed with costs, both here and in the Trial Division.

Urie, J:—I concur.

Kelly, DJ:—I concur.