Gifford v.
Canada, [2004] 1 S.C.R. 411, 2004 SCC 15
Thomas
Gifford Appellant
v.
Her Majesty
The Queen Respondent
and
Canadian
Bankers Association Intervener
Indexed
as: Gifford v. Canada
Neutral
citation: 2004 SCC 15.
File
No.: 29416.
2003:
November 14; 2004: March 4.
Present:
McLachlin C.J. and Major, Bastarache, Binnie, Arbour, Deschamps and
Fish JJ.
on appeal from
the federal court of appeal
Income tax — Income from employment — Deductions — Sales expenses —
Purchase of client list — Financial advisor borrowing money to purchase
colleague’s client list — Whether payment to purchase client list and interest
paid on borrowed funds deductible — Whether payments were “on account of
capital” — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .),
s. 8(1) (f).
The appellant and B worked as financial advisors in an investment
firm. When B decided to leave the firm, the appellant borrowed $100,000 to
purchase B’s client list. They entered into an agreement whereby B agreed to
provide a written endorsement of the appellant to each client identified on a
client list and direct the firm to transfer those clients to the appellant. B
also agreed to a 30-month non-compete clause and agreed not to provide material
information about the clients on the list to anyone without the appellant’s
consent. The question is whether the appellant could, for tax purposes, deduct
from his income either the purchase price or the interest paid on the money he
borrowed to make the purchase. The Minister of National Revenue denied the
appellant’s claim for a deduction. The Tax Court of Canada allowed both
expenditures to be deducted but the Federal Court of Appeal set aside the
decision.
Held: The appeal should be dismissed.
The agreement to pay $100,000 to purchase accumulated goodwill and the
agreement not to compete were made to create an enduring benefit for the
appellant. The payment for this asset was a payment “on account of capital”
and s. 8(1) (f)(v) of the Income Tax Act prevents a deduction
from being made for such an expense. Under the tests outlined in Johns-Manville,
the client list was a capital asset: (1) it significantly expanded the
appellant’s client network, the structure within which he earned his employment
income; (2) the purchase of someone else’s accumulated goodwill is not the same
as the recurring marketing expenses the appellant would have had to incur to
create his own goodwill; (3) the payment secured the discontinuance of competition;
and (4) it was a payment made with the intention of securing an asset of
enduring benefit that would provide the appellant with a lasting advantage.
The fact that the transaction occurred between two employees instead of two
businesses does not, by itself, change the characterization of the transaction
or cause the earlier client list cases to be ignored.
The interest payment in this case is also a payment “on account of
capital”, because the funds borrowed to make the payment to B themselves added
to the financial capital of the appellant and as such are expressly denied
deductibility under s. 8(1)(f)(v) of the Act. When determining the
deductibility of interest, the important question is not whether the payment is
a capital expenditure but whether it is “on account of capital”. This
distinction is particularly important in relation to interest payments because,
unlike other capital assets, loan proceeds are seldom retained in the form they
are received. This distinction means that under the Income Tax Act it
is only necessary in each case to consider what the proceeds of the loan are to
the borrower when they are received, and does not require an examination of
what those loan proceeds are spent on. If, as here, the money adds to the
financial capital, then the payment of interest on that loan will be considered
to be a payment “on account of capital”. In circumstances where interest is
not a payment “on account of capital”, it may be deducted as long as it meets
the other requirements, such as those set out in s. 8(1) (f) or
s. 18(1) (a), and is not precluded by some other section of the Act.
The costs in the courts below are confirmed and the appellant is
awarded his reasonable and proper costs in this Court.
Cases Cited
Applied: Johns-Manville Canada Inc.
v. The Queen, [1985] 2 S.C.R. 46; considered: Canada
Safeway Ltd. v. Minister of National Revenue, [1957] S.C.R. 717; Bronfman
Trust v. The Queen, [1987] 1 S.C.R. 32; Tennant v. M.N.R.,
[1996] 1 S.C.R. 305; Shell Canada Ltd. v. Canada, [1999]
3 S.C.R. 622; referred to: Wharf Properties Ltd. v.
Commissioner of Inland Revenue, [1997] 2 W.L.R. 334; Cumberland
Investments Ltd. v. The Queen, [1975] C.T.C. 439; The Queen v. Farquhar
Bethune Insurance Ltd., [1982] C.T.C. 282; Bennett & White
Construction Co. v. Minister of National Revenue, [1949] S.C.R. 287; Steele
v. Deputy Commissioner of Taxation (1999), 161 A.L.R. 201.
Statutes and Regulations Cited
Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp .), ss. 8(1) (f) [am. 1994, c. 7, Sched. II, s. 5(1)],
(j) [idem, ss. 5(4) , 5(5) ], (2), 9(1), 18(1)(a), (b),
20(1)(a), (b), (c) [idem, s. 15(1) ].
Tax Court of Canada Act, R.S.C. 1985,
c. T-2, ss. 18 , 18.25 [ad. c. 51 (4th Supp.), s. 5 ].
APPEAL from a judgment of the Federal Court of Appeal (2002), 293 N.R.
111, [2002] 4 C.T.C. 64, 2002 D.T.C. 7197, [2002] F.C.J. No. 1127 (QL),
2002 FCA 301, quashing a decision of the Tax Court of Canada, [2001] 2 C.T.C.
2162, 2001 D.T.C. 168, [2001] T.C.J. No. 100 (QL), and confirming the
assessment of the Minister of National Revenue. Appeal dismissed.
Michael Templeton and Richard Thomas, for the
appellant.
Gordon Bourgard and Wendy Burnham, for the
respondent.
Al Meghji and Mahmud Jamal, for the intervener.
The judgment of the Court was delivered by
1
Major J. — The appellant,
Thomas Gifford, a financial advisor and employee of Midland Walwyn Capital Inc.
(“Midland Walwyn”), borrowed $100,000 to purchase the list of Mr. Bentley’s
clients. Bentley was a fellow financial advisor who was leaving the firm. The
question is whether the appellant could, for tax purposes, deduct from his
income either the purchase price or the interest paid on the money he borrowed
to make the purchase. Neither of these amounts are deductible, as both were
payments “on account of capital” which are expressly denied deductibility under
s. 8(1) (f)(v) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .)
(the “Act ”). I would dismiss the appeal.
I. Factual Background
2
The appellant and Bentley were employees of Midland Walwyn in North Bay,
Ontario. They worked as financial advisors, each dealing with their own
clients.
3
Bentley decided to leave the firm and the appellant entered into an
agreement with him on December 10, 1995 titled “Agreement to Purchase Client
Base of Financial Advisor” (the “Agreement”), whereby Bentley agreed to provide
a written endorsement of the appellant to each client identified on a client
list and direct Midland Walwyn to transfer those clients to the appellant.
Bentley also agreed to a non-compete clause which, in general terms, precluded
him from providing retail securities investment advice to those clients for a
period of 30 months, nor could he provide material information about the
clients on the list to anyone without the appellant’s consent.
4
In exchange, the appellant paid Mr. Bentley $90,000 on closing and a
further $10,000 on April 8, 1996. The hold back of $10,000 was subject to
reduction according to a formula in the Agreement if the total amount invested
by the clients on the list decreased.
5
The employer Midland Walwyn’s primary consideration was keeping the
clients at the firm. The branch manager facilitated the Agreement and
transferred the clients to the appellant. Evidence was given that in the
absence of the Agreement the appellant would probably only have acquired about
one quarter of Mr. Bentley’s clients with the rest distributed to other
financial advisors in the firm.
6
The appellant’s claim for a deduction was denied by the Minister of
National Revenue. The appellant appealed to the Tax Court of Canada under the
informal procedure outlined in s. 18 of the Tax Court of Canada Act,
R.S.C. 1985, c. T-2 . Bowman A.C.J.T.C. summarized the appellant’s claim to the
Minister for a deduction:
In filing his return of income the appellant
deducted $13,258.07, which he claimed represented depreciation of goodwill
($5,250) and interest and insurance expense ($8,008.07). The Minister
disallowed this amount on the basis that no provision allowed the appellant to
deduct an amount as depreciation of goodwill or interest for the purchase of a
customer list.
([2001] 2 C.T.C. 2162, at para. 5)
At the Tax
Court the appellant shifted his submission and claimed that the payment to
Bentley was a current marketing expense made for the purposes of obtaining
clients, and that the interest should be deductible as a current expense.
Bowman A.C.J.T.C. allowed both expenditures to be deducted and this decision
was subsequently reversed by the Federal Court of Appeal.
II. Relevant Statutory Provisions
7
While this appeal can be decided solely on s. 8, the rationale for the
decision is aided by the reference to portions of ss. 9 , 18 and 20 of the Act
which, for convenience, are reproduced below.
8. (1) In computing a taxpayer’s
income for a taxation year from an office or employment, 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:
.
. .
(f) where the taxpayer was employed in the year in connection
with the selling of property or negotiating of contracts for the taxpayer’s
employer, and
(i) under the contract of employment was required to pay the
taxpayer’s own expenses,
(ii) was ordinarily required to carry on the duties of the
employment away from the employer’s place of business,
(iii) was remunerated in whole or part by commissions or other
similar amounts fixed by reference to the volume of the sales made or the
contracts negotiated, and
(iv) was not in receipt of an allowance for travel expenses in respect
of the taxation year that was, by virtue of subparagraph 6(1)(b)(v), not
included in computing the taxpayer’s income,
amounts expended by the taxpayer in the year for the purpose of
earning the income from the employment (not exceeding the commissions or
other similar amounts referred to in subparagraph (iii) and received by the
taxpayer in the year) to the extent that those amounts were not
(v) outlays, losses or replacements of capital or payments on
account of capital, except as described in paragraph (j),
.
. .
(j) where a deduction may be made under paragraph (f), (h)
or (h.1) in computing the taxpayer’s income from an office or employment
for a taxation year,
(i) any interest paid by the taxpayer in the year on borrowed money
used for the purpose of acquiring, or on an amount payable for the acquisition
of, property that is
(A) a motor vehicle that is used, or
(B) an aircraft that is required for use in the performance of the
duties of the taxpayer’s office or employment, and
(ii) such part, if any, of the capital cost to
the taxpayer of
(A) a motor vehicle that is used, or
(B) an aircraft that is required for use in the performance of the
duties of the office or employment as is allowed by regulation;
.
. .
(2) Except as permitted by this section, no
deductions shall be made in computing a taxpayer’s income for a taxation year
from an office or employment.
.
. .
9. (1) Subject to this Part, a taxpayer’s
income for a taxation year from a business or property is the taxpayer’s profit
from that business or property for the year.
.
. .
18. (1) 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;
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of depreciation, obsolescence or
depletion except as expressly permitted by this Part;
.
. .
20. (1) 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:
(a) such part of the capital cost to the taxpayer of property,
or such amount in respect of the capital cost to the taxpayer of property, if
any, as is allowed by regulation;
(b) such amount as the taxpayer may claim in respect of a
business, not exceeding 7% of the taxpayer’s cumulative eligible capital in
respect of the business at the end of the year;
(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),
(iii) an amount paid to the taxpayer under
(A) an appropriation Act and on terms and conditions approved by the
Treasury Board for the purpose of advancing or sustaining the technological
capability of Canadian manufacturing or other industry, or
(B) the Northern Mineral Exploration Assistance Regulations
made under an appropriation Act that provides for payments in respect of the
Northern Mineral Grants Program, or
(iv) borrowed money used to acquire an interest in an annuity contract
in respect of which section 12.2 applies (or would apply if the contract had an
anniversary day in the year at a time when the taxpayer held the interest)
except that, where annuity payments have begun under the contract in a
preceding taxation year, the amount of interest paid or payable in the year
shall not be deducted to the extent that it exceeds the amount included under
section 12.2 in computing the taxpayer’s income for the year in respect of the
taxpayer’s interest in the contract,
or a reasonable amount in respect thereof, whichever is the lesser;
[Emphasis added.]
III. Judicial History
A. Tax Court of Canada, [2001] 2 C.T.C.
2162
8
Bowman A.C.J.T.C., the trial judge at the Tax Court of Canada,
distinguished earlier cases that characterized the purchase of client lists as
a capital expense. He found Bentley did not have a client list to sell because
the clients belonged to Midland Walwyn. He considered the tests summarized by
this Court in Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R.
46, and concluded the payment to Bentley was a current expense. Bowman
A.C.J.T.C. also found the interest payment was a current expense because: (a)
it was used to secure a loan for the payment to Bentley, which he had found to
be a current expense; (b) nothing about interest makes it inherently a current
or capital expense; (c) this Court had not conclusively decided interest was
either a current or a capital expense; and (d) s. 8(1) (j) did not
completely occupy the field of interest deductibility by an employee. He
classified the interest payment as a current expense under s. 8(1) (f).
B. Federal Court of Appeal, [2002] 4
C.T.C. 64, 2002 FCA 301
9
Rothstein J.A., in reversing the Tax Court decision, held the simple
lack of a proprietary interest in the list did not preclude the application of
previous client list cases. Applying those cases and the tests from Johns-Manville,
supra, he found the payment to Bentley to be a capital expense. On the
question of interest deductibility, Rothstein J.A. determined that he was
prevented from finding interest a current expense for two reasons: (1) earlier
decisions of this Court had held that interest was always a capital expense;
and (2) the Act was a complete code on the deductibility of interest. His
conclusion was that if it were not for these two reasons then, as a matter of
logic, he would have agreed the interest payment was a current expense in
accordance with the test used by the Privy Council in Wharf Properties Ltd.
v. Commissioner of Inland Revenue, [1997] 2 W.L.R. 334.
IV. Issues
10
This appeal raises the following issues:
1. Was the
payment to Bentley a current expense deductible under s. 8(1) (f) or a
payment on account of capital precluded from deduction by s. 8(1) (f)(v)?
2. Was the
interest Mr. Gifford paid on the borrowed funds a current expense deductible
under s. 8(1) (f) or a payment on account of capital precluded from
deduction by s. 8(1) (f)(v)?
V. Analysis
11
Before turning to the specific issues raised by this appeal, it is
useful to review the general scheme for allowing deductions under the Act . The
appellant taxpayer here earned income from employment and under the Act could
only make deductions, as a result of s. 8(2) , if the deduction was expressly
allowed under s. 8 .
12
If an employee meets the requirements of s. 8(1) (f)(i) to (iv),
he is then allowed to deduct any expense made for the purpose of “earning the
income from the employment”. If the expense is a payment “on account of
capital”, s. 8(1) (f)(v) removes it from the scope of expenses that can
be deducted.
13
When the source of income is a business or property as opposed to
employment, the scope of available deductions is much broader because s. 9
states that the taxpayer’s income will be the profit from the business or
property. In calculating the profit from a business or property a taxpayer can
make deductions in accordance with generally accepted accounting principles
unless precluded by some other section of the Act . Sections 18(1) (a)
and (b) are similar to the portions of s. 8(1) (f) that act as
general limits on what can be deducted. Section 18(1) (a) states that
only those expenses incurred for the purpose of gaining or producing income
from a business or property can be deducted, and s. 18(1) (b) uses
similar language as s. 8(1) (f)(v) to, among other things, preclude
deductions of payments “on account of capital”.
14
While the general rules are similar, the exceptions create differences
in the ability of taxpayers who earn their income from employment as opposed to
from business or property to claim deductions in what appear to be similar
circumstances.
15
If an employee otherwise meets the requirements of s. 8(1) (f) but
is prohibited from making a deduction because the expense is a payment “on
account of capital” within s. 8(1) (f)(v), the only exception provided
by the Act is s. 8(1) (j). This section allows for the deduction of
payments on account of capital where the item purchased is either a motor
vehicle or an aircraft in a manner similar to the capital cost allowance
deduction under s. 20(1) (a) discussed below. The employee taxpayer is
also allowed to deduct the interest paid on money borrowed to purchase either
of these items.
16
In contrast, a taxpayer earning income from business or property may be
able to deduct expenses that fall within s. 18(1)(b) pursuant to a
number of exceptions in the Act . Two of the more common exceptions are in s.
20(1) (a) and (b). Section 20(1) (a) allows a portion of
the capital cost of certain property to be deducted from this income, if the
regulations provide for a capital cost allowance in relation to that type of
property. Section 20(1) (b) provides a similar deduction for
expenditures to purchase certain intangible capital assets, such as goodwill.
Section 20(1) (c) is a specific provision that allows interest to be
deducted when it is paid on money borrowed for certain purposes.
17
That employees are treated differently than taxpayers earning income
from business or property under the Act is not novel nor readily seen as fair.
It has resulted in significant litigation when taxpayers attempted, with
limited success, to cast themselves as independent business owners as opposed
to employees to attempt to get the advantage of the more favourable
deductions.
18
If the payment to Bentley or the interest payment are payments “on
account of capital”, the appellant, as an employee, will not be able to make
any deductions from his income for these expenses. Conversely, if the
appellant was earning income from a business and not from employment, he would
likely be able to deduct both these payments in calculating his profit for the
year. This seemingly inequitable result for the appellant is the result of the
structure of the Act but cannot alter the characterization of these payments.
A. The Payment to Mr. Bentley
19
I agree with Rothstein J.A. that the purchase of client lists was not a
new consideration, and that the facts of this case did not distinguish it from
the earlier cases, making this a payment on account of capital, contrary to
Bowman A.C.J.T.C.’s finding at trial. The leading cases on characterizing the
purchase of client lists are Cumberland Investments Ltd. v. The Queen,
[1975] C.T.C. 439 (F.C.A.), and The Queen v. Farquhar Bethune Insurance Ltd.,
[1982] C.T.C. 282 (F.C.A.). In addition to the specific cases dealing with
client lists, a leading authority on whether an expense is a current expense or
a payment on account of capital is Johns-Manville, supra.
Rothstein J.A. found, and I agree, the tests in Johns-Manville support
the finding that the payment was “on account of capital”.
20
What Bentley had to sell was goodwill, developed over years of dealing
with his clients, and the agreement not to compete with the appellant. The
appellant was interested in Bentley’s relationship with his clients and not
just the names on the list. The Agreement required Bentley to provide written
endorsements of the appellant to a specific group of clients and not to compete
for them for 30 months. If the appellant only wanted access to the names of the
clients he theoretically would not have needed to involve Bentley at all and
could have dealt directly with Midland Walwyn. The fact that the transaction
occurred between two employees instead of two businesses does not, by itself,
change the characterization of the transaction or cause the earlier client list
cases to be ignored.
21
Under the tests outlined in Johns-Manville, supra, the
client list was a capital asset for a number of reasons. It significantly
expanded Mr. Gifford’s client network, the structure within which he earned his
employment income. The purchase of someone else’s accumulated goodwill is not
the same as the recurring marketing expenses the appellant would have had to
incur to create his own goodwill. As well this payment secured the
discontinuance of competition. Finally, it was a payment made with the
intention of securing an asset of enduring benefit that would provide Mr.
Gifford with a lasting advantage.
22
The trial judge found that this payment did not result in the
acquisition of an enduring asset because “[c]lients are fleeting, volatile and
evanescent” (para. 13). The fact that, if not properly cared for, the asset
may decrease in value cannot determine the question of what the asset was to
the purchaser at the time of acquisition. A building purchased as a rental
property does not lose its characterization as a capital asset if it burns down
the day after the sale closes. The goodwill and the agreement not to compete
amounted to a capital asset to Mr. Gifford. The payment for this asset was a
payment “on account of capital” which could not be deducted from his income
because of s. 8(1) (f)(v).
B. Interest
23
The question under the second issue is whether the interest paid by the
appellant on the money he borrowed to purchase Bentley’s client list is
deductible. As discussed above, an expense can be deducted by an employee
under s. 8(1) (f) if it is made for the purpose of earning income from
his employment and is not a payment “on account of capital” that would be
precluded from deduction by s. 8(1) (f)(v).
24
To determine whether the interest paid by Mr. Gifford was “on account of
capital” it is necessary to consider three subsidiary issues: (1) whether this
Court has declared the payment of interest is always a payment “on account of
capital”; (2) whether the Act provides a complete code to interest
deductibility; and (3) what test should be used to classify an interest payment
for the purposes of the Act .
(1) Has This Court Held That an Interest
Payment Is Always a Payment “On Account of Capital”?
25
This case is an opportunity to address the question as the appellant was
an employee and therefore not able to rely on s. 20(1)(c) to make a
deduction if this interest payment is held to be “on account of capital”.
Rothstein J.A. considered this question at para. 35:
In my respectful opinion, the Tax Court Judge erred
in law when he concluded that he was not precluded by Supreme Court
jurisprudence from treating interest as a current expense in this case. As I
read the relevant decisions, in the absence of statutory provisions permitting
the deduction of interest, interest is considered a non‑deductible
capital expenditure. [Emphasis added.]
It may be
doubtful that the authorities support a statement as broad as that. The cases
referred to by him were primarily concerned with whether the interest payment
in question could be deducted under s. 20(1)(c) and the comments made
with respect to interest in general must be read in that light.
26
Interest has not been held to always be a capital expense. The position
in Canada is that loan proceeds are usually additions to the financial capital
of the borrower and interest is usually a payment on account of that financial
capital. Because interest payments are usually payments “on account of
capital”, they are precluded from deduction either by s. 8(1) (f)(v) or
by s. 18(1)(b).
27
In Bennett & White Construction Co. v. Minister of National
Revenue, [1949] S.C.R. 287, Rand J. recognized that the proceeds of
a loan added to the capital of the borrower. See pp. 292-93:
The acquisition of capital may be by various
methods including stock subscriptions, permanent borrowings through issues
of securities, or term loans; and ordinarily it should make no
difference in taxation whether a company carried on financially by one means or
another. In the absence of statute, it seems to be settled that to bring
interest paid on temporary financing within deductible expenses requires that
the financing be an integral part of the business carried on. That is
exemplified where the transactions are those of daily buying and selling of
securities: Farmer v. Scottish North American Trust [[1912] A.C.
118]; or conversely lending money as part of a brewery business: Reid’s
Brewery v. Mail [[1891] 2 Q.B. 1]. [Emphasis added.]
28
In this case we must analyse the foundation upon which Rothstein J.A.
relied in stating that this Court has held that interest is always a capital expense.
Rand J.’s reasons in Canada Safeway Ltd. v. Minister of National Revenue,
[1957] S.C.R. 717, are used to support that proposition. The interest in that
case was not deductible because it was found to be an expense incurred to earn
exempt income and therefore precluded from deduction by the Act at the time.
In a concurring judgment, Rand J. made this comment about the deductibility of
interest, at p. 727:
It is important to remember that in the absence
of an express statutory allowance, interest payable on capital indebtedness is
not deductible as an income expense. If a company has not the money
capital to commence business, why should it be allowed to deduct the interest
on borrowed money? The company setting up with its own contributed capital
would, on such a principle, be entitled to interest on its capital before
taxable income was reached, but the income statutes give no countenance to such
a deduction. To extend the statutory deduction in the converse case would add
to the anomaly and open the way for borrowed capital to become involved in a
complication of remote effects that cannot be considered as having been
contemplated by Parliament. What is aimed at by the section is an employment
of the borrowed funds immediately within the company’s business and not one
that effects its purpose in such an indirect and remote manner. [Emphasis
added.]
29
A review of the first sentence demonstrates that Rand J. did not hold
that interest could never be deducted in the absence of a specific statutory
provision but, with his reference to capital indebtedness, limited his
statement to interest on money borrowed for use as capital.
30
The next case raising the same issue is Bronfman Trust v. The Queen,
[1987] 1 S.C.R. 32. In that case this Court was asked to determine whether
interest on money borrowed to make a capital distribution from a trust could be
deducted under s. 20(1)(c). Before he analysed that particular issue
Dickson C.J. made a preliminary comment about the deductibility of interest.
At p. 45, he stated:
It is perhaps otiose to note at the outset that in
the absence of a provision such as s. 20(1)(c) specifically authorizing
the deduction from income of interest payments in certain circumstances, no
such deductions could generally be taken by the taxpayer. Interest expenses
on loans to augment fixed assets or working capital would fall within the
prohibition against the deduction of a “payment on account of capital” under s.
18(1)(b): Canada Safeway Ltd. v. Minister of National Revenue,
[1957] S.C.R. 717, at pp. 722‑23 per Kerwin C.J. and at p. 727 per
Rand J. [Emphasis added.]
31
Dickson C.J. made it clear that when the proceeds of a loan added to the
financial capital of the borrower, the interest on that loan would be
considered a payment “on account of capital”. Iacobucci J. followed this line
of reasoning in Tennant v. M.N.R., [1996] 1 S.C.R. 305, at para. 16:
In my opinion, s. 20(1)(c)(i) is not ambiguous.
It clearly states that interest can be deducted as an expense when the interest
is paid or payable in the taxation year pursuant to a legal obligation to pay
interest, and when the interest is payable on money borrowed for the purpose of
earning income from a business or property. The purpose of the interest
deduction provision is to encourage the accumulation of capital which would
produce taxable income, as Dickson C.J. noted in Bronfman Trust, supra,
at p. 45. But for s. 20(1)(c)(i), the deduction of interest payments
would be prevented by s. 18(1)(b) (Canada Safeway Ltd. v. Minister of
National Revenue, [1957] S.C.R. 717; some commentators suggest that
Canada Safeway is wrongly decided; see P. W. Hogg and J. E. Magee, Principles
of Canadian Income Tax Law (1995), at p. 221, note 36; however, I need not
address that issue in these reasons). [Emphasis added.]
32
By stating that the purpose of s. 20(1)(c) is to encourage the
accumulation of capital before referring to the interest precluded from deduction
by s. 18(1)(b), it seems clear that Iacobucci J. held only that interest
on money that adds to the capital of the borrower is prevented from being
deducted. The case cannot be used to support the position that, as a result of
s. 18(1)(b), interest payments are never deductible. In Shell Canada
Ltd. v. Canada, [1999] 3 S.C.R. 622, McLachlin J. (as she then was)
continued to follow the line of authority that began in Canada Safeway, supra.
At para. 28, she stated:
Section 20(1)(c)(i) allows taxpayers to
deduct from their income interest payments on borrowed money that is used for
the purpose of earning income from a business or property. It is an
exception to s. 9 and s. 18(1) (b), which would otherwise prohibit the
deduction of amounts expended on account of capital, i.e., interest on borrowed
funds used to produce income: Canada Safeway Ltd. v. Minister of
National Revenue, [1957] S.C.R. 717, at pp. 722‑23, per Kerwin
C.J., and at p. 727, per Rand J.; Bronfman Trust v. The Queen,
[1987] 1 S.C.R. 32, at p. 45, per Dickson C.J. [Emphasis added.]
At paragraph
74, she again referred to Canada Safeway:
Furthermore, it is important to underline that interest expenses on
money used to produce income from a business or property are only deemed
by s. 20(1)(c)(i) to be current expenses and, in the absence of that
provision, would be considered to be capital expenditures: Canada Safeway,
supra, per Rand J., at p. 727. This Court was not invited on
this appeal to revisit this characterization of such interest expenses:
they therefore remain capital expenses which s. 20(1)(c)(i) deems to be
deductible from Shell’s gross income notwithstanding the general prohibition of
such capital deductions in s. 18(1). [First emphasis in original; second
emphasis added.]
33
Shell was a case where the focus was not on whether the deduction
was prohibited by s. 18(1)(b) but on whether, if it was prohibited, it
could nevertheless be deducted under s. 20(1)(c).
34
McLachlin J. stated that the Court was not asked to consider how
interest payments should be characterized. Even in this context she did not
state that all interest payments would be “on account of capital”. In both
passages she refers to interest on borrowed funds used to produce income and
in the second passage simply extends this by adding “from a business or
property”.
35
In the current appeal we have been asked to consider directly the issue
of when interest is deductible. The above review of the cases McLachlin J.
relied upon in Shell indicates the important question is not whether the
payment is a capital expenditure but whether it is “on account of capital”, a
distinction that is explored further below. It also indicates that even the
limited statement in Shell that all payments of interest on borrowed
money used to produce income will be payments “on account of capital” is too
broad. While this will usually be the result, each case requires an analysis
of what the funds are to the borrower at the time of receipt.
36
To summarize, the decisions of this Court have not held that interest is
always a capital expense, but have consistently found that when the proceeds of
the loan add to the financial capital of the borrower any interest paid on that
loan will be considered a payment “on account of capital”. This distinction
becomes more important when one examines the tests used to characterize
interest expenses in other jurisdictions, which is considered below.
(2) Does the Act Provide a Complete Code on
the Deductibility of Interest?
37
I do not agree with Rothstein J.A. that the Act is a complete code on
interest deductibility. The Minister submitted to this Court that the Act was
a complete code for the deductibility of interest as interest payments can only
be deducted if they meet the requirements of specific sections of the Act such
as s. 8(1) (j) or s. 20(1) (c). It is evident from the manner in
which the Canada Customs and Revenue Agency (now Canada Revenue Agency) allows
moneylenders to deduct interest payments, without reliance on any specific
section of the Act , when they are calculating profits for the purposes of
determining their income for the year under s. 9 that they have not adhered to
this position in the past. In circumstances where interest is not a payment
“on account of capital”, it may be deducted as long as it meets the other
requirements, such as those set out in s. 8(1) (f) or s. 18(1) (a),
and is not precluded by some other section of the Act .
(3) What Test Should Be Used to Classify an
Interest Payment for the Purposes of the Act ?
38
There are a number of ways to characterize the payment of interest. The
method adopted by Bowman A.C.J.T.C., which looked at the purpose the proceeds
of the loan were being used for, is in accordance with general accounting
principles and logic. In Steele v. Deputy Commissioner of Taxation (1999),
161 A.L.R. 201, the Australian High Court adopted a test that results in
interest almost always being a current expense. In Wharf Properties, supra,
the Privy Council adopted a test that looked at what the loan proceeds were
being used for at the point in time when the interest was paid. While these
tests are not all the same, they have one underlying feature that significantly
reduces their application to determining the deductibility of interest in
Canada. They are all concerned with determining whether each payment of
interest is an “expenditure of a capital nature” (Wharf Properties, supra),
or an “outgoing of a capital nature” (Steele, supra), neither of
which answers the question which is relevant for Canadian purposes of whether
it was a payment “on account of capital”. In attempting to determine if the
expenditure or outgoing was of a capital nature, as required by the relevant
statutes, other jurisdictions have looked to what the loan proceeds were spent
on. Under the current wording in our Act this is not necessary, as we are only
concerned with whether the payment is “on account of capital”.
39
Under our current Act it is not necessary to determine whether the
payment is a capital expenditure but to determine whether the payment is being
made “on account of capital”. This distinction in terms is particularly
important in relation to interest payments, because loan proceeds are seldom
retained in the form they are received, unlike other capital assets. This
distinction means that under our Act it is only necessary to consider what the
proceeds of the loan are to the borrower when they are received, and does not
require an examination of what those loan proceeds are spent on. If the money
adds to the financial capital then the payment of interest on that loan will be
considered to be a payment “on account of capital”. If the loan proceeds
constitute the inventory of the borrower, as is the case with moneylenders,
then the payment of interest would be deductible. Lord Hoffmann in Wharf
Properties, supra, discussed how loan proceeds can be different
things to the borrower, at p. 339:
This decision does not seem to their Lordships to help Mr. Gardiner at
all. It is directed to a different question, namely whether the sum borrowed
constitutes an addition to the company’s capital or is a revenue receipt.
In other words, it looks at the nature of the loan in the hands of
the recipient rather than the question of whether a payment of interest is a
capital or revenue expense. It is unusual for a loan of money to constitute a
revenue receipt but this can be the case if borrowing money is “part of the
ordinary day to day incidence of carrying on the business” (per Lord
Templeman in the Beauchamp case, at p. 497) which may be the case
in businesses of banking, financing or otherwise dealing in money: see
Farmer v. Scottish North American Trust Ltd. [1912] A.C. 118. Ordinarily,
however, a loan to a trading company, whatever the purpose for which it is
intended to be used, will be an addition to that company’s capital. Mr.
Gardiner did submit that the shortness of the successive terms of the loans in
this case was enough to make them revenue receipts, but their Lordships do not
agree. The borrowing did not form part of the company’s trading activities.
While it or a replacement loan remained in place it was an addition to Wharf’s
capital: compare European Investment Trust Co. Ltd. v. Jackson (1932) 18
T.C. 1. [Italics in original; underlining added.]
40
As earlier pointed out, loan proceeds are usually thought of as
additions to the financial capital of the borrower. This view makes it
necessary to deal briefly with the wording at the beginning of both s. 8(1) (f)(v)
and s. 18(1)(b) that prohibits the deduction of “outlays . . . of
capital”. A literal reading of this phrase could render every expenditure that
could not be directly traced to revenue non-deductible as an outlay of
capital. This has not been the approach under these sections in the past, and
the analysis should continue to look at what is acquired rather than examining
where the money to make the payment originates.
C. Costs
41
Under s. 18.25 of the Tax Court of Canada Act , the Minister must
pay the reasonable and proper costs of the taxpayer when it seeks to judicially
review a decision made under the informal procedure.
18.25 Where the Minister of National Revenue
makes an application under section 28 of the Federal Court Act to review
and set aside a judgment referred to in section 18.24 , the reasonable and
proper costs of the taxpayer in respect of the application shall be paid by Her
Majesty in right of Canada.
The purpose of
s. 18.25 is to ensure the Minister bears the costs of the appeal process once
he begins it. Accordingly, the costs in the courts below are confirmed and the
appellant is awarded his reasonable and proper costs in this Court.
VI. Conclusion
42
The Agreement to pay $100,000 to purchase accumulated goodwill and the
agreement not to compete were made to create an enduring benefit for the
appellant taxpayer Gifford and therefore the payment was “on account of
capital”. The interest payment in this case, under current Canadian law, was
also a payment “on account of capital”, because the funds, borrowed to make the
payment to Bentley, themselves added to the financial capital of the
appellant. As both payments in question were “on account of capital”, s. 8(1) (f)(v)
prevents a deduction from being made for either expense. This appeal is
dismissed. The reasonable and proper costs in this Court are to be paid to the
appellant by the respondent. The costs awarded in the lower courts are upheld.
Appeal dismissed with costs.
Solicitors for the appellant: McMillan Binch, Toronto.
Solicitor for the respondent: Deputy Attorney General of Canada,
Ottawa.
Solicitors for the intervener: Osler, Hoskin & Harcourt,
Toronto.
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