The Queen v. Antoine Guertin Ltée, 88 DTC 6126, [1988] 1 CTC 360, [1988] 1 CTC 117, [1987] DTC 5458 (FCA)

Marceau, J. [Translation] : —This appeal, brought on behalf of Her Majesty, is against a judgment of the Trial Division which vacated the assessments of the respondent company made by the Minister of National Revenue for the 1970, 1971 and 1972 taxation years. It raises two questions which are both of the same type, as in each case the question is whether a certain expense appearing on the company's balance sheet was deductible in computing its taxable income, but which have nothing else in common, nor do they cover the same years. There are thus two parts to the appeal, which can only be dealt with independently of each other.

I

The first part of the appeal covers the three years, and the expense the deduction of which is at issue was incurred to pay life insurance premiums. The facts are straightforward. In 1969 the respondent company — a Quebec family company engaged in the manufacture of feed and raising of turkeys in St-Pie, a village near Montreal — borrowed $300,000 from the Industrial Development Bank to purchase a piece of land and construct buildings to be used in expanding its operations. Among the many securities required by the Bank was the following:

The transfer of a sum of insurance on the lives of Messrs Jacques Guertin ($200,000) and Emile Cordeau ($100,000), this insurance to be held either by the company and payable to it or by Messrs Guertin and Cordeau and payable to their estates or to the company.

To meet this requirement the company obtained two $100,000 insurance policies on the life of Jacques Guertin, who was its president, and transferred them to the Bank. They were whole life policies with a surrender value and dividend option, and the annual premiums totalled $4,022, $2,011 for each one. In computing its taxable income for each of the next three years, the company used this transaction to include the sum of $1,090 in its expenses, representing what it considered would be the annual premiums it would have paid if, instead of whole life policies, it had only purchased temporary policies as it had done to meet the Bank's requirement for a Mr. Cordeau. The Minister challenged this procedure but the trial judge ruled against him, and the Deputy Attorney General submitted on behalf of Her Majesty that the learned judge was in error.

The old Income Tax Act and the new one which replaced it in 1972 are both involved in view of the years in question, but the provisions directly applicable are to the same effect in each one. In the old Act, R.S.C. 1952, c. 148, the sections concerned are 11 (l)(cb)(ii) and 12(l)(b) :

Deductions Allowed in Computing Income

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

(cb) an expense incurred in the year,

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt) . . .

Deductions Not Allowed in Computing Income

12. (1) In computing income, no deduction shall be made in respect of

(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. . .

In the current Act, S.C. 1970-71-72, c. 63, the sections are 18(1)(b) and 20(1)(e)(ii):

DEDUCTIONS

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(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:

(e) an expense incurred in the year,

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt) . . .

The Deputy Attorney General of course argued that the special and exceptional deduction allowed by subparagraph 11(1)(cb)(ii) of the old Act and 20(1)(e)(ii) of the new was inapplicable because the cost of purchasing the two life insurance policies with surrender value was not “an expense incurred in the course of borrowing money", and he relied in this regard on the authority of the decision of the Exchequer Court in Equitable Acceptance Corporation Limited v. M.N.R., [1964] C.T.C. 74; 64 D.T.C. 5045. The respondent argued that Cattanach, J.'s judgment in that case did not support the contention of the Deputy Attorney General. The trial judge, it said, clearly explained the scope of that judgment when he wrote: "Cattanach, J. ruled that premiums for an insurance policy on the life of the plaintiff company's president were not deductible, precisely because this was permanent insurance which was not restricted to the term of the loan but covered the entire life of the insured, with a surrender value". It was precisely in order to take account of the judgment in Equitable Acceptance Corporation, the respondent explained, that it deliberately refrained from claiming the total premium it had paid; but it was quite understandable that it should deduct what it would have spent if it had purchased only a temporary policy for the duration of the loan. To this the Deputy Attorney General responded that while it is true that if the insurance obtained had only been temporary, deduction of the premium could have been approved (as it was in the case of the policy obtained on the life of Mr. Cordeau), the fact remains that this is not what was done.

I should say first that I have some difficulty understanding how the scope of the judgment in Equitable Acceptance Corporation can be limited to cases in which the life insurance obtained and transferred is whole life insurance. In my opinion, Cattanach J.'s reasoning is entirely contained in this paragraph from his reasons:

In my view the cost of the purchase of the two life insurance policies and the maintenance in force thereof by the payment of premiums is not an expense incurred in the year in the course of borrowing money used by the taxpayer for the purpose of earning income from a business. While it is true that the purchase of these life insurance policies and their assignment to Triarch was a condition imposed by Triarch before making the loan to the appellant, nevertheless the true nature of the transaction was that the appellant acquired an asset which could be used, and was in fact used, as a collateral security necessary to borrow money to be used in its business. In short, the appellant, by the purchase of the two insurance policies, merely enhanced its position as a reliable lending risk.

It seems to me that this reasoning applies just as much to the case of temporary insurance as to that of whole life insurance. The right of the insured under a temporary life insurance contract is an "asset" in the sense in which the word is used by Cattanach, J., that is, a usable security from which a benefit can be obtained, or valuable property, in the same way as the right conferred on an insured by a "permanent" life insurance contract, even though the asset is of a lower value and its transformation into cash is of course only a contingency. Cattanach J.'s judgment has often been treated as based simply on an interpretation of the phrase “in the course of” contained in the wording of the applicable provision, the judge being of the view that the expense was prior to the loan and not “in the course of borrowing” (cf Côté-Reco Inc. v. M.N.R., [1980] C.T.C. 2019; 80 D.T.C. 1012). On the contrary, the reasoning appears to me to go much further than that. I understand it to mean that, in order to speak strictly and accurately of an expense incurred in the course of a loan, the expenditure must as such have had no consideration other than the loan, or in other words, it must be an expenditure resulting in a diminution of the borrower's property. The property right represented by temporary insurance is the premium paid in another form with an equivalent value, and no diminution could possibly result in the property of the insured.

It is true that, in his reasons, Cattanach, J. went on to say, in a paragraph subsequent to the one just cited, the following:

If the insured, Emil E. Schlesinger, had died while the policies were in force and before the repayment of the loan, the appellant would then be in the position of the loan being fully paid from the proceeds of the insurance policies and the amount of the loan received by the appellant would become part of the appellant's assets without any corresponding debit entry. Again if the proceeds were in excess of the amount required to repay the loan, then any such excess would have accrued to the appellant's assets. Further when the loan was repaid, as it was, there was nothing to prevent the appellant from securing another loan from the same or a different source on the strength of the security of the two life insurance policies, if the necessity arose.

In my view, however, in so doing the judge added nothing to his reasoning and merely elucidated the various aspects of the “asset” represented by the policies at issue in the case before him. I know that this paragraph (in particular, I take it, because of what he said in the last sentence) seems to have given rise to a limiting interpretation of his judgment, an interpretation which the Department even adopted in its Interpretation Bulletin IT-309R of January 10, 1979. I would still, with respect, dispute the legitimacy of this reaction. In my view the reasoning underlying Equitable Acceptance Corporation applies just as much to temporary insurance for the duration of the loan as to insurance which will continue beyond it, and it is a reasoning which appears to me to be unimpeachable.

I have taken the time to examine the question of whether temporary insurance could more adequately meet the conditions for application of subparagraphs 11 (1)(cb)(ii) and 20(1)(e)(ii) of the Act than permanent insurance because it was the focus of the parties' concerns and the basis of their arguments. I think nevertheless that strictly speaking, in the circumstances of the case at bar, it is not necessary for the Court to adopt a final position on the point as, even assuming that a difference in treatment between permanent and temporary insurance is warranted, there is still the response of the Deputy Attorney General that, in any case, here the company obtained not temporary but permanent insurance, and I think this response is conclusive. Quite recently, once again, in Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32; [1987] 1 C.T.C. 117, the Supreme Court restated the rule that in a tax matter what must be considered is what was done, not what might have been done. The following is an extract from the reasons of the Chief Justice, speaking for the Court, at 54 (C.T.C. 129):

Before concluding, I wish to address one final argument raised by counsel for the trust. It was submitted — and the Crown generously conceded — that the trust would have obtained an interest deduction if it had sold assets to make the capital allocation and borrowed to replace them. Accordingly, it is argued, the trust ought not to be precluded from an interest deduction merely because it achieved the same effect without the formalities of sale and repurchase of assets. It would be a sufficient answer to this submission to point to the principle that the courts must deal with what the taxpayer actually did, and not what he might have done: Matheson v. The Queen, 74 D.T.C. 6176 (F.C.T.D.), per Mahoney, J., at p. 6179.

I think that the first part of the appeal is definitely valid.

II

The second part of the appeal relates to a single taxation year, 1972. Though like the preceding case this one again involves a disallowed expense, the question raised is much more difficult to define, as it is rooted in a somewhat complex series of facts. However, in view of the conclusion I intend to adopt, it will not be necessary for me to go into any detail. Broadly speaking, the matter is as follows.

The respondent company was established by Antoine Guertin, the father of Jacques, who was its president in 1972. Antoine Guertin had also created a foundation whose funds were to be used for religious purposes. This foundation received gifts primarily from the respondent company and its employees; it loaned the amounts received to the respondent company in return for interest and donated this interest for use in missionary work.

In its tax returns, for the purpose of computing its 1972 income tax, the company first reported a gift of $12,400 to the foundation, and then the payment to all its employees without exception of large annual bonuses a third of which, $39,155 out of $111,600, was never received by the employees but was simply represented by cheques endorsed to the foundation. The Minister refused to allow both the deduction of the $12,400 gift and that of the part of the bonuses paid to the foundation, on the ground that these deductions, if allowed, would unduly or artificially reduce the company's income contrary to subsection 245(1) of the Act.

The trial judge dismissed the Minister’s arguments. His understanding of the evidence led him to conclude that the sum of $12,400 paid to the foundation by the respondent represented a true gift and that of $39,155 had in fact been paid to the employees in the form of bonuses, although they agreed with Antoine Guertin that it should be paid to his foundation. In the judge's opinion, there had been no deceit.

The appellant's counsel no longer disputes that the $12,400 gift was really a gift. However, he argues that the judge erred in allowing deduction of the sum of $39,155. This, he said, had not really been paid to the employees in the form of bonuses, it was paid to them on the basis and subject to the condition that they pay it to the foundation, so that it was in fact a gift made by the respondent to the Foundation through intermediaries and this gift could not be deducted in addition to that of the $12,400, since the latter was the maximum deductible under paragraph 110(1)(a) of the Act.

This argument by counsel for the appellant of course rests on a basic assumption, that the sum of $39,155 would not have been distributed to the employees if they had not previously agreed to pay it to the foundation as Antoine Guertin asked them to do. However, the respondent's president Jacques Guertin testified to the contrary, and asserted that the amount of each employee's bonus was set by the management committee without intervention by Antoine Guertin, and regardless of whether the employee in question had agreed to make a gift to the foundation. The trial judge clearly could not have decided as he did unless he believed this part of Jacques Guertin's testimony. It seems to me, after reading and re-reading the evidence, that I would have been inclined to take a more critical view of the testimony, but I cannot say that the judge made a manifest error in believing it. That being so, I also cannot say that he erred in deciding as he did. Once it is admitted that the amount of the bonuses was set in the way described by Jacques Guertin, it cannot be concluded that a part of these bonuses represented a disguised gift made to the foundation by the respondent. Accordingly, the appellant cannot succeed on the second part of the action.

I therefore conclude that the appeal should be allowed and the assessments restored as to the disallowing of deductions in the amount of $1,090 for insurance premiums for each of the years 1970, 1971 and 1972, but should be dismissed as to the payment of bonuses to the employees. In view of the mixed outcome, I would let each party pay its costs.

Appeal allowed in part.