The Queen v. Thyssen Canada Ltd., 87 DTC 5038, [1987] 1 CTC 112 (FCA)

Pratte, J.:—This is an appeal from a judgment of Rouleau, J. of the Trial Division allowing with costs the respondent's appeal from income tax reassessments made by the Minister of National Revenue in respect of the respondent's 1973, 1974 and 1975 taxation years.

It is common ground that the trial judge erred in allowing the respondent's appeal in respect of the 1975 taxation year since the respondent's counsel had clearly stated, at the outset of the trial, his intention to abandon the appeal in so far as it was directed against the reassessment for that year.

The issue on the appeal is whether the respondent, in computing its income for 1973 and 1974, was prohibited by subsection 18(4) of the Income Tax Act from deducting part of certain payments that it had made to its German parent company.* [1]

The respondent is a corporation which, at all material times, was resident in Canada and controlled by Thyssen Stahlunion GmbH of West Germany. Its business was the import and export of steel. It did not carry any inventory. Once it had secured a purchase order from a customer, it ordered the steel from its parent company upon terms that the property of the steel would pass to the respondent at a specified port of destination in Europe and that the price would be due upon delivery in Canada. The price, however, was never paid at that time; the respondent waited for paying until it had received payment from its customer. That is why it had to pay "late payment charges” to its parent company. The amount of those charges, for which the respondent was invoiced by its parent company immediately after it had received payment of a shipment of steel, was calculated at the current market rates of interest on the outstanding balance of the purchase price.

The price of the steel sold by the respondent to its customers was not payable on delivery. The respondent had few customers and knew their payment habits. The date of payment was, in each case, fixed accordingly and the price was adjusted so as to include financing charges up to the expected date of payment. As the respondent normally paid its parent company as soon as it had received payment from its customers, the amount of those financing charges roughly corresponded to the late payment charges that the respondent then anticipated to have to pay to its parent company.

In computing its income for the 1973 and 1974 taxation years, the respondent, as it obviously had to, included the payments received from its customers which, as I have said, comprised an amount for financing charges; on the other hand, the respondent deducted the late payment charges paid to its parent company. The Minister, in reassessing the respondent, disallowed those deductions to the extent of $468,333 for 1973 and $20,779 for 1974 on the ground that the deduction of those amounts was prohibited by subsection 18(4). The respondent appealed to the Trial Division. Rouleau, J. allowed the appeal and set aside the Minister’s reassessments on the ground that the late payment charges were not amounts to which subsection 18(4) applied.

At the trial, respondent's counsel conceded that, assuming that subsection 18(4) applied to the payments in question, the Minister had correctly calculated the portion of those payments that could not be deducted. He also conceded that the late payment charges paid by the respondent to its German parent company had been paid to a "specified non-resident" within the meaning of subsection 18(4). It followed that the question to be resolved was whether the late payment charges in question were "interest" within the meaning of the subsection.

The trial judge answered that question in the negative. He gave two reasons for that answer: first, that the late payment charges were "incorporated into the actual costs and/or selling price of the goods" and, second, that to hold otherwise "would go beyond the objective of the Act” since the denial of the deduction of the late payment charges “would be tantamount to double taxation".

I am not convinced by those reasons. The late payment charges had all the characteristics of interest.* [2] The record shows clearly, and I do not think that Rouleau, J. found otherwise, that, as between the respondent and its parent company, the late payment charges were not included in the price of the steel sold to the appellant.! True, the record also discloses that, as found by the judge, the respondent, in fixing the price at which it would sell to its customers, quite normally considered those late payment charges as part of its costs. However, this could not change the nature of the charges payable to the parent company; the nature of those charges was determined by the agreements entered into by the respondent and its parent company and could not be changed unilaterally by the respondent.

I do not find the judge's second reason more persuasive than the first one. The denial of the right to deduct the late payment charges clearly resulted in the respondent having to pay more tax. However, it did not result in double taxation or in anything resembling double taxation since, as a consequence of that denial, the respondent did not and will not have to pay tax twice on the same income.

Counsel for the respondent made two further submissions in support of the conclusion of the trial judge. First, Mr. Sweeney contended that the rules prescribed by subsection 18(4) do not apply to current trade accounts which are paid within normal commercial trade terms. This view cannot, in my opinion, be reconciled with the plain words of the subsection and, for that reason, must be rejected.

The second submission was made by Ms. Krasa. It is based on the assumption that, according to the general rules governing the computation of income, a taxpayer who paid interest to acquire an inventory may always, instead of claiming that interest as a deductible expense, choose to capitalize it by adding it to the costs of the inventory so as to deduct it in the year in which the inventory is sold. When interest is paid which cannot, pursuant to subsection 18(4), be deducted as an expense, subsection 18(7) specifies that that interest cannot be capitalized pursuant to section 21. It follows, says counsel, that when the deduction of interest is forbidden by subsection 18(4), it is only the capitalization that could be made pursuant to section 21 in the circumstances described in that section that is prohibited; the capitalization of interest that is not authorized by section 21 can therefore be made even if the deduction of that interest is prohibited by subsection 18(4). As section 21 clearly has no application in this case, counsel concludes that the respondent could, instead of claiming the late payment charges as deductible expenses, add them to the costs of the goods purchased and deduct them when the goods are sold.

That submission is based on the wrong assumption that interest may, in all cases, be capitalized. Section 21 expressly authorizes the capitalization of interest in certain circumstances and, for that reason, Parliament thought it necessary to enact subsection 18(7). The capitalization of interest may also be permissible in other circumstances that are not specified in the Act, in accordance with generally accepted accounting principles, provided, however, it does not result in a contravention of a provision of the Act. Generally accepted accounting principles cannot, therefore, be invoked as authorizing the capitalization of interest payments the deduction of which is expressly prohibited by the statute. One cannot defer the deduction of an expense that is not deductible.

I would allow the appeal, set aside the judgment of the Trial Division and, rendering the judgment that should have been pronounced by the Trial Division, I would dismiss the respondent's appeal from the income tax assessments made by the Minister of National Revenue in respect of the respondent's 1973 and 1974 taxation years. I would order the respondent to pay the appellant’s taxable costs both in this Court and in the Trial Division.

Appeal allowed.