Canwest Broadcasting Ltd. v. The Queen, 96 DTC 1375, [1995] 2 CTC 2780 (TCC)

McAarthur J.T.C.C.:—These appeals heard in Toronto, Ontario, are in respect of the appellant’s 1982, 1983, 1984, 1985, 1986 and 1991 taxation years.

At issue is the deductibility of interest expense and guarantee fees in the amounts of $4,246,884 (interest) and $502,546 guarantee fees in 1985 and $767,887 interest and $22,454 and $10,620 guarantee fees in 1986. The appellant seeks to deduct these substantial sums incurred through a complex financial plan entered into which utilized the losses of a non-related corporation.

Issues as set out by the parties are:

1. Whether the interest expense in respect of the appellant’s 1985 and 1986 taxation years is deductible in accordance with paragraph 20(1 )(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act”).

2. Whether the guarantee fees in respect of the appellant’s 1985 and 1986 taxation years are deductible in accordance with section 9 of the Act and are not denied under paragraph 18(1 )(a) or (b) of the Act.

3. Whether the guarantee fees in respect of the appellant’s 1985 and 1986 taxation years are deductible in accordance with paragraph 20(1 )(e) of the Act.

4. Whether the guarantee fees and interest expense claimed as deductions were outlays or disbursements that would artificially or unduly reduce the appellant’s income and therefore prohibited as deductions pursuant to subsection 245(1).

5. Whether the amounts reported as dividends and deducted under subsection 112(1) were interest and were required to be included in the appellant’s income under paragraph 12(1 )(c) and section 9, and whether any deduction of the amounts under subsection 112(1) was applicable in computing the appellant’s taxable income.

Facts

The appellant is a corporation incorporated pursuant to the laws of the Province of Manitoba. During the 1984 and 1985 taxation years, the appellant undertook a series of transactions which resulted in non-capital losses in its 1985 and 1986 taxation years. Pursuant to paragraphs 11 l(l)(a) and 111(8)(b) of the Act, it carried back these non-capital losses to offset income in 1982, 1983 and 1984, and carried forward these losses to offset income in 1991.

The companies involved in the series of transactions can be grouped as follows:

Can west Related Companies:

Canwest Capital Corporation ("CCC") Canwest Financial Holdings Limited ("CFHL") Canwest Broadcasting Limited (the "appellant") 602744 Ontario Inc. ("602744")

FCPL (Charne) Related Companies:

TLC Holdings Limited ("TLC") 606734 Ontario Limited ("606734") 606735 Ontario Limited ("606735") First Commercial Properties Limited ("FCPL")

The Canwest Companies were unrelated to the FCPL (Charne) Companies.

Commencing in early 1983, the appellant, through its officers Mr. I.H. Asper and Mr. S. Gross commenced discussions with Mr. Charne of FCPL relating to the possible acquisition by the appellant of an interest in FCPL which was in the business of developing, owning and managing commercial real estate, primarily shopping centres in western Canada.

The discussions met an impasse primarily because FCPL (Mr. Charne) was not prepared to grant the equity and control of his company sought by the appellant and the sale price quoted by FCPL for its shares was almost double what the appellant appeared to be prepared to pay. In 1983 and particularly in the early fall 1984, FCPL was in a desperate financial position and was in immediate danger of going into receivership or bankruptcy as a result of action threatened by the Toronto-Dominion Bank to collect the approximate $1.2 million owed to it by FCPL.

FCPL and the Toronto-Dominion Bank arrived at a settlement reducing the debt to $700,000 payable in two lump sum payments of $350,000 each. From Mr. Charne’s evidence, apparently the only marketable commodity of FCPL, in the fall of 1984, was its substantial income losses. He sought assistance from Canwest and as a result a series of transactions were completed, including the following:

1. Nov. 1, 1984: 602744 was incorporated.

2. Nov. 29, 1984: 606734 was incorporated.

3. Nov. 29, 1984: 606735 was incorporated.

4. Nov. 30, 1984: CCC issued a promissory note (the "CCC Note") to CFHL, in the principal amount of $39,448,095.15 with interest accruing at 14.5 per cent payable monthly. (CFHL obtained the $39,448,095.15 upon the sale of an insurance company it had owned. It would appear that the sum $39,448,095.15 was actually advanced to CCC.)

5. Nov. 30, 1984: CFHL sold the CCC Note to the appellant. In exchange, the appellant issued an identical promissory note (the "Broadcasting Note") to CFHL. Both notes had the same amount of principal and the same amount of interest.

6. Nov. 30, 1984: CFHL declared a dividend of $39,448,095.15 to CCC. CFHL satisfied its dividend obligation by transferring the Broadcasting Note to CCC. As a result, CCC and the appellant owed each other $39,448,095.15.

7. Nov. 30, 1984: The appellant subscribed for an additional 999 common shares in the capital of 602744 for a subscription price of $99.00. The appellant also transferred the CCC Note to 602744 as a capital contribution. As security for the appellant’s obligations under the Broadcasting Note, the appellant pledged to CCC the 602744 shares owned by it.

8. Nov. 30, 1984: The appellant loaned $350,000 to FCPL in exchange for a non- interest bearing demand promissory note of $350,000 (the "FCPL Note").

9. Dec. 3, 1984: 602744 transferred the CCC Note to 606734 in exchange for an identical promissory note issued by 606734 (the "606734 Note").

10. Dec. 3, 1984: 606734 transferred the CCC Note to 606735 in exchange for $39,488,000 of Class A preferred shares of 606735, and a promissory note payable to 606734 in the amount of $95.15 bearing interest at the rate of 21.75 per cent per annum (the "606735 Note").

11. Dec. 3, 1984: 602744 transferred back the 606734 Note to 606734 in exchange for the $39,488,000 Class A shares of 606735, and the 606735 Note.

12. Dec. 3, 1984: By resolution, 606735 reduced the stated capital of the Class A shares from $39,448,000 to $39.45. (It does not serve a purpose, in this decision, to repeat the reasoning of the appellant behind this resolution.)

13. Dec. 3, 1984: 606735 guaranteed the obligations of the appellant, under the Broadcasting Note held by CCC (the "606735 Guarantee"), and as security 606735 pledged the CCC Note to CCC (the "First Pledge").

14. Dec. 3, 1984: As alleged consideration for the guarantee, the appellant agreed to pay 606735 (i) $1,100 a day or, at the option of 606735, a lump sum payment of $300,000, and (ii) $20,454 each month that the guarantee was effective. The option was subsequently exercised and the appellant satisfied the requirement for the lump sum payment by delivering up the FCPL Note (to the extent of $300,000) for cancellation.

15. Dec. 3, 1984: The appellant and 606735 entered into a "Purchase Agreement" giving the appellant the right to require 606735 to purchase its shares of 602744 for $39,448,000, with interest payable at 14.5 per cent on any unpaid amount.

16. Dec. 3, 1984: As security for its obligation under the Purchase Agreement, 606735 pledged to the appellant, its interest in the CCC Note (the "Second Pledge").

17. Dec. 3, 1984: As consideration for the rights granted under the Purchase Agreement, the appellant agreed to pay $1,500 per week to 606735. After Dec. 4, 1984, 606735 had the right under the Purchase Agreement to convert the payments to a lump sum of $50,000.

18. Dec. 3, 1984: FCPL provided a guarantee to CCC and to the appellant of 606735’s obligations to CCC, under the 606735 Guarantee, and to the appellant, under the Purchase Agreement.

19. Dec. 3, 1984: Thaddeus Charne provided a guarantee of the obligations of 606735, TLC and FCPL.

20. Dec. 3, 1984: As security for Thaddeus Charne’s guarantee, Charne pledged and assigned to the appellant all of his shares in TLC.

21. Dec. 3, 1984: Various agreements were executed between CCC, the appellant, 606735, and 602744 whereby their respective interests in shares or notes of the various companies could be relinquished.

22. Dec. 3, 1984: 606735 declared dividends at 14.5 per cent on the Class A shares (held by 602744), paid during 1985, amounting to $5,014,758.40.

23. Dec. 3, 1984: 606735 was continued under the Canada Business Corporations Act as 137772 Canada Limited ("137772").

24. Dec. 4, 1984: 137772 and FCPL amalgamated to form First Commercial Properties Limited ("New FCPL").

25. Dec. 5, 1984: 606735 exercised its right under the Purchase Agreement and converted the payments to a lump sum of $50,000. The appellant satisfied the requirement for the lump sum payment by delivering up the remaining FCPL Note for cancellation.

26. October 16, 1985: 602744 delivered a redemption notice to New FCPL requiring redemption of 39,448 Class A shares.

27. October 21, 1985: New FCPL passed resolutions authorizing the redemption of the Class A shares and waived the redemption date notice period required in the Class A share conditions.

28. October 21, 1985: New FCPL executed and delivered a direction to CCC and the appellant to release their security interests in the CCC Note and to deliver the CCC Note to 602744 together with a consent to assignment.

29. October 21, 1985: CCC executed and delivered a release of the FCPL Guarantee and of the security interest in the CCC Note to New FCPL. The appellant executed and delivered a release of the security interest in the CCC Note to New FCPL.

30. October 21, 1985: New FCPL executed and delivered an assignment of the CCC Note to 602744 in satisfaction of the redemption price.

31. October 21, 1985: 602744 voluntarily dissolved. Its sole asset, the CCC Note was distributed to its sole shareholder, the appellant, and the appellant offset the CCC Note against its Note held by CCC.

32. October 21, 1985: The appellant and CCC released Thaddeus Charne of his obligations under the Charne Guarantee, released New FCPL of its obligations under the FCPL Guarantee and delivered the 1000 common shares of TLC back to Thaddeus Charne.

The mechanics and the purpose of each step was explained to the Court in detail by one of the appellant’s solicitors who had organized the overall plan. I do not feel it serves a useful purpose to repeat the explanation by the appellant’s counsel of the purpose behind each manoeuvre. The Court is satisfied that each step was carefully planned and accurately carried out. After the final transaction the appellant and FCPL were back to the same position as they were before the transactions took place except that:

1. The appellant had incurred expenses in excess of $5,500,000.

2. FCPL used its substantial losses to offset the tax consequences of interest received by it under the CCC Note.

3. The appellant received an amount equal to the interest paid by it by way of what the appellant claimed were tax free inter-corporate dividends. (The appellant got back the approximate $5,000,000 paid in interest.)

4. FCPL retained approximately $525,000 which, according to the evidence, saved the corporation from its creditors.

5. FCPL believed it no longer retained its substantial income losses to set off against future earnings.

An integral part of the transaction was that the appellant group of companies remained secure at all times and free from FCPL’s creditors. While the approximately $39 million note was transferred to FCPL in order that the appellant incur interest expense and guarantee fees, the note never left the control of the Canwest companies having been transferred back as a part of FCPL’s guarantee.

Following these transactions the appellant:

I. deducted the expenses and fees from its 1985 and 1986 income, creating a non-capital loss in 1985 and 1986 which was carried back to previous years, and forwarded to later years.

II. received intercorporate dividends from FCPL of approximately $5,000,000 which was equal to the amount of interest paid to FCPL.

III. included these dividends in its income, but also deducted them under subsection 112(1) of the Act. Since intercorporate dividends are tax free, the appellant considered the result to be a "wash" for income tax purposes with respect to the dividends received, and no extra amount was included in the appellant’s income with respect to these dividends.

Fcpl:

As a result of these transactions:

I. FCPL received taxable income in the form of interest and guarantee fees from the appellant at a time when FCPL was in a loss position.

II. FCPL paid dividends to the appellant equal to the amount of interest income received. FCPL gave the appellant its money back.

III. FCPL kept a portion of the "guarantee fee" and the "purchase agreement fee" for its involvement in this plan (approximately $525,000).

A memorandum summarizing the plan, from Stephen Gross to the board of directors of the appellant dated November 12, 1984 included, in part, the following:

I am currently close to finalizing an acquisition by CanWest Broadcasting of preferred shares of the parent company of First Commercial Properties Limited. I believe that this is an excellent investment opportunity for CanWest Broadcasting and will be asking the board of directors to approve the acquisition at a meeting to be held on Wednesday, November 14. Further information as to the precise time of the meeting will be supplied later. Following is an outline of the transaction that is contemplated:

1. CanWest Broadcasting will acquire a note owing by CanWest Capital to CanWest Financial Holdings in the amount of approximately $39.4 million, from CanWest Financial Holdings. The price of this note is $39.4 million and will be satisfied by the issuance to CanWest Financial Holdings of a note of CanWest Broadcasting in the same amount. The interest rate on the note being acquired is 14 1/2 per cent and the interest rate on the note given by CanWest Broadcasting to CanWest Financial Holdings is 14 1/2 per cent.

2. Through a series of transactions, which I will not detail in this memorandum, CanWest Broadcasting will sell the note to a newly-formed company which in turn will sell the note to the parent of First Commercial Properties. The proceeds from the sale of the note to First Commercial Properties parent will ultimately be preferred shares of that company which will have a dividend yield of 14 1/2 per cent.

7. The interest on the note issued to CanWest Financial Holdings by CanWest Broadcasting will be a deductible expense for tax purposes. Therefore, the final result of this transaction will be that CanWest Broadcasting will have deductible interest expense in the area of $4.4 million (i.e., interest at 14 1/2 per cent on $39.4 million for approximately nine months—until August, 1985). It will receive an equal amount of preferred share dividends (which will not be included in taxable income), resulting in an after-tax profit to CanWest Broadcasting of approximately $2.2 million.

8. As mentioned previously, CanWest Broadcasting will pay a guarantee fee in an amount of approximately $570,000, which will be a tax deductible expense. The after-tax cost of this guarantee fee is therefore $285,000, which will reduce the overall profit on the transaction from $2.2 million to approximately $1.95 million after-tax.

There is no mention in the memorandum that a purpose of the transaction was to save FCPL for possible acquisition for the appellant as stated in evidence on behalf of the appellant. There was no evidence that the appellant obtained any option to purchase or other similar concession from FCPL as part of the consideration for the transaction.

The relevant portions of paragraphs 18(l)(a) and 20(1 )(c) of the Act read as follows:

18.(1 )(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;

20.(1) Notwithstanding paragraphs 18(l)(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 upon the method regularly followed by the taxpayer in computing his 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 therefrom 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),

Used for the purpose of earning income from a business or property-paragraph 20(1)(c)

Both parties acknowledge that in order for interest expense to be deductible under paragraph 20(1)(c), three conditions must be met:

I. the interest is paid or payable pursuant to a legal obligation;

II. the interest is reasonable; and

III. the interest is for borrowed money used for the purpose of earning income from a business or property or the interest is for 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.

Position of the appellant

The appellant submits that the interest expense incurred on the Broadcasting Note satisfies all of these conditions and should therefore be deductible under paragraph 20(1)(c).

I. Legal obligation

Under the first condition, the interest must be paid under an obligation where the taxpayer is legally bound to pay the interest, and where legal recourse may be utilized to ensure the obligation is met. In the case at bar, the appellant submitted documents which show that the appellant did incur such a legal obligation to pay interest. The satisfaction of this requirement is not disputed by the respondent.

Il. Reasonable

The appellant produced uncontradicted evidence that the rate of interest paid by the appellant is comparable to the market rate of interest at that time.

III. For the purpose of gaining or producing income

The appellant argues that it had three purposes for entering into the series of transactions:

A. to keep FCPL alive as a potential investment. The appellant claims that if it had not entered into this transaction, FCPL’s bank would have foreclosed on FCPL, FCPL would not have survived, and the appellant would have lost an investment opportunity.

B. to purchase dividend producing shares; and

C. to make a profit from the transaction itself through tax savings.

Counsel for the appellant stated:

I submit the evidence was clear that the transaction was put forward by Mr. Gross for two purposes. The first was, and the primary one, as he put it, was to save First Commercial as a possible acquisition for Canwest Broadcasting either in terms of equity or in terms of some of its assets. And the second purpose, Mr. Gross testified, was the potential for Canwest Broadcasting in the transaction to put forward or carry out a transaction which would result in an after-tax cash benefit to Canwest Broadcasting. And Mr. Gross was very up front about those two purposes.

The appellant’s counsel conceded that "to keep FCPL alive as a potential purchase" was not a purpose which satisfies the requirement of "gaining or producing income" under paragraph 20(1 )(c) and contends that the purchase of dividend producing shares satisfies the requirement of "gaining or producing income".

Counsel relied on The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, 1 C.T.C. 117, 87 D.T.C. 5059, wherein the Supreme Court of Canada employed the direct use of funds method in determining the purpose of the use of funds to satisfy the requirement of "gaining or producing income". Relying on the Bronfman case the appellant states that it is the "direct use" of the borrowed funds-i.e., the acquisition of income producing shares-which should be looked at in determining the deductibility of interest expense, and not the indirect and remote effects of the borrowing-i.e., tax savings. He submits that it is this "direct use" which represents the true commercial and practical nature of the transaction.

Both parties referred to a decision of Bowman J.T.C.C. in Mark Resources Inc. v. Canada, [1993] 2 C.T.C. 2259, 93 D.T.C. 1004, which is presently under appeal before the Federal Court of Appeal. In Mark Resources, the Canadian parent borrowed funds from the Royal Bank of Canada for a predetermined period at a specified interest rate. The borrowed funds were inserted into its U.S. subsidiary as contributed capital. The U.S. subsidiary invested the funds in a term deposit at a specified interest rate (which was lower than that paid on the borrowing by the parent) for the same term as the loan. The U.S. subsidiary posted the term deposit with the lender as security for the parent’s loan. The U.S. subsidiary earned interest and used it to absorb its accumulated losses, which were expiring that year. The U.S. subsidiary paid the parent a tax-free dividend of the interest so earned. The U.S. subsidiary then transferred the funds back to the parent by way of loan when the term deposit matured and the losses had been used up. The parent then repaid its loan. The subsidiary was liquidated and the loan to the parent disappeared. The parent deducted the interest on the borrowed funds in computing its income. The issue was whether interest on money borrowed as an integral part of a carefully planned arrangement which had as its economic object the utilization in Canada of losses sustained by a U.S. subsidiary by their absorption in the profits earned in Canada by the Canadian parent was deductible under paragraph 20(1)(c). Bowman J.T.C.C. held that it must be the ultimate purpose of the use, and not the intermediate purpose which must be looked at. Thus, Bowman J.T.C.C. found that the real purpose was not the receipt of dividends, but that of tax savings and disallowed the parent company from deducting its interest expenses under paragraph 20(1)(c).

Although the facts and transactions undertaken in Mark Resources appear similar to those in the case at bar, the appellant submits that the facts in the two cases are different enough to warrant this Court reaching a different conclusion from that in Mark Resources. The appellant argues that in Mark Resources, the purpose of the whole scheme was admitted as being purely for tax savings, while in the case at bar, the purpose was the acquisition of dividend producing shares. Further, Mark Resources involved a U.S. subsidiary’s losses, which was not part of the Canadian tax system. Appellant’s counsel stated the fact that the U.S. subsidiary may not be able to use the losses later on is irrelevant for Canadian tax purposes. On the other hand, in the case at bar, FCPL is a Canadian company and the fact that FCPL will not be able to use its losses later on is relevant, as it would now have to pay taxes on future income in Canada. Moreover, the appellant submits that the U.S. subsidiary was wound up, while FCPL continues to be a prosperous business. Finally, in Mark Resources, the interest expense was greater than the dividend income, while in the case at bar, the interest expense is equal to the dividends earned.

Should this Court find that the fact situation of the present case cannot be distinguished from the facts of Mark Resources, the appellant submits further that Bowman, J.T.C.C. did not apply the Bronfman case correctly in that the Ssupreme Court of Canada in Bronfman decided that one must look at the direct purpose and not at the indirect purpose of the borrowing.

The appellant’s counsel added that should this Court conclude that the "purpose" in the present case of borrowing money was not the acquisition of income producing shares but was to save tax, then this purpose also satisfies the requirement under 20(1)(c) of "gaining or producing income".

The appellant produced cases, uncontested by the respondent, which have held interest expense to be deductible where the interest expense exceeds the income from property (Alberta & Southern Gas Co. v. The Queen, [1976] C.T.C. 639, 76 D.T.C. 6362 (F.C.T.D.); aff’d [1977] C.T.C. 388, 77 D.T.C. 5244 (F.C.A.) and (1978), [1979] 1 S.C.R. 36, 78 D.T.C. 6566 (S.C.C.), and where the interest expense was from the borrowing of money for the purpose of purchasing shares (Auld v. MNR, (1962), 62 D.T.C. 27, 28 Tax ABC 236 (T.A.B.)).

Position of respondent

Simply put, the respondent submitted that the interest expense incurred by the appellant was not for an amount payable for property acquired for the "purpose" of gaining or producing income from property. The respondent submits that the overall purpose of the series of transaction was to achieve substantial tax savings for the appellant and the immediate purpose of acquiring income producing shares does not satisfy the requirements of 20(1 )(c).

The respondent relies considerably on the reasoning of Bowman J.T.C.C. in Mark Resources and agrees with the following statement of Lord Wilberforce in Ramsay v. LR.C., [1981] 1 All E.R. 865, 2 W.L.R. 449 at 457 (All E.R. 871):

While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect as part of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded: to do so is not to prefer form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded.

The respondent submits that in the case at bar, everything was done as a complete prearranged set of steps, interdependent upon each other, and intended to be carried out as a whole. The series of transactions did not form an investment, but was undertaken to take advantage of tax losses. Under the scheme, no capital was truly at risk. It was a circle of capital and income, within which, at the end of the day, all the parties ended up where they began. The capital and income returned to where they started. As held in Mark Resources, it is the purpose of the scheme as a whole which gives the true and actual purpose of the transactions, and it is the ultimate purpose of the entire series of steps which must be looked at. This purpose was that of tax savings. The respondent submitted that from the evidence of Mr. Gross and Mr. Charne the true purpose behind the series of transactions was the reduction of tax for the appellant and the utilisation for a fee, of FCPL’s income losses.

The respondent submits that a distinction must be made between composite transactions with one effect or purpose, as in the present case and in Mark Resources, and two distinct transactions with two distinct purposes that stand legitimately on their own as in Bronfman.

In concluding that the appellant’s purpose in entering into the series of transactions was tax avoidance, the respondent argued that profit from tax avoidance is not ’’income” as referred to in paragraphs 18(l)(a) and 20(1)(c) and quoted inter alia Mark Resources, The Queen v. Mara Properties Ltd., [1995] 2 C.T.C. 86, 95 D.T.C. 5168 (F.C.A.), Moloney v. Canada, 92 D.T.C. 6570 (F.C.A.).

Analysis paragraph 20(1 )(c) of the Act "used for the purpose of earning income from a business or property"

The appellant’s claim to deduct the interest is based on paragraph 20(1 )(c) of the Act. The submissions of both parties boil down to two points of contention.

1. What was the "purpose" of the series of transactions? and

2. Having determined the "purpose" does that "purpose" satisfy the requirements in paragraph 20(1 )(c)?

At pages 1012 and 1016 (C.T.C. 2270 and 2275), in Mark Resources Bowman J. stated as follows:

The direct and immediate use was the injection of capital into a subsidiary with the necessary and intended consequence that the subsidiary should earn interest income from term deposits from which it could pay dividends. The earning of dividend income cannot, however, in my opinion, be said to be the real purpose of the use of the borrowed funds...in determining the "purpose" of the use of borrowed funds within the meaning of paragraph 20(1 )(c) the court is faced with practical considerations with which the pure theorist is not concerned. That purpose-and it is a practical and real one, and in no way remote, fanciful or indirect-is the importation of the losses from the U.S. Here the immediate step of investing in a subsidiary that in accordance with the scheme must necessarily pay dividends was not the real purpose of the use of the funds. The earning of interest income by PDI and the payment by it of dividends to PDL were integral but subservient and incidental steps to the real objective that lay behind the implementation of the plan. The amount of dividends, albeit deductible in computing taxable income, and based upon the interest from the term deposits, was less than the interest paid to the Royal Bank. It is true that the overall economic result, if all of the elements of the plan work, is a net gain to the appellant, but this type of gain is not from the production of income but from a reduction of taxes otherwise payable in Canada. I am cognizant of the fact that the dividends, although deductible in computing taxable income, are nonetheless income. It is, however, this feature of our Canadian tax system whereby such dividends are deductible in computing taxable income that gives to the plan its apparent economic viability. ...

The true purpose for which the borrowed money was used was to implement a plan to absorb into the Canadian parent’s income the losses of a foreign subsidiary. That result is not contemplated by the Canadian income tax system and it is not consistent with the scheme of the Act which contemplates the separation for fiscal purposes of the profits and losses of separate corporate entities. As Mr. Chambers observed in his argument, the consolidation for tax purposes of the financial results of domestic companies is not contemplated by our Act and this holds true a fortiori in the case of foreign subsidiaries. An arrangement that seeks in effect to do so runs counter to a fundamental principle that is firmly entrenched in our Act and accordingly is not in accordance with the object and spirit of the Income Tax Act as a whole.

I agree with this reasoning of Judge Bowman and adopt it as my own with respect to determination of "purpose".

I conclude that in the present case the "true" or "ultimate purpose" behind the series of transactions was to absorb into the appellant’s income the losses of FCPL. Through the series of transactions, the appellant was able to deduct interest expenses without actually having to pay out any money, as the interest expense allegedly incurred and paid to the Charne Companies (FCPL) (via CCC) was offset by an identical amount of dividends received from the Charne Companies (via 602744). These dividends were, in turn, deducted as tax-free intercorporate dividends (subsection 112(1) of the Act). This "ultimate purpose" resulted in the reduction of the appellant’s taxes.

The memorandum of Stephen Gross, to the appellant’s shareholders, dated November 12, 1984 sets out the true or real purpose of the transaction as he summarized it as follows:

7. ...Therefore, the final result of this transaction will be that CanWest Broadcasting will have deductible interest expense in the area of $4.4 million (i.e., interest at 14 1/2 per cent on $39.4 million for approximately nine months-until August, 1985). It will receive an equal amount of preferred share dividends (which will not be included in taxable income), resulting in an aftertax profit to CanWest Broadcasting of approximately $2.2 million.

8. As mentioned previously, CanWest Broadcasting will pay a guarantee fee in an amount of approximately $570,000, which will be a tax deductible expense. The after-tax cost of this guarantee fee is therefore $285,000, which will reduce the overall profit on the transaction from $2.2 million to approximately $1.95 million after-tax.

[Emphasis added.]

As stated by Judge Bowman in Mark Resources, this result is not contemplated by the Canadian income tax system and it is not consistent with the scheme of the Act which contemplates the separation for fiscal purposes of the profits and losses of separate corporate entities. The arrangement is not in keeping with the intent object and spirit of the Act. It is superficial and misleading.

The situation the Supreme Court of Canada in Bronfman faced was very different from the one in the case at bar. In deciding that the "direct use of the funds" is the purpose which should be looked at, the Supreme Court chose a "direct, ineligible" use over an "indirect, eligible" use. Chief Justice Dickson restricted himself to situations in which the choice was between a direct ineligible use and an indirect, eligible use. There was no mention in the judgment as to which method should be applied in a situation, with which we are presented in this case. The Court noted with approval that there has been a recent trend in tax cases towards attempting to ascertain the true commercial and practical nature of the taxpayer's transaction.

I find that the Court must look at the commercial, practical and economic reality of the taxpayer’s transactions, and not permit form to override substance. The Court must ensure that the "purpose” which is used for a paragraph 20(1 )(c) analysis is one that represents what the taxpayer’s real intentions are, and not what he or she makes them appear to look. In Bronfman, the "real purpose” was the distribution of capital. In the present case, the "real purpose”, as demonstrated by the evidence, was tax savings.

Having concluded that the "purpose” of the series of transactions was to obtain tax savings, does this purpose satisfy the requirement of "gaining or producing income" pursuant to paragraph 20(1 )(c)? I agree with the respondent’s position that it does not in that to conclude otherwise would run counter to the object and spirit of the Act as a whole.

In Moloney, Justice Hugessen stated at 6570

the reduction of his own tax cannot by itself be a taxpayer’s business for the purpose of the Income Tax Act. To put the matter another way, for an activity to qualify as a "business" the expenses of which are deductible under paragraph 18(l)(a), it must not only be one engaged in by the taxpayer with a reasonable expectation of profit, but that profit must be anticipated to flow from the activity itself rather than exclusively from the provisions of the taxing statute.

Although in Moloney, the Court dealt with the deductibility of expenses under paragraph 18(1 )(a), the test in paragraph 18(1)(a) is the same as in paragraph 20(1)(c). A plan which is aimed at taking advantage of the losses of an unrelated taxpayer is contrary to the intention of the statute. In the present case the original corporations only became related through a complexity of transactions motivated solely for the purposes of saving taxes.

I find as a fact that a purpose of the transaction did not include the saving of FCPL for future equity participation or that it was so remote as to not warrant consideration. The original negotiations had discontinued months before the actual series of transactions were initiated. When FCPL was most vulnerable to take over in the fall of 1984 no agreement, either oral or written, was entered into with respect to the equity acquisition of FCPL by the appellant.

The appellant submitted that the guarantee fees are deductible within the meaning of subparagraph 20(l)(e)(ii) of the Act in that they were "incurred in the course of a borrowing of money used by the taxpayer for the purpose of earning income from a business or property". For the purposes of this decision "put fees" are included under the term "guarantee fees".

The relevant portion of subparagraph 20( 1 )(e)(ii) reads as follows:

there may be deducted...such part of an amount that is not otherwise deductible in computing the income of the taxpayer and that is an expense incurred in the year or a preceding taxation year

(ii) in the course of a borrowing of money used by the taxpayer for the purpose of earning income from a business or property.

In order to deduct an expense under subparagraph 20( 1 )(e)(ii), this subparagraph also requires that the purpose be the "earning of income from a business or property". The same test as required in paragraphs 18(1 )(a) and 20(1 )(c) is to be applied. Based on the conclusion with respect to paragraph 20(1 )(c) that the purpose for the series of transactions, including the payment of guarantee fees, is tax savings and I have concluded that tax savings do not qualify as a purpose of gaining or producing income. Therefore the guarantee fees are not deductible under subparagraph 20(1)(e)(11).

Now dealing briefly with the issue number (4) and subsection 245(1) of the Act:

In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

The respondent submitted that the series of transactions constitute artificial transactions within the meaning of subsection 245(1) of the Act. The respondent argues that the series of transactions contain features of commercial abnormality that makes them not conform to commercial reality, as referred to by Bowman J.T.C.C. in Mark Resources.

Having decided that the real purpose of the use of the borrowed funds in the taxpayer’s case was not to earn dividend income from its affiliate but to implement a plan to deduct interest expense taking advantage of FCPL’s losses, it is not necessary to decide whether subsection 245(1) of the Act applies as submitted by the respondent. However, I have difficulty not commenting that surely this is a "transaction" that clearly "would unduly or artificially reduce income" within the meaning of subsection 245(1) of the Act.

The Canwest FCPL transactions are fiscal manipulation not commercial reality. The artificiality of the transactions is obvious, the sole purpose of which was for Canwest to use the losses of FCPL in consideration of approximately $525,000 guised as guarantee fees. The artificiality of the scheme is clear and, in my opinion, an abuse of the system.

The final issue dealing with subsection 112(1) was not actively pursued and, in view of my decision, need not be dealt with.

My conclusion is that the interest and guarantee fees were not paid on borrowed money used for the purpose of earning income from a business or property.

The appeals are therefore dismissed with costs.

Appeals dismissed with costs.