Interprovincial Pipe Line Company v. Minister of National Revenue, 68 DTC 5093, [1968] CTC 156, [1968] SCR 498

JUDSON, J. (all concur) :—We are concerned here with appeals of Interprovincial Pipe Line Company from re-assessments made for its 1960 and 1961 taxation years. The Exchequer Court has affirmed these re-assessments. The facts are substantially the same as those in I nt er provincial Pipe Line Company v. M.N.K., [1959] S.C.R. 763; [1959] C.T.C. 339. The sole question again is how the calculation of the foreign tax deduction under Section 41 of the Income Tax Act is to be made and the result depends upon the effect to be given to the amendment to the Income Tax Act enacted in the year 1960 following the former decision.

The amendment is to be found in 8-9 Eliz. II, 8. C. 1960, e. 43, Section 33. It repeals Section 139(1) (az) of the Act as it stood when the 1959 litigation was decided and substitutes for it a new Section 139(la) and (lb). I will put the old legislation and the new legislation in two parallel columns for the purpose of comparison. I am not reproducing the new legislation in full but only those parts that are relevant to this appeal : year for the purposes of Part I . . . shall be deemed to be applicable either wholly or in part to a particular source or to sources in a particular place.

There is no substantial difference between Section 41(1) and (5) of the Income Tax Act applicable to this appeal and the section as it read when the 1959 appeal was decided. This section deals with foreign tax deduction. The other sections of the Act are the same in both cases: Section 3 (world income) ; Section 4 (income from business or property) ; Section 6(1) (b) (interest), and Section 11(1) (b) (deduction allowed for interest paid on borrowed money for the purpose of computing income).

Interprovincial’s method of financing is set out in the 1959 Report. Interprovincial owns and operates a pipe line in Canada with a connecting link in the United States. The connecting link is owned and operated by Lakehead Pipe Line Company Inc., a wholly-owned subsidiary. Interprovincial raised all the money to construct these lines. It lent the necessary money to Lake- head and took bonds in return. In the year 1960 Interprovincial received interest on these bonds but it itself had to pay interest on its own bonds which it had issued to acquire the Lakehead bonds. These are the figures:

These figures can be broken down by taking the Lakehead bonds series by series and making the same calculation. The result is the same and there is no dispute about the figures.

During the 1960 taxation year, the item of $2,421,165.80 above shown was not an actual receipt in that the sum of $363,174.87 was remitted by Lakehead to the Government of the United States pursuant to the provisions of the Internal Revenue Code of that country. This was a 15 per cent withholding tax. But Interprovincial, in computing its income as required by Section 6 of the Act, included the full sum of $2,421,165.80. Lakehead, in computing its income, deducted as an expense the said sum of $2,421,165.80.

Interprovincial claimed and was allowed as a deduction for interest on borrowed money pursuant to Section 11(1) (c) of the Income Tax Act the sum of $4,549,355. This sum includes the sum of $2,363,966.79 referred to above under the heading ‘Cost of borrowed money used to acquire Lakehead Bonds’’.

The question is what is to be done about the $363,174.87 withholding tax paid to the United States. The 1959 decision held

(1) that his was available as a tax credit in respect of foreign tax paid on a gross basis on receipts of an income nature whether or not those receipts, after deduction of expenses incurred to earn them, resulted in a net profit when brought into the computation of the taxpayer’s overall taxable income;

(2) that there was no authority for splitting up the income of the business of the taxpayer; and

(3) that the income of the business to be determined in order to ascertain what was taxable income was the entire income of the appellant and not that income split up into parts according to the situs of the source of that income.

Interprovincial still submits that it is entitled to deduct under Section 41 of the Act the full amount of the United States withholding tax, $363,174.87. The Minister submits that subsection

(lb) of Section 139 of the Act contains a mandatory direction that in computing income from various sources for the purpose of Section 41 of the Act, the deduction of $4,549,355, 1.e., the total interest on borrowed money claimed by Interprovincial and allowed to it pursuant to Section 11(1) (c) of the Act, is to be broken up and related to Interprovincial’s various sources of income. If this is done, as I have shown above, Interprovincial’s income for the year 1960 from United States sources was $57,199.01. In my opinion the Minister is right and the effect of the 1960 amendment (the new Section 139(la) and (lb) above quoted) is to require this to be done. This is the conclusion also reached by the Exchequer Court and I would affirm it.

We now must start by segregating the income from United States sources. That income is not a gross amount of $2,421,165.80, but a net amount of $57,199.01 after deducting the cost of borrowed money used to acquire the Lakehead bonds. Interprovin- cial’s submission that its income from sources in the United States for the purpose of computing the amount deductible under Section 41 was still the gross amount of interest received from the United States without being reduced by its interest expense in Canada, is in error.

I cannot see that there is any substantial difference between Section 41(1) and (5) dealing with the foreign tax deduction as it stood when the 1959 case was decided and as it now stands. Briefly, it enables the taxpayer to deduct from the tax payable an amount equal to the lesser of two sums,

(a) any income or profits taxes paid to the government of a country other than Canada for the year, or

(b) that proportion of the tax that (i) the taxpayer’s income from sources in that country is of (ii) the taxpayer’s income for the year.

The lesser of these two sums is now the sum calculated in accordance with the provisions of Section 41(1) (b) and this is all that is allowable as a foreign tax credit when the provisions of the new Section 139 (la) and (lb) are applied.

Interprovincial also put forward an alternative argument that the provisions of the Canada-U.S. Reciprocal Tax Convention prevented the application of the Income Tax Act in the way above outlined and that the Minister could not deny the taxpayer the full deduction of foreign taxes paid.

Article XV of the Convention provides :

1. As far as may be in accordance with the provisions of the Income Tax Act, Canada agrees to allow as a deduction from the Dominion income and excess profits taxes on any income which was derived from sources within the United States of America and was there taxed, the appropriate amount of such taxes paid to the United States of America.

2. As far as may be in accordance with the provisions of the United States Internal Revenue Code, the United States of America agrees to allow as a deduction from the income and excess profits taxes imposed by the United States of America the appropriate amount of such taxes paid to Canada.

I agree with the judgment of the Exchequer Court that the effect of this Article was to establish a mutual covenant to apply as between each country whatever foreign tax credit provision the respective domestic laws of each country might from time to time adopt and that this covenant does not require any alteration in the appellant’s rights as determined by the interaction of Section. 41 of the Income Tax Act and Section 139 (la) and (lb).

I therefore agree with the judgment of the Exchequer Court on both grounds and I would affirm it.

The appeal should be dismissed with costs.