Gestion Guy Ménard Inc. v. MNR, 93 DTC 1058, [1993] 2 CTC 2793 (TCC)

P.R. Dussault, T.C.C.J.:— These matters were heard together on common evidence. The appeals of Gestion Guy Ménard Inc. ("Gestion") concern its 1985, 1986, 1987 and 1988 taxation years. The appeals of Guy Ménard relate to his 1986 and 1987 taxation years. An agreed statement of facts was filed and two witnesses were heard in the appeals of Gestion. As the transactions made by both appellants are similar, counsel for the appellants informed the Court that he was of the opinion that the same holding should follow.

Issue

The issue raised in these cases is the proper tax treatment of the difference between the proceeds of disposition and the cost of treasury bills typically disposed of one day prior to maturity by the appellants. The appellants' position is that the purchase of a treasury bill represents an investment, the realization of which should give rise to a capital gain. In assessing the taxpayer, the Minister of National Revenue (the"Minister") treated the amounts in issue as interest. However, the issue of whether part of the proceeds obtained could alternatively be considered business income was also raised in the reply to the notice of appeal and was argued by counsel for the respondent.

Facts

The agreed statement of facts reads as follows: [1]

1. The plaintiff is a corporation having its head office and principal business in Brossard, Québec.

2. During the taxation years under appeal, the plaintiff made investments in treasury bills.

3. Such treasury bills were disposed of in arm's length market transactions prior to maturity, almost always within a day or two of such maturity.

4. Treasury bills are normally issued for short terms, such as 30 days, 60 days, 90 days, 180 days or 1 year.

5. In calculating its income for tax purposes, the plaintiffs included the difference between the cost of such treasury bills and the proceeds of disposition thereof as capital gains.

6. The defendant has treated such difference as interest in the taxation years in which the dispositions occurred and has reassessed the plaintiffs accordingly.

7. The plaintiffs duly objected to such reassessments, the defendant has confirmed such reassessments and the plaintiffs have duly appealed therefrom.

8. Appendices A through D to the document entitled reply to the notice of appeal set forth the purchases and sales of the treasury bills made by the plaintiffs in each of the taxation years under appeal.

9. The market value of treasury bills may fluctuate during the term such bills are outstanding, with the result that gains and/or losses, not referable solely to an interest calculation, may be incurred if such treasury bills are disposed of prior to maturity.

10. Treasury bills are purchased by a restricted number of banks and investment dealers, as principals, and may be sold to their clients. It is not possible for nonaccredited persons to tender on the weekly auction at the Bank of Canada. The treasury bills are sold on the secondary market to clients. There is no "commission" as such on such transactions, simply a price at which the security is sold.

With respect to this agreed statement of facts, counsel for the respondent noted that the expression "made investments in treasury bills” in paragraph 2 should not be understood as indicating a conclusion in law and that the expression “ purchased treasury bills” would be more appropriate.

With respect to schedules A through D referred to in paragraph 8 of the agreed statement of facts counsel for the appellants stated that they represented an accurate description of the transactions that occurred and stated that neither the transactions nor the amounts in issue for the taxation years in question were contested. He added that the result of the various transactions represented 52 per cent, 29 per cent, 39 per cent and 46 per cent of the total corporate income for the years 1985, 1986, 1987 and 1988 respectively.

The last paragraph of the agreed statement of facts describes the market context in which treasury bills are bought and sold. In fact, since only accredited financial institutions, or investment dealers can attend the weekly auction at the Bank of Canada, a secondary market is created where subsequent purchases and sales take place between those institutions or dealers and any other person, corporate or individual, wanting to buy or sell treasury bills.

Dr. Ménard testified that the main business of Gestion is to acquire medical supplies and sell them to him to be used in his medical practice. Dr. Ménard said that he was very busy with his practice and that he wanted to spend the least amount of time possible attending to administrative matters of the company or managing investments. According to him, the purchase of treasury bills seemed to be a simple and relatively sure way of obtaining a satisfactory yield on surplus funds of the company. He said that the risk was minimal in that a loss could occur only if he needed the funds earlier than planned (which event did not occur in the years under appeal) and the bills were then sold prior to maturity at a time when interest rates would have risen. Dr. Ménard also stated that his interest in buying treasury bills was enhanced by the fact that his broker advised him that he could realize a capital gain instead of ordinary income if the bills were sold one day prior to maturity. When funds were available, he contacted his broker who recommended the purchase of a treasury bill at a fixed or predetermined yield. He said that he decided to purchase only if the yield was satisfactory to him. Dr. Ménard also said that he did not remember having received any documentation from his broker with respect to transactions in treasury bills. Essentially, these were the explanations given as to why the sales one day prior to maturity were carried out in the way they were during the years in question.

Mr. Carl Deslongchamps, an appeal officer for Revenue Canada, testified about the typical process of assessment in the case of the disposition of a treasury bill by a taxpayer. He explained that as a treasury bill does not carry a stated rate of interest, the difference between the purchase price and the face value is simply divided by the purchase price to obtain the effective yield. If a taxpayer disposes of the bill prior to maturity, the interest is computed for the period up until the date of disposition using that effective yield. A capital gain or loss is thereafter measured by subtracting from the proceeds of disposition both the adjusted cost base and any amount treated as interest. In the present case, as the sale would always occur one day prior to maturity, the full amount of the discount was assessed as interest since the purported gain itself was negligible.

Appellants’ position

Counsel for the appellants argued that the transactions should be treated on capital account because the funds, which come from after tax profits, were carefully invested in treasury bills in order to minimize the risk other forms of investment might present. He submitted that there was never a borrower/ lender relationship between the government and the appellants during the period the bills were held so that interest could not be said to be payable or to accrue. In essence his argument was that the appellants simply held a short term security issued by the government and resold it on the market prior to maturity without being paid by or receiving anything from the government as would be the case had the bills been held to maturity. According to him, the appellants essentially disposed of securities that constituted capital property. He further submitted that the testimony of Mr. Deslongchamps indicated that even the respondent recognized a minimum amount of capital gain. I might comment immediately here that this assertion amounts to a conclusion in law. On appeal, it is for the Court to decide whether or not the transactions can be said to give rise to a capital gain. No authorities were referred to by counsel for the appellants in support of his arguments. However, he distinguished the facts in the present case from those in O’Neil v. M.N.R., 91 D.T.C. 692 (T.C.C.), in that the treasury bills were sold one day prior to maturity in secondary market transactions while in O'Neil (supra), the bills were held until maturity. In O'Neil (supra), Judge Lamarre Proulx of this Court held that the difference between the purchase price and the maturity value of a treasury bill held until maturity was interest pursuant to subsection 16(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and thus should be included in income as income from property pursuant to section 9 or as interest pursuant to paragraph 12(1)(c) of the Act.

Respondent's position

The position of counsel for the respondent was more ambivalent. First, he argued that there was a borrower/lender relationship between the government and the appellants so that the difference between the purchase and the sale price in the present case should be treated as interest. My understanding is that he would conclude that there could also be a capital gain or loss had the bills been disposed of further away from maturity. In any case, this is not the situation under review. In his argument, counsel relied on various provisions of the Act and Regulations and notably on subsection 9(1), paragraph 12(1)(c), subsection 12(9) and Regulation 7000 and subsections 16(1), 16(3) and 20(14) of the Act. According to him, the whole legislative scheme leads to the conclusion that the discount should be treated as interest. In this respect, counsel relied on the decision in O’Neil (supra). According to counsel, selling one day or two prior to maturity should not result in a different treatment of the proceeds. The other cases referred to by counsel were the following:

Steeves v. M.N.R., [1979] C.T.C. 2445, 79 D.T.C. 378 (T.R.B.);

Courtright v. M.N.R., [1980] C.T.C. 2632, 80 D.T.C. 1609 (T.R.B.);

Antosko v. Canada, [1992] 2 C.T.C. 350, 92 D.T.C. 6388 (F.C.A.).

Secondly, counsel for the respondent argued that the discount should be taxed as ordinary income resulting from trading activities. The argument was based on the fact that the appellants purchased short-term financial instruments frequently and with the deliberate intention of reselling them prior to maturity in order to realize what was thought to bea a capital gain. He submitted that the transactions were not real investments but were more in the nature of trade directed at earning income. In making this argument counsel relied, by analogy, on the following cases involving trade or "an adventure in the nature of trade":

McIntosh v. M.N.R., [1958] S.C.R. 119, [1958] C.T.C. 18, 58 D.T.C. 1021;

Scott v. M.N.R., [1963] S.C.R. 223, [1963] C.T.C. 176, 63 D.T.C. 1121;

M.N.R. v. Sissons, [1969] S.C.R. 507, [1969] C.T.C. 184, 69 D.T.C. 5152;

Hall v. The Queen, [1986] 1 C.T.C. 399, 86 D.T.C. 6208 (F.C.T.D.);

Loewen, M.N.R. v., [1993] 1 C.T.C. 212, 93 D.T.C. 5109 (F.C.T.D.).

Counsel for the respondent also referred to Interpretation Bulletin IT-114 (August 3, 1973), Discounts, Premiums and Bonuses on Debt Obligations and to Interpretation Bulletin IT-265R2 (September 26, 1984), Payments of Income and Capital Combined, as expressing positions similar to those he took for both arguments.

Analysis

First, given the issue and the context of this case, I would like to restate the principle that it is the result of the assessment that is in issue, not the process by which it was arrived at or the reasons given by the Minister. [2]

Secondly, resorting simply to basic tax principles and to the old metaphor of the tree and the fruit, I do not think that one can seriously challenge that the yield (or return) resulting from buying a treasury bill at discount on the secondary market and holding it to maturity or one day short has the character of income. It is income either from property or from business. Whether it can be more specifically characterized as interest or deemed interest under the Act is another question altogether.

A treasury bill is defined in section 2 of the Financial Administration Act, R.S.C., 1985, c. F-11, in the following terms:

“treasury bill" means a bill issued by or on behalf of Her Majesty for the payment of a principal sum specified in the bill to a named recipient or to a bearer at a date not later than twelve months from the date of issue of the bill;

The appellants’ purchases were made on the secondary market from an accredited institution allowed to attend the weekly auction at the Bank of Canada. The bills do not bear any specific interest rate and are bought at a discount. The principal amount of the bills are payable at fixed dates. In essence, it is a form of short-term borrowing by the government. The discount represents the reward or compensation for the use or retention by the government of money belonging to someone else for a precise period of time. [3]

I was not provided with evidence or a detailed analysis of the specific legal relationships between the government, the accredited institutions and the purchasers of treasury bills in secondary market transactions. However, it is my view that those relationships and the substance of the transactions do not change materially whether the bills are sold one day prior to maturity or held until maturity. Individuals and corporations other than accredited institutions do not normally deal directly with the Bank of Canada although it appears that a named or registered purchaser could obtain payment directly from the Bank of Canada at maturity. If all purchases and sales before maturity are carried out through accredited institutions, most of the time the payment at maturity is also obtained from those institutions and not from the Bank of Canada directly. If one does not question that the government is in the position of a borrower when it issues a treasury bill, it seems difficult to sustain that a purchaser, even on the secondary market, is not in the position analogous to that of a creditor as a Claim for payment can be made directly from the Bank of Canada at maturity if the bill is registered in the purchaser's name. Although at maturity an accredited institution or investment dealer would, in the normal course, pay the holder of a bill and then obtain payment from the government, it seems to me that the different transactions involve in substance if not in form an initial loan to the government by an accredited institution followed by a sale or assignment of the debt to persons such as the appellants. A second holder of a treasury bill can then certainly be considered a creditor of the amount payable by the government at maturity. In such a case, there is no doubt that the higher amount payable at maturity by the government represents, using the classic definition of Mr. Justice Rand referred to above, in part the compensation for the use or retention by one person, for a certain period, of a sum of money owed to someone else. I fail to see the magic that a sale one day prior to maturity has in changing the whole nature of the transactions from their inception or the legal position of the holder as a creditor.

When a treasury bill is issued at a discount there is a direct relation between the purchase price, the principal sum payable at maturity and the period to maturity so that the exact yield or return can be easily determined. The same relation exists and the process is similar when the bill is purchased at a slightly higher price from an accredited institution. It was admitted that the purchases were made precisely because the offered percentage yield was thought to be satisfactory. However, counsel for the appellants argued that as the market value of a treasury bill can vary due to the prevailing rates of interest on the market, the proceeds of disposition could not be said to represent a regular accrued yield on the purchase price. In other words, the discount obtained at the time of purchase might not accrue day to day in those circumstances as interest would. [4] It is true that the market value of a treasury bill can vary during the term according to prevailing returns on the monetary market but it is also true that it will never be worth more than the face value or the principal sum payable at maturity. Moreover, in my view, there is no longer any market influence one day before maturity so that the predetermined rate of return has accrued or been earned but for one day during the period.

In Re Unconscionable Transactions Relief Act, [1962] O.R. 1103 at page 1108, Schroeder, J.A. of the Ontario Court of Appeal discussed the nature of interest as following:

The word “interest” is not, then, a technical term and it is not restricted in any sense to compensation determinable by the application of a rate per centum to the principal amount of a loan. It may be for a fixed sum of money whether denominated a bonus, discount or premium, provided that it is referable to a principal money or obligation to pay money.

In West Coast Parts Co. v. M.N.R., [1965] C.T.C. 519, 64 D.T.C. 5316 at page 526 (D.T.C. 5320) Cattanach, J. of the Exchequer Court noted:

When a person enters into a contract whereby he advances money to another person on terms that it is to be repaid at a fixed time together with an additional amount, if the additional amount is described as interest, there is no problem. Interest is income from property within section 3 of the Income Tax Act and it is specifically required to be included in computing income by section 6. When such a contract requires repayment with such an additional amount, but does not describe it as interest, it becomes a question of fact as to whether the additional payment is or is not in fact interest or, in any event, a profit from property in the sense of revenue derived from the money advanced. If the additional payment is the sole consideration for use of the money, there would appear to be a very strong probability that it is interest or a payment in lieu of interest. The problem is more complicated where, as here, the contract provides for repayment with interest as such plus an additional fixed amount.

[Emphasis added.]

Vern Krishna in The Fundamentals of Canadian Income Tax, Fourth Edition, 1993 discusses the meaning of blended payments at pages 336 and following. He states at page 337:

Interest and principal may be blended by issuing a debt instrument at a discount and redeeming it at its face value upon maturity. Government Treasury Bills, for example, do not stipulate any interest rate or amount on their face, but are issued at a discount from their face value. The discount rate is a direct function of the prevailing interest rate, and the substance of the transaction is that the redemption value is, in effect, made up of principal and interest. Thus, the payment on maturity must be broken down into interest and principal.

[Emphasis added.]

Krishna analyzes the nature of discounts and premiums at page 728 as follows:

An amount paid as a premium or bonus or on account of a discount may be characterized as being on account of interest or capital. The courts look at the “true nature” of the discount to determine its character: they will determine whether the debt obligation carries a commercial rate of interest, whether the bonus or discount varies with the length of time that the loan funds are outstanding, the extent of the capital at risk, and the nature of the financial operation. For example, discounts on financial market instruments, such as treasury bills, bankers' acceptances, and call loans, are generally considered to be on account of interest. In all these cases, the discount is simply the economic reward for holding the instrument fora period of time, and is determined by reference to the principal amount payable on maturity of the debt.

[Emphasis added.]

In O'Neil, supra, Judge Lamarre Proulx was of the opinion that subsection 16(1) of the Act (as amended and applicable to amounts paid or payable after June 1988) should be resorted to in order to treat part of the proceeds of disposition as interest rather than as a capital receipt. I think that former subsection 16(1) is also applicable to the present situation. As it read for the years in issue (before July 1988), former subsection 16(1) provided the following:

(1) Where a payment under a contract or other arrangement can reasonably be regarded as being in part a payment of interest or other payment of an income nature and in part a payment of a capital nature, the part of the payment that can reasonably be regarded as a payment of interest or other payment of an income nature shall, irrespective of when the contract or arrangement was made or the form or legal effect thereof, be included in computing the recipient's income from property for the taxation year in which it was received to the extent that it was not otherwise included in computing the recipient’s income.

[Emphasis added.]

In my view, the words “contract or other arrangement" and "irrespective . . . (of) the form or legal effect thereof" are sufficiently wide to cover the situation where proceeds of disposition are received in secondary market transactions one day before maturity when part of those proceeds can reasonably be regarded as interest accrued to that day. I might add that the result of the application of former subsection 16(1) is that the difference between the sale price and the purchase price is to be included in the recipient's income as income from property. However, if it is interest it should be treated as such under the more specific provisions of the Act applying to interest.

Subsection 16(5) provides that subsection 16(1) does not apply where subsection 16(2) or (3) are applicable. Subsection 16(2) applied to the issue of certain obligations before June 19, 1971. As for subsection 16(3) it reads as follows:

Where, in the case of a bond, debenture, bill, note, mortgage, hypothec or similar obligation issued after June 18, 1971 by a person exempt from tax under section 149, a non-resident person not carrying on business in Canada, or a government, municipality or municipal or other public body performing a function of government,

(a) the obligation was issued for an amount that is less than the principal amount thereof, and

(b) the yield from the obligation, expressed in terms of an annual rate on the amount for which the obligation was issued (which annual rate shall, if the terms of the obligation or any agreement relating thereto conferred upon the holder thereof a right to demand payment of the principal amount of the obligation or the amount outstanding as or on account of the principal amount thereof, as the case may be, before the maturity of the obligation, be calculated on the basis of the yield that produces the highest annual rate obtainable either on the maturity of the obligation or conditional upon the exercise of any such right) exceeds h of the interest stipulated to be payable on the obligation, expressed in terms of an annual rate on

(i) the principal amount thereof, if no amount is payable on account of the principal amount before the maturity of the obligation, or

(ii) the amount outstanding from time to time as or on account of the principal amount thereof, in any other case,

the amount by which the principal amount of the obligation exceeds the amount for which the obligation was issued shall be included in computing the income of the first owner of the obligation who is a resident of Canada and is not a person exempt from tax under section 149 or a government, for the taxation year of the owner of the obligation in which he became the owner thereof.

[Emphasis added.]

I think that subsection 16(3) of the Act is not applicable to the present situation. The reasons are simple: first, the appellants are not the first owners of the treasury bills and second, the bills did not carry a stipulated interest. This was also the view of Judge Lamarre Proulx in O’Neil, supra.

The words used in paragraph 12(1)(c), the basic provision dealing with inclusion of interest, are also very broad. I am inclined to think that they can be interpreted so as to cover what might be viewed in the present situation as an indirect payment by an accredited institution one day before maturity. That paragraph refers to any amount" received . . . or receivable . . . as, on account or in lieu of payment of, or in satisfaction of, interest. . . .” Here, there is no doubt that part of the sale price represents compensation for the interest earned and that the accredited institution or other purchaser of the bill one day prior to maturity will recover the next day upon payment at maturity. In that sense, the amount received can probably be described as received “in lieu of payment of interest”.

As I mentioned before, even failing to be interest, the difference between the sale price and the purchase price upon a sale in the above described circumstances would still be income from property or business income and not a capital gain.

Given the context of this case and the sole issue raised, I do not feel it is necessary to analyze the other provisions of the Act with respect to interest. It is also unnecessary for me to deal with the alternative argument of counsel for the respondent.

For the above reasons, the appeals of both Gestion Guy Ménard Inc. and Guy Ménard are dismissed.

Appeal dismissed.