Brulé,
J.T.C.C.:—The
appellant
has
objected
to
the
disallowance
by
the
Minister
of
National
Revenue
("Minister")
of
interest
deductions
paid
in
the
1985
and
1986
taxation
years
pursuant
to
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").
These
appeals
are
the
result
of
the
objection.
Facts
The
facts
of
these
appeals
were
agreed
between
the
parties.
Ramada
Inn
Inc.
(U.S.)
("Ramada
Inc.")
is
the
parent
company
of
Ramada
Inns
Overseas
Inc.
("Overseas").
Both
of
these
companies
are
American
residents.
Overseas
owns
100
per
cent
of
the
shares
of
Ramada
Canada
Ltd.
("Canada").
Canada,
which
is
a
Canadian
resident,
owns
100
per
cent
of
the
common
and
100
per
cent
of
the
Class
B
shares
of
the
appellant,
Ramada
Ontario
Ltd.
("Ontario")
which
is
a
Canadian
resident.
Throughout
the
1985
and
1986
taxation
years,
the
paid-up
capital
of
the
shares
of
the
appellant
was
$2,093,910.
In
1985
Ramada
Inc.
advanced
$16,560,000
(Canadian)
to
the
appellant
on
an
interest
bearing
basis.
Simultaneously,
Overseas
subscribed
for
$3,943,500
(Canadian)
worth
of
Class
A
shares
of
the
appellant.
In
the
1985
and
1986
taxation
years,
the
appellant
deducted,
pursuant
to
paragraph
20(1
)(c)
of
the
Act,
the
interest
incurred
in
each
respective
year
in
respect
of
the
loan.
For
the
1985
taxation
year
the
Minister,
by
notice
of
reassessment,
dated
October
12,
1990,
disallowed
the
deduction
of
$439,710
pursuant
to
subsection
18(4)
of
the
Act.
For
the
1986
taxation
year,
the
deduction
of
the
amount
of
$420,404
was
disallowed.
The
appellant
objected
in
a
timely
fashion
and
the
reassessments
were
confirmed.
In
the
notice
of
reply,
the
Minister
assumed,
inter
alia,
that
Ramada
Inc.
was
a
“specified
non-resident
shareholder"
of
the
appellant
pursuant
to
paragraph
18(5)(b)
of
the
Act;
that
the
appellant's
paid-up
capital
in
respect
to
shares
owned
by
Canada
was
$2,093,910;
and,
that
Canada
was
a
"specified
shareholder"
but
not
a
"specified
non-resident
shareholder"
of
the
appellant
pursuant
to
paragraphs
18(5)(b)
and
(c)
of
the
Act.
There
was
no
evidence
to
rebut
these
assumptions
and,
as
such,
they
are
taken
to
be
true
by
this
Court.
Issue
The
issue
in
these
appeals
involves
the
application
of
the
Canada-U.S.
Income
Tax
Convention
(1980)
and
whether
or
not
paragraphs
7
and
8
of
Article
XXV
preclude
subsection
18(4)
of
the
Act
so
as
to
restrict
the
amount
of
interest
deductible
by
the
appellant
in
the
years
under
appeal.
In
order
to
arrive
at
a
decision
it
is
necessary
to
consider
the
provisions
of
the
relevant
statutes.
Canada-U.S.
Income
Tax
Convention
(1980)
Article
XXV
7.
Except
where
the
provisions
of
paragraph
1
of
Article
IX
(Related
Persons),
paragraph
7
of
Article
XI
(Interest)
or
paragraph
7
of
Article
XII
(Royalties)
apply,
interest,
royalties
and
other
disbursements
paid
by
a
resident
of
a
contracting
state
to
a
resident
of
the
other
contracting
state
shall,
for
the
purposes
of
determining
the
taxable
profits
of
the
first-mentioned
resident,
be
deductible
under
the
same
conditions
as
if
they
had
been
paid
to
a
resident
of
the
first-mentioned
state.
Similarly,
any
debts
of
a
resident
of
a
contracting
state
to
a
resident
of
the
other
contracting
state
shall,
for
the
purposes
of
determining
the
taxable
capital
of
the
first-mentioned
resident,
be
deductible
under
the
same
conditions
as
if
they
had
been
contracted
to
a
resident
of
the
first-mentioned
state.
8.
The
provisions
of
paragraph
7
shall
not
affect
the
operation
of
any
provision
of
the
taxation
laws
of
a
contracting
state:
(a)
relating
to
the
deductibility
of
interest
and
which
is
in
force
on
the
date
of
signature
of
this
convention
(including
any
subsequent
modification
of
such
provisions
that
does
not
change
the
general
nature
thereof);
or
(b)
adopted
after
such
date
by
a
contracting
state
and
which
is
designed
to
ensure
that
a
person
who
is
not
a
resident
of
that
state
does
not
enjoy,
under
the
laws
of
that
state,
a
tax
treatment
that
is
more
favorable
than
that
enjoyed
by
residents
of
that
state.
Canada-United
States
Tax
Convention
Act,
1984,
S.C.
1984,
c.
20
3
(2)
In
the
event
of
any
inconsistency
between
the
provisions
of
this
Act,
or
the
convention,
and
the
provisions
of
any
other
law,
the
provisions
of
this
Act
and
the
convention
prevail
to
the
extent
of
the
inconsistency.
Income
Tax
Act
18
(4)
Notwithstanding
any
other
provision
of
this
Act,
in
computing
the
income
for
a
taxation
year
of
a
corporation
resident
in
Canada
from
a
business
or
property,
no
deduction
shall
be
made
in
respect
of
that
proportion
of
any
amount
otherwise
deductible
in
computing
its
income
for
the
year
in
respect
of
interest
paid
or
payable
by
it
on
outstanding
debts
to
specified
non-residents
that
(a)
the
amount,
if
any,
by
which
(i)
the
greatest
amount
that
the
corporation’s
outstanding
debts
to
specified
non-residents
was
at
any
time
in
the
year,
exceeds
(ii)
three
times
the
aggregate
of
(A)
the
retained
earnings
of
the
corporation
at
the
commencement
of
the
year,
except
to
the
extent
that
those
earnings
include
retained
earnings
of
any
other
corporation,
(B)
the
corporation’s
contributed
surplus
at
the
commencement
of
the
year,
to
the
extent
that
it
was
contributed
by
a
specified
non-resident
shareholder
of
the
corporation,
and
(C)
the
greater
of
the
corporation’s
paid-up
capital
at
the
commencement
of
the
year
and
the
corporation’s
paid-up
capital
at
the
end
of
the
year,
excluding
the
paid-up
capital
in
respect
of
shares
of
any
class
of
the
capital
stock
of
the
corporation
owned
by
a
person
other
than
a
specified
non-resident
shareholder
of
the
corporation,
is
of
(b)
the
amount
determined
under
subparagraph
(a)(i)
in
respect
of
the
corporation
for
the
year.
[Emphasis
added
for
the
amendment.]
18
(5)
Notwithstanding
any
other
provision
of
this
Act,
in
this
subsection
and
subsections
(4)
and
(6),
(a)
“outstanding
debts
to
specified
non-residents"
of
a
corporation
at
any
particular
time
in
a
taxation
year
means
(i)
the
aggregate
of
all
amounts
each
of
which
is
an
amount
outstanding
at
that
time
as
or
on
account
of
a
debt
or
other
obligation
to
pay
an
amount
(A)
that
was
payable
by
the
corporation
to
a
person
who
was,
at
any
time
in
the
year,
(I)
a
specified
non-resident
shareholder
of
the
corporation,
or
(II)
a
non-resident
person,
or
a
non-resident-owned
investment
corporation,
who
was
not
dealing
at
arm's
length
with
a
specified
shareholder
of
the
corporation,
and
(B)
on
which
any
amount
in
respect
of
interest
paid
or
payable
by
the
corporation
is
or
would
be,
but
for
subsection
(4),
deductible
in
computing
the
corporation's
income
for
the
year,
(b)
"specified
non-resident
shareholder”
of
a
corporation
at
any
time
means
a
specified
shareholder
of
the
corporation
who
was
at
that
time
a
non-resident
person
or
a
non-resident-owned
investment
corporation,
and
(c)
“specified
shareholder"
of
a
corporation
at
any
time
means
a
shareholder
of
the
corporation
who
at
that
time,
either
alone
or
together
with
persons
with
whom
he
was
not
dealing
at
arm's
length,
owned
25
per
cent
or
more
of
the
issued
shares
of
any
class
of
the
capital
stock
of
the
corporation.
Subsection
18(4)
was
amended
in
1983
for
taxation
years
starting
after
November
12,
1981
as
shown
above.
The
clause
in
question
(18(4)(a)(ii)(C))
is
referred
to
as
the
“thin
capitalization
rule".
The
purpose
of
this
provision
is
clear:
to
prevent
corporations
from
being
undercapitalized
and
thus
relying
on
investment
by
debt
and
thus
being
able
to
deduct
interest
paid
on
debt
in
place
of
capital
contribution.
The
rationale
is
that
corporations
should
not
be
permitted
to
accumulate
debt
and
operate
solely
on
this.
Thus
a
certain
debtequity
ratio
is
required
by
the
Act.
Appellant's
position
Counsel
for
the
appellant
submitted
that
subsection
18(4)
was
enacted
to
ensure
that
companies
resident
in
Canada
with
significant
non-resident
shareholdings
(25
per
cent)
maintain
an
appropriate
level
of
equity
or
share
capital
investment
instead
of
relying
on
investment
by
debt.
This
measure,
in
his
submission,
was
necessary
because
the
government
needed
to
prevent
Canadian
companies
from
unduly
reducing
income
for
Canadian
tax
purposes
through
entitlement
to
deductions
on
account
of
interest
payments.
It
was
further
meant
to
avoid
additional
reduction
of
tax
because
interest
paid
to
the
non-resident
was
only
subject
to
the
15
per
cent
withholding
tax.
Therefore
subsection
18(4),
in
his
submission,
was
enacted
to
ensure
that
income
was
distributed
by
dividends
(Non-deductible)
rather
than
by
interest
payments
(Deductible)
through
the
maintenance
of
an
appropriate
level
of
share
capital.
Counsel
stated
that
a
result
of
making
the
changes
set
out
above
the
calculation
of
equity
was
"fundamentally
altered”
to
exclude
from
the
definition
of
"paid-up
capital”
any
capital
owed
by
a
person
other
than
a
"specified
non-resident
shareholder"
thus
changing
the
"general
nature"
of
the
provision.
Under
subsection
3(2)
of
the
Convention
Act,
provisions
of
the
convention
prevail
over
provisions
of
the
Act
where
there
is
an
inconsistency.
Therefore,
appellant's
counsel
submitted
that
paragraph
7
of
Article
XXV
of
the
convention
rendered
amended
subsection
18(4)
of
the
Act
inoperative.
The
interest
paid
by
a
Canadian
resident
to
an
American
resident
was
deductible
pursuant
to
paragraph
20(1)(c)
of
the
Act
as
if
paid
to
a
Canadian
resident.
Counsel
further
submitted
that
paragraph
8
of
Article
XXV
of
the
convention
does
not
affect
the
operation
of
paragraph
7
because
the
amendment
was
a
subsequent
“modification”
that
changed
the
"general
nature"
of
the
provision.
Counsel
cited
the
definition
of
modification"
in
Black's
Law
Dictionary,
6th
Edition:
A
change;
an
alteration
or
amendment
which
introduces
new
elements
into
the
details,
or
cancels
some
of
them,
but
leaves
the
general
purpose
and
effect
of
the
subject-matter
intact.
This
definition
was
adopted
in
Corpus
Juris
Secundum,
in
the
American
cases
of
Van
Deusen
v.
Ruth
(1938),
343
Mo.
1096
(Supreme
Court
of
Missouri)
and
Cass
County,
Iowa,
plaintiffs-appellants
v.
Board
of
Education
In
and
For
Cass
County
(1959),
250
Iowa
1107
(Supreme
Court
of
Iowa).
In
Canada
the
definition
of
“modification”
in
Black's
Law
Dictionary,
5th
Edition
was
the
same
and
was
cited
in
Re
Miramichi
Pulp
&
Paper
Inc.
&
Canadian
Paperworkers
Union,
Local
869
(1987),
29
L.A.C.
(3d)
48
(N.B.).
The
Court
was
told
that,
in
the
context
of
the
non-discrimination
nature
of
the
Article
and
the
exception
within
paragraph
8
itself,
no
extended
meaning
should
be
given
to
the
word
"modification".
The
amendment
could
not
be
characterized
as
an
alteration
merely
changing
details
of
the
existing
legislation
because
the
relationship
of
equity
to
debt
of
the
taxpayer
was
the
fundamental
element
of
subsection
18(4)
of
the
Act
as
it
existed
at
the
time
that
the
convention
came
into
force.
Counsel
argued
that,
in
relying
on
paragraph
8,
the
respondent
had
the
task
of
establishing
that
the
Amendment
was
a
"modification"
and
that
it
did
not
change
the
"general
nature"
of
subsection
18(4)
of
the
Act.
He
submitted
that
paragraph
8
used
the
words
"general
nature";
whereas,
all
other
examples
of
similar
provisions
used
the
words
"general
principle”.
He
submitted
that
this
choice
of
words
imposed
a
more
restrictive
test
since
it
was
possible
to
change
the
“general
nature"
without
necessarily
changing
the
"general
principle".
Therefore,
in
his
submission,
if
the
Amendment
was
a
“
modification”
and
it
did
not
change
the
"general
principle”
of
subsection
18(4),
it
nonetheless
changed
the
^general
nature"
of
the
subsection
by
changing
how
capital
is
computed
for
the
purposes
of
the
thin
capitalization
rules.
It
was
indicated
for
the
proposition
that
a
tax
treaty
is
to
be
interpreted
liberally
to
carry
out
its
purpose
of
double
taxation
that
reliance
could
be
had
on
a
number
of
cases
wherein
such
was
referred
to.
Counsel
mentioned
the
following:
Saunders
v.
M.N.R.
(1954),
11
Tax
A.B.C.
399,
54
D.T.C.
524
(T.A.B.);
Shahmoon
v.
M.N.R.,
[1975]
C.T.C.
2361,
75
D.T.C.
275
(T.R.B.);
Vauban
Productions
v.
The
Queen,
[1975]
C.T.C.
511,
75
D.T.C.
5371
(F.C.T.D.);
aff'd
[1979]
C.T.C.
263,
79
D.T.C.
5186
(F.C.A.);
Gladden
Estate
v.
The
Queen,
[1985]
1
C.T.C.
163,
85
D.T.C.
5188
(F.C.T.D.);
Scott
Estate
v.
The
Queen,
[1988]
1
C.T.C.
45,
88
D.T.C.
6012
(F.C.T.D.);
Vista
Wood
Estates
Ltd.
v.
M.N.R.,
[1989]
2
C.T.C.
2376,
89
D.T.C.
567
(T.C.C.).
A
passage
from
the
Saunders
case,
supra,
expresses
the
situation
and
is
found
at
page
399
(D.T.C.
526)
as
follows:
The
accepted
principle
appears
to
be
that
a
taxing
Act
must
be
construed
against
either
the
Crown
or
the
person
sought
to
be
charged,
with
perfect
strictness—so
far
as
the
intention
of
Parliament
is
discoverable.
Where
a
tax
convention
is
involved,
however,
the
situation
is
different
and
a
liberal
interpretation
is
usual,
in
the
interests
of
the
comity
of
nations.
Tax
conventions
are
negotiated
primarily
to
remedy
a
subject’s
tax
position
by
the
avoidance
of
double
taxation
rather
than
to
make
it
more
burdensome.
This
fact
is
indicated
in
the
preamble
to
the
convention.
This,
it
was
said,
is
what
is
present
in
this
case
under
appeal
and
accordingly
the
Court
should
hold
that
the
interest
payments
are
deductible.
Respondent's
position
Counsel
for
the
respondent
submitted
that
the
amended
section
of
the
Act
restricts
deductibility
because,
although
it
contravenes
paragraph
7
of
Article
XXV
of
the
convention,
it
was
in
force
at
the
time
that
the
convention
was
entered
into.
The
amendment
was
one
of
modification"
which
did
not
change
the
"general
nature"
of
clause
18(4)(a)(ii)(C)
of
the
Act.
In
his
submission,
the
amendment
was
a
"tightening
up"
of
the
rules
to
limit
ways
in
which
funds
can
be
transferred
between
Canada
and
the
United
States.
The
Shorter
Oxford
English
Dictionary
at
page
840
was
cited
for
the
following
definition
of
the
word
"general":
Pertaining
to
all,
or
most,
of
the
parts
of
a
whole;
completely
or
approximately
universal
within
implied
limits;
opp.
to
partial
or
particular.
[Emphasis
in
the
original.]
It
was
stated
that
this
had
to
be
read
in
conjunction
with
the
word
"modification".
Counsel
stated
that
in
Uddeholm
Ltd.
v.
The
Queen,
[1987]
2
C.T.C.
236,
87
D.T.C.
5431
(F.C.T.D.),
it
was
said
that
the
thin
capitalization
rules
were
a
"general
principle"
which
could
be
modified
accordingly.
Under
Gladden,
supra,
he
argued
that
the
liberal
interpretation
to
be
given
to
tax
treaties
must
only
be
used
to
ascertain
the
intent
of
the
parties
and
to
give
effect
to
the
intent
of
the
parties
when
the
agreement
was
entered
into.
Although
the
overriding
intent
may
be
looked
at,
counsel
submitted
that
the
particular
intent
with
respect
to
the
specific
provision
must
also
be
considered.
In
the
Tax
Management
International
Journal,
Vol.
19,
No.
1,
January
12,
1990,
an
article
entitled"Canada-U.S.
Tax
Practice”
by
Boidman
and
Gartner
set
out
at
page
35,
that
the
purpose
of
Article
XXV(7)
and
(8)
was
to
confirm
Canada's
right
to
apply
thin
capitalization
rules
to
an
American-owned
Canadian
subsidiary
notwithstanding
the
non-discrimination
rule
of
paragraph
7
of
the
Article.
The
excerpt
further
pointed
out
that
such
provisions
applied
to
both
parties
to
the
agreement.
There
was
added
the
caveat
that
provisions
such
as
subsection
18(4)
of
the
Act
which
relate
to
the
deductibility
of
interest
must
have
been
in
force
prior
to
the
date
of
signing
of
the
1980
convention,
or
must
be
non-substantive
modifications
of
such
pre-signing
provisions.
Counsel
pointed
out
that
the
"Technical
Explanation:
Canada-U.S.
Income
Tax
Convention
of
1980”
set
out
in
Stikeman,
Canada
Tax
Service
of
July
1986
mentions
that
notes
to
the
amending
protocols
were
dated
April
26,
1984,
and
as
a
result
such
reflected
the
opinions
of
the
drafters
after
the
amendment
was
enacted
and
at
page
5104
was
the
explanation:
.
.
.
accurately
reflects
understandings
reached
in
the
course
of
negotiations
with
respect
to
the
interpretation
and
application
of
the
various
provisions
in
the
1980
Tax
Convention
as
amended.
In
the
same
discussion
of
the
Technical
Explanation,
supra,
of
August
1986,
the
following
passage
is
found
at
page
5177:
Paragraph
8
provides
that,
notwithstanding
the
provisions
of
paragraph
7,
a
contracting
state
may
enforce
the
provisions
of
its
taxation
laws
relating
to
the
deductibility
of
interest,
in
force
on
September
26,
1980
[which
is
the
date
it
was
signed],
or
as
modified
subsequent
to
that
date
in
a
manner
that
does
not
change
the
general
nature
of
the
provisions
in
force
on
September
26,
1980;
or
which
are
adopted
after
September
26,
1980,
and
are
designed
to
ensure
that
non-residents
do
not
enjoy
a
more
favourable
tax
treatment
under
the
taxation
laws
of
that
state
than
that
enjoyed
by
residents.
Thus,
Canada
may
continue
to
limit
the
deductions
for
interest
paid
to
certain
non-residents
as
provided
in
section
18(4)
of
Part
I
of
the
Income
Tax
Act.
Analysis
In
1983
subsection
18(4)
of
the
Act
was
amended
to
take
effect
for
taxation
years
after
November
12,
1981.
The
purpose
of
the
amendment
was
to
prevent
corporations
from
being
undercapitalized
and
thus
relying
on
investment
by
debt.
As
a
result
a
certain
debt-equity
ratio
is
required
by
the
Act.
The
purpose
of
the
amendment,
on
the
other
hand,
is
more
contentious.
The
appellant
submitted
that
it
“fundamentally
altered”
the
calculation
of
equity.
The
test
was
changed
"from
a
three
to
one
debt
to
equity
ratio
to
a
three
to
one
debt
to
direct
equity
of
a
non-resident
ratio".
It
may
be
said
however
that
the
purpose
of
such
amendment
was
to
solve
this
problem:
corporations
resident
in
Canada
were
deducting
large
sums
of
interest
paid
to
their
American
parent
on
loans
from
the
parent;
such
income
was
consequently
sheltered
from
Canadian
tax,
except
for
the
15
per
cent
withholding
tax.
An
article
written
before
the
amendment,
by
Paul
Cantor
et
al,
"The
1982
Draft
Amendments:
Implications
for
International
Taxation”,
1982
C.R.
199,
demonstrates
the
opinion
of
the
Minister.
It
is
stated
at
page
243
that"there
are
no
changes
of
substance
created
by
the
addition
ana
modification
of
these
definitions”
[of
"specified
shareholders"
and
“non-resident
specified
shareholders"].
At
page
244,
the
changes
are
referred
to
as
a"tightening
of
the
thin
capitalization
rule".
Prior
to
the
amendment,
the
calculation
of
shareholders'
equity
consisted
of
the
aggregate
of
a
corporation's
retained
earnings,
its
contributed
surplus,
and
its
paid-up
capital.
The
amendment
restricts
the
inclusion
of
contributed
surplus
to
the
extent
that
it
is
contributed
by
a
specified
non-resident
shareholder.
The
paid-up
capital
now
must
be
in
respect
of
shares
owned
by
specified
non-resident
shareholders.
At
the
time
of
the
amendment,
definitions
of
"specified
shareholders",
both
resident
and
non-resident,
were
inserted
into
the
Act.
Subsection
18(4)
of
the
Act
ensures
that
companies
resident
in
Canada
with
25
per
cent
non-resident
shareholdings
maintain
an
appropriate
level
of
share
capital
to
prevent
the
Canadian
companies
from
unduly
reducing
income
for
Canadian
tax
purposes
through
deductible
interest
payments.
It
was
meant
to
ensure
that
income
of
the
company
was
distributed
through
dividends
thus
preventing
an
artificial
reduction
of
income.
The
amendment
altered
the
calculation
of
equity
in
clause
18(4)(a)(ii)(C)
to
exclude
from
the
definition
of
“paid-up
capital”
any
capital
owed
by
a
person
other
than
a
"specified
nonresident
shareholder".
It
is
important
to
examine
how
the
application
of
the
Canada-U.S.
Income
Tax
Convention
affects
the
changes
to
subsection
18(4)
of
the
Act.
The
convention
was
signed
on
September
26,
1980,
yet
was
subsequently
amended
by
protocols
dated
June
14,
1983
and
March
28,
1984.
The
convention
was
ratified
and
entered
into
force
on
August
16,
1984.
Article
XXX
(Entry
into
Force)
provides
in
paragraph
2
that
certain
Articles
would
apply
two
months
after
the
convention
came
into
force.
The
rest,
including
Article
XXV
would
apply
after
January
1
of
the
year
after
which
the
convention
came
into
force
which
would
be
January
1,
1985.
The
first
taxation
year
of
1985
brought
in
this
appeal
began,
in
fact,
on
November
30,
1984.
This
provision
would
only
apply
if
the
1984
year
were
affected
but
it
is
not
for
the
reasons
set
out
below.
Article
XXV(7)
Non-Discrimination
of
the
convention,
which
is
in
issue,
provides
in
part
that
interest,
among
other
things,
shall
be
deductible
if
paid
to
a
resident
of
the
other
contracting
state,
under
the
same
conditions
as
if
it
were
paid
internally.
This
also
holds
true
for
a
resident's
debts.
Article
XXV(8)
of
the
convention
allows
some
exceptions.
Pre-existing
legislation
on
the
deductibility
of
interest
is
grandfathered.
As
well,
subsequent
modifications
are
permitted,
as
long
as
they
do
not
change
the
general
nature
of
the
provisions.
The
legislation
may
also
be
modified
to
ensure
that
nonresidents
do
not
receive
more
favourable
tax
treatment
than
that
accorded
to
residents.
It
is
the
second
exception
that
is
crucial
in
this
appeal.
It
is
necessary
to
determine
if
the
1983
amendment
changed
the
“general
nature”
of
the
interest
deductibility
provisions.
Under
subsection
3(2)
of
the
convention
Act,
the
convention
prevails
over
the
Act
in
the
event
of
an
inconsistency.
Paragraph
7
of
Article
XXV
of
the
convention
provides
that
interest
payments
made
to
an
American
resident
are
deductible
under
the
same
conditions
as
those
made
to
a
Canadian
resident.
Paragraph
8
of
Article
XXV
of
the
convention
provides
that
paragraph
7
does
not
affect
the
operation
of
taxation
laws
of
Canada
relating
to
the
deductibility
of
interest
in
force
at
the
time
that
the
convention
was
entered
into
including
"subsequent
modifications"
that
do
not
change
the
“
general
nature"
of
such
provisions.
The
question
for
determination
is
whether
the
amendment
was
a
"modification"
which
changed
the
"general
nature"
of
clause
18(4)(a)(ii)(C)
of
the
Act.
As
set
out
above
counsel
for
the
appellant
explored
the
meaning
of
the
word"
modification"
at
some
length,
using
dictionaries
and
American
case
law.
"Modification"
is
considered
to
be
merely
a
partial
alteration
of
a
pre-existing
thing.
It
is
not
the
bringing
into
existence
of
something
new.
Nor
is
the
general
purpose
and
effect
of
the
subject
matter
changed.
The
Minister
relied
on
a
dictionary
definition
of"general",
as
set
out
above,
as
something
pertaining
to
most
of
something,
and
not
just
a
few
parts
of
it.
The
Minister
claimed
that
this
meaning
had
to
be
read
along
with
the
word
"modification"
in
order
to
obtain
the
full
meaning.
The
Minister's
contention
is
that
although
the
amendment
contravenes
Article
XXV(7),
it
remains
valid
because
it
was
already
in
force
at
the
time
the
convention
was
entered
into.
The
amendment
did
not
change
the
"general
nature"
of
the
provision.
It
was
merely
a
"tightening
of
the
rules",
and
did
not
change
their
substantive
content.
Counsel
for
the
Minister
argued
that,
when
interpreting
a
tax
treaty,
the
Court
may
consider
the
overriding
intent
of
the
agreement,
as
well
as
the
particular
intent
of
a
provision.
He
alleges
that
the
purpose
of
this
provision
was
to
ensure
that
non-residents
do
not
receive
more
favourable
tax
treatment
from
the
Canadian
government
than
do
Canadians.
However,
such
amendments
are
expressly
permitted
by
another
part
of
Article
XXV(8).
This
would
render
any
discussion
of
the
phrase
"general
nature"
unnecessary,
yet
the
Minister
discussed
this
at
length.
Paragraph
8
uses
the
words
"general
nature",
whereas,
all
other
examples
of
similar
provisions
use
the
words
"general
principle”.
This
may
be
a
more
restrictive
test
since
it
is
possible
to
change
the
"general
nature"
without
necessarily
changing
the
"general
principle".
Nonetheless,
the
word
"general"
must
be
closely
examined
and
read
in
conjunction
with
the
word
"modification".
The
Minister
relied
on
one
case
regarding
the
thin
capitalization
provisions:
Uddeholm,
supra.
The
facts
of
that
case
related
to
a
wholly-owned
subsidiary
(the
appellant)
of
a
Swedish
company.
The
appellant
was
indebted
to
the
parent
in
the
short
and
long
term,
for
goods
it
bought
from
the
parent
to
sell
in
Canada.
Although
the
parent
company
charged
interest
starting
on
the
first
day
of
the
month
following
delivery,
the
appellant
was
only
required
to
pay
interest
on
the
short-term
debt
every
four
months.
During
a
short
period
of
time,
the
total
of
long
and
short-term
debts
exceeded
three
times
the
taxpayer's
equity,
contrary
to
the
requirements
of
subsection
18(4)
of
the
Act.
The
Court
found
that
interest
was
in
fact
payable
from
the
first
day
of
the
month
following
delivery,
despite
the
arrangements
that
existed
between
the
parties.
The
ratio
during
those
few
days
triggered
the
thin
capitalization
provisions.
Madam
Justice
Reed
stated
at
the
outset
the
purpose
of
the
thin
capitalization
provisions
at
page
237
(D.T.C.
5432):
Those
provisions
are
directed
at
preventing
non-residents
of
Canada
who
own
significant
shareholdings
(generally
over
25
percent),
in
Canadian
resident
corporations,
from
withdrawing
the
profits
of
the
Canadian
corporation
in
the
form
of
interest
payments
rather
than
in
the
form
of
dividends
paid
on
the
shares
of
the
corporation.
She
then
quoted
from
the
CCH
Canadian
Tax
Service,
at
4423:
Both
interest
and
dividends
paid
to
non-residents
are
subject
to
withholding
tax
under
Part
XIII
but
since
interest
is,
but
for
the
limitation
in
subsection
18(4),
deductible
in
computing
the
income
of
the
resident
corporation
subject
to
Canadian
tax,
it
would
clearly
be
to
a
non-resident's
advantage
to
finance
the
operation
of
a
Canadian
resident
corporation
through
interest
bearing
debt
rather
than
through
share
capital,
which
would
lead
to
the
establishment
of
thinly
capitalized
corporations.
Although
this
case
is
helpful
for
determining
the
general
policy
of
these
provisions,
it
was
decided
on
the
section
the
way
it
stood
before
the
1983
amendment.
There
is
no
jurisprudence
on
this
amendment.
The
respondent
also
places
reliance
on
academic
writings
about
the
thin
capitalization
provisions.
These
articles
support
the
Minister's
position
that
the
amendment
is
only
a
"tightening
of
the
rules",
and
that
there
are
no
fundamental
changes.
This
is
implicitly
stated
in
an
article
by
Barry
W.
Pickford,
CA,
entitled
"New
Protocol
to
the
Canada-US
Income
Tax
Treaty:
Proposals
for
Change".
The
author
stated
at
page
41:20:
It
should
be
noted
that
article
XXV(8)(a)
of
the
current
treaty
generally
confirms
Canada’s
provisions
on
thin
capitalization
and
the
limitation
on
interest
deductibility
since
they
were
in
force
prior
to
the
signing
of
the
treaty.
This
article
appeared
in
1990;
it
implies
that
the
1983
amendments
did
not
change
the
“general
nature"
of
the
provisions,
and
therefore
do
not
fall
counter
to
the
non-discrimination
rule
of
Article
XXV.
While
this
is
not
a
legal
analysis
I
fully
agree
with
the
statement.
The
purpose
of
subsection
18(4)
of
the
Act,
has
not
changed.
It
has
simply
been
"tightened",
as
the
Minister
alleges.
The
goal
of
the
provision
always
has
been,
and
still
is,
to
prevent
thin
capitalization.
Parliament
was
of
the
impression
that
this
goal
was
not
being
met
by
the
old
provisions,
and
consequently
made
the
rules
stricter.
The
fact
that
a
different
phrasing
was
used
than
in
other
tax
treaties
is
worth
considering.
However,
even
though
"general
nature"
does
appear
to
be
broader
than”
"general
principle”,
I
conclude
that
neither
one
was
changed
by
this
amendment.
The
sources
cited
by
the
respondent
also
tacitly
support
this
conclusion.
See,
for
example,
the
Cantor
article,
supra.
Although
the
calculation
was
changed,
this
was
merely
to
make
the
provision
more
effective.
Certain
goals
were
not
being
met
by
the
existing
legislation.
Although
this
has
the
effect
of
placing
an
additional
burden
on
taxpayers,
it
is
not
necessarily
contrary
to
the
convention
for
that
reason.
This
is
especially
true
given
that
the
United
States,
the
only
other
party
to
this
treaty,
has
implemented
more
severe
measures.
It
would
be
difficult
to
contend
in
this
situation
that
the
Minister
may
not
invoke
this
section
whenever
American
taxes
are
involved.
This
would
make
Parliament's
role
of
creating
and
fine-tuning
legislation
impracticably
difficult.
Amending
treaties
is
a
difficult
and
time-consuming
process.
Subsection
18(4)
of
the
Act
is
a
thin
capitalization
provision.
Its
purpose
is
to
prevent
corporations
from
carrying
on
business
in
a
certain
way.
Within
this
purpose,
there
is
no
reason
why
Parliament
may
not
make
amendments
in
a
more
effective
manner
to
achieve
its
stated
goals.
Such
changes
must,
naturally,
be
reasonable.
If
they
are
done
in
such
a
way
as
to
circumvent
the
purpose
of
the
provision,
or
have
that
effect,
they
would
not
be
valid
without
an
amendment
of
the
convention.
However,
the
word"general"
found
in
both
“general
nature"
and
"general
principle”
shows
a
focus
on
the
whole
provision,
or
set
of
provisions,
in
question.
If
only
one
item
has
been
modified,
as
in
this
case,
it
is
unlikely
to
be
enough
to
change
the
situation.
The
impact,
or
the
form,
of
the
provision
must
be
substantially
altered.
Although
this
is
the
appellant's
contention
("fundamentally
altered”),
I
cannot
agree
with
it.
The
secondary
sources,
as
well
as
the
impracticalities
of
such
a
result,
and
the
words
"general
nature"
themselves,
lead
me
to
the
opposite
conclusion.
The
result
is
that
the
appeals
are
dismissed.
Appeals
dismissed.
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