Parthenon Investments Ltd. v. Her Majesty the Queen, [1993] 2 CTC 2872

St-Onge, T.C.C.J.:- The appeal of the company Parthenon Investments Ltd. was heard on June 8 and 9, 1993 in the City of Montreal, Province of Quebec, and the issue is whether the respondent was right in disallowing deductions of interests in the computation of the appellant's income for the 1985/ 86 and '87 taxation years.

At the hearing the question of sham was abandoned by the respondent. In his reply the respondent made the following assumptions of facts, subparagraph 9 and paragraphs 12, 13, 14, 16, 17 are an integral part of my judgment.

9. In the agreement dated November 13, 1984, the appellant accepted the transfer of rights of the note to Ottawa-Elgin.

12. The interest in respect of the said note has been included in Ottawa-Elgin's income for the same taxation years.

13. The Minister has disallowed such deduction of interest in the computation of the appellant's income for the 1985, 1986 and 1987 taxation years.

14. The issue to be decided is whether the interest in respect of the said promissory note is deductible in computing the appellant's income for the taxation years 1985, 1986 and 1987.

16. The interest paid in respect of the said promissory note by the appellant was properly deductible in computing its income for each of the said taxation years on interest paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.

17. The appellant is a Canadian controlled private corporation within the meaning of that expression in the Act and should be taxed accordingly.

According to the proceedings and the evidence adduced, the following facts are established:

1. The appellant's company was incorporated under the Quebec Com- panies Act and had its head office and principal place of business in Montreal;

2. The appellant's is a wholly-owned subsidiary of Pacific Canada;

3. Ottawa-Elgin Investment Ltd. a corporation having its head office and principal place of business in Ottawa is also a wholly owned subsidiary of Pacific Canada;

4. The appellant, its sister and parent company held real estate for rental purpose;

5. In its 1985 taxation year, the appellant declared a dividend to Pacific Canada in the amount of $2.6 million and substituted the debt thereby created by the issuance of a promissory note in the said account bearing interest at the rate of 12 per cent per annum.

6. The said promissory note was assigned by Pacific Canada to Ottawa-Elgin and the appellant did accept the assignment.

7. In filing its income tax returns for 1985, ‘ 86 and'87, Ottawa-Elgin included interest in respect of the said promissory note in its income.

Mr. Maurice Abdulezer is the general manager of the appellant company and was the controller of the three Canadian companies in the years under appeal.

He testified that:

1. All three Canadian companies were doing business in real estate for the purpose of rental income and have August 31 as the end of its fiscal period;

2. That the appellant company was a profitable one in the years under appeal and had realized a capital gain in 1985 in the amount of $489,474;

3. That the three companies involved to know Pacific Canada, Ottawa-Elgin Investment Ltd. and Parthenon Investment Ltd. were wholly owned by a U.S. company Pacific International Equities Inc. whereas the appellant company and Ottawa-Elgin were wholly owned by Pacific Canada;

4. Exhibits R-2, 3 and 4, the income tax returns of the appellant company show the amounts of $247,000, $312,000 and $377,681 as interest accrued and claimed as expenses in the financial statement for 1985, ‘86 and'87 respectively.

The witness also explained that the promissory note was actually paid in 1987 by the reduction of the amount owing (R-24). In their journal entries it was reported as income and receivable being, according to him, the normal method of reporting when the payment is not made in cash. Otherwise, it would be money received. And because the interest was not paid in each year, there was an additional charge for compound interest.

Exhibit R-24 prepared by the witness shows how the interests were calculated. This exhibit is an integral part of my judgment.

OTTAWA ELGIN — PARTHENON NOTE PAYABLE AND INTEREST 1985—1989

Payable by Parthenon to

Ottawa Elgin

			Note		Interest
			$		$
Issuance of note Nov '84 by Parthenon			$2,600,000
—Interest for period to Aug. 31/85
(288/365 x 12 per cent x $2,600,000)			—	$	247,000
Balance—August 31/85			2,600,000		247 ,000
Interest—Sept. 1/85—Aug. 31/86
(12 cent $2,600,000)			__:_"_		312,000
(12 per cent x $2,600,000)
Balance—August 31/86			2,600,000		559,000
Interest at 12 per cent for 1987
On $2,600,000 to Feb. 28/87		6/12			156,000
Repaid Feb. 23/87			(25,000)
On $2,575,000 to June 30/87		4/12			103,000
Repaid June 22/87 ($433,000 + 40,000)			(473,000)
On $2,102,000 to July 31/87		1712			21,020
Repaid July 31/87 ($800,000 + 2,000)			(802,000)
On $1,300,000 to Aug. 31/87		1/12			13,000
On $559,000 of interest due by Parthenon at Aug.
31/86 (interest on interest) 12 per cent x $559,000 +
12 per cent on average current years interest
(2982,0202 (A)			—		84,661
2
Balance—August 31, 1987			1,300,000		936,681
Repaid
Sept. 87	appear to be		(119,000)
Oct. 87	payments made by		(10,000)
March 88 Parthenon on behalf			(35,500)
April 88	of Ottawa-Elgin and		(35,000)
Unknown not by cheque directly to Ottawa-Elgin			(10,500)
Interest set-up to Aug. 31/88 and entered in books					262,231
Interest cancelled by auditors adjusting entry			—		(262,231)
Balance—Aug. 31/88			1,090,000		936,681
Balance forward			1,090,000		936,681
Repaid
Sept. 88	by cheque		(700,000)
Sept. 88	by transfer		(390,000)		(440,000)
Oct. 88	by cheque		-		(1,500)
	by transfer		—		(40,000)
Nov. 88	by cheque		—		(10,000)
	by net transfers		—		(9,000)
Dec. 88	by cheque
			—	(1,300,000)
	received by transfer		—		40,000
Jan. 89	received by cheque				10,000
Mar. 89	transfer				56,000
			—		56,000

Apr. 89	net transfers	—	548,000
May 89	net transfers	—	20,000
June 89	transfer	—	(42,000)
July 89	transfer	—	25,000
Balance—Aug. 31/89
Due to Parthenon		—	( $206,819)

The witness also explained that Ottawa-Elgin, because of vacancies, was in the loss position whereas the appellant company was in a tax position. Consequently, the directors were advised to use the loss company and the $2.6 million promissory note was transferred to Ottawa-Elgin. The income was declared by Ottawa-Elgin and accepted by the Minister.

The witness also testified that for the period from 1976 to 1989 books were missing and the resolution to declare dividend could not be located. Upon cross-examination, he said that all voting shares of the appellant company and Ottawa-Elgin were held by Pacific Canada whereas all the voting shares of the latter were held by Pacific U.S.; that the same persons were directors of the three Canadian companies and of the American companies; that Pacific U.S. had six other subsidiaries of which directors live in Florida; that Pacific U.S. was incorporated in U.S.; that as controller of the three Canadian companies; he was responsible for operating in Montreal and had nothing to do with the U.S. companies; that Ben and Charles Bedzow were Canadian citizens, Ben residing in U.S. and Charles in Canada; that Pacific U.S. did not carry any business in Canada because the major part of its business was the holding of three U.S. companies and that with respect to the payment of dividend and interest, the books are missing but with respect to the resolution to declare dividend he had seen it prepared even if he cannot tell the exact words of it.

Then A-4 and A-5 were filed to show the existence of the transaction. These documents are an integral part of my judgment.

A-4: The agreement made November 13, 1984 between Pacific International Equities Corp. herein called "Pacific" and Parthenon Investment Limited, herein called “Parthenon”.

1. Parthenon recognizes having declared at this date a dividend of $2,600,000 to its only shareholder, the company Pacific.

2. Parthenon recognizes having issued in payment of the dividend a promissory note with a par value of $2,600,000 bearing interest at 12 per cent.

3. Chaque soussigné reconnaît qu'il a exigé que ce qui précède soit rédigé en anglais et s’en déclare satisfait. And the parties have signed at Montreal, this 13th day of November 1984.

A-5: The agreement made November 13, 1984 between Pacific International Equities Corp., herein called “ Pacific” and Ottawa-Elgin Investments Limited, herein called "Ottawa" and Parthenon Investment Limited, herein called "Parthenon".

1. Pacific recognizes having received, on this day, a promissory note bearing interest at 12 per cent, in consideration for a dividend from its subsidiary Parthenon. This note has a par value of $2,600,000.

2. In consideration of prior material advances made by Ottawa to Pacific, the latter consents to give the said note of $2,600,000 to Ottawa.

3. By the present, Parthenon accepts the transfer of rights of Pacific’s note to Ottawa, and accepts that the interest on the said note be payable to Ottawa.

4. Ottawa accepts the transfer of the said note of $2,600,000 in its favor, and will decrease, by as much, its debt with Pacific.

5. Parthenon will repay, on demand, to Ottawa, the entire (or part of the) note and the accrued interest.

6. Chaque soussigné reconnaît qu’il a exigé que ce qui précède soit rédigé en anglais et s'en déclare satisfait. And the parties have signed at Montreal, this 13th day of November 1984.

A-4 and A-5 were signed by Charles Bedzow for all the companies. In the balance sheet of Ottawa-Elgin for 1985 the liability was shown by a reduction of the asset of $2.6 million. No cash changed hands and a liability was substituted for another one. As may be seen, the note and assignment were made the same day.

The witness admits that the appellant company did not have the cash available to pay the dividend and did not borrow any money but added that even if all the properties were mortgaged, the market value was higher than the book value.

With respect to the repaid amount of $25,000 in Exhibit R-24, he does not recall having seen the cheque but insisted on the fact that it was not a forgiveness or a write-off.

With respect to the second page of Exhibit R-24, he stated that when it is marked by cheque or by transfer, he has seen the cheque or the transfer slip. Finally he admitted that by declaring the interest as income in 1985, '86, 87, Ottawa-Elgin did not change anything, its income was nil because of prior losses. Whereas for the appellant company, the amount of interest in 1985, ‘ 86 and'87, would have been an income instead of an expense.

In redirect, the witness said that at no time was Pacific Canada a public company; that the accountants in their comments never said that the method of reporting income was improper; that the transfer of promissory note was an assignment for value and not a forgiveness; that there was no borrowing from a third party; that the figures in Exhibit R-24 were taken from the books of the company and that the transactions should be looked at as an economic whole.

Counsel for appellant argued that since the respondent abandoned the question of sham, the alleged transaction of the appellant did occur; that even if the minutes books were lost and the resolution to declare dividend was not found and filed, the witness has seen it and dividend was in fact declared and paid. It was a legal promissory note even if the terms of payment were not mentioned. The interests were accrued in the years and paid in 1988 and there was no forgiveness or write-off. The books' income tax returns and financial statements are consistent and by the abandonment of sham the transaction did occur.

According to him, the respondent did not introduce any evidence to prove his allegation. His sole witness was not called to testify and his allegations have no foundation.

His paragraph 10 of the reply was only written to colour the transactions and R-1 and R-2 clearly show that there was cash available to prevent impairment of capital. Mr. Kuzak's testimony was contradicted with respect to the insinuation that the transactions were not real and his assessment was incorrect. Then he refers to Stubart v. M.N.R., [1984] 1 1S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305. For the utilization of losses within a corporate group. The transactions under appeal are not offensive, on the contrary they are within the spirit of the legislation and the interpretation bulletins. To him the real question is whether the interest is deductible under paragraph 20(1)(c) of the Act. The promissory note did create an obligation to pay and the interest was payable in the year and was accrued the appellant being on an accrued basis method. The appellant declared a dividend when its retained earnings were close to $2.6 million and there is no obligation for a company to maintain a surplus; and if they impaired the capital, the directors would be personally responsible; consequently the nullity would not be absolute but only relative.

Because the obligation to pay a dividend was extinguished by the note between the appellant and its sister company, it did create a debtor-creditor relationship with the obligation to pay money on demand with interest. According to him, the money needed was borrowed in the corporate group and it was used in the course of its business. Consequently paragraph 20(1)(c) was met.

Counsel for respondent gives to the Court a written submission to follow.

Pages 8 to 20 of the said submission are an integral part of my judgment.

Il. The issues

27. The issues in this appeal are twofold:

(1) Was the appellant in its 1985, 1986 and 1987 taxation years a "Canadian- controlled private corporation” within the meaning of paragraph 125(7)(b) of the Income Tax Act, so as to be entitled to claim the deductions provided in subsection 125(1) of the Income Tax Act [R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act")]?

(2) Was the interest on the alleged promissory note that was accrued as payable in its 1985, 1986 and 1987 taxation years in the amounts of $247,000, $312,000 and $377,681, respectively, deductible by the appellant in computing its income for those years?

III. Argument

Canadian-controlled Private Corporation

28. On the undisputed evidence all of the appellants issued voting shares in the 1985, 1986 and 1987 taxation years were owned by Pacific International Equities Corporation and all of the issued voting shares of that company were owned in those years by a nonresident of Canada, i.e., Pacific International Equities Inc.

29. Control of a corporation rests in the owners of the majority of the voting power in it. M.N.R. v. Dworkin Furs (Pembroke) Ltd., [1967] S.C.R. 223, [1967] C.T.C. 50, 67 D.T.C. 5035, at pages 227-28 (C.T.C. 52-53; D.T.C. 5036).

30. The respondent therefore submits that in law the appellant was at the material times indirectly controlled by a nonresident of Canada and was thus not a "Canadian-controlled private corporation", within the meaning of paragraph 127(7)(b) of the Income Tax Act.

31. In the respondent's submission, it is immaterial that at the material times the appellant may have been ultimately indirectly controlled by a resident of Canada, i.e., through Mr. Charles Bedzow's ownership of the shares of F.M.E. Holdings Ltd. For paragraph 127(7)(b) of the Income Tax Act does not require ultimate control as a test of indirect control. Produits Alimentaires Anco (1961) Inc. v. M.N.R., [1979] C.T.C. 2669, 79 D.T.C. 573 (T.C.C.).

32. The respondent accordingly submits that since the appellant was not a Canadian-controlled private corporation during its 1985, 1986 and 1987 taxation years, within the meaning of paragraph 125(7)(b) of the Income Tax Act, it was not entitled to the small business deduction provided by subsection 125(1) of the Income Tax Act.

Deductibility of Interest

33. The respondent submits that the interest on the alleged promissory note is not deductible by the appellant, because:

(a) it does not meet the requirements of subparagraph 20(1)(c)(i) of the Income Tax Act, and

(b) alternatively, even if it does, its deduction is prohibited by subsection 245(1) of the Income Tax Act.

Subparagraph 20(1) (c)(i)

34. Interest is generally a payment on account of capital, whose deduction is prohibited by paragraph 18(1)(b) of the Income Tax Act and is deductible, if at all, only if it meets the requirements of paragraph 20(1)(c) of the Act. Canada Safeway Ltd. v. M.N.R., [1957] S.C.R. 717, [1957] C.T.C. 335,57 D.T.C. 1239 at page 727 (C.T.C. 344-45, D.T.C. 1244); The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059 at C.T.C. page 124 (D.T.C. 5064); The Queen v. MerBan Capital Corp. Ltd., [1989] 2 C.T.C. 246, 89 D.T.C. 5404 (F.C.A.) at 258 (D.T.C. 5412); B o water Canadian Ltd. v. The Queen, [1987] 2 C.T.C. 47, 87 D.T.C. 287 (F.C.A.), at pages 52-56 (D.T.C. 5291-94); and D.W.S. Corp. v. M.N.R., [1968] C.T.C. 65, 68 D. T.C. 5045 (Ex. Ct.) at pages 72-73 (D.T.C. 5050).

35. While the modern approach to statutory interpretation should not ignore commercial realities, this does not mean that provisions, such as subparagraph 20(1)(c)(i) of the Income Tax Act which by their very text are made available to taxpayers in limited circumstances are to lose their strictures. The Queen v. Bronfman Trust, supra, at C.T.C. pages 128-29 (D.T.C. 5067).

36. The respondent therefore submits that unless the interest that was accrued by the appellant as payable on the alleged promissory note falls squarely within the ambit of subparagraph 20(1)(c)(i) of the Income Tax Act, it is not deductible by the appellant.

37. In the respondent's submission, none of the requirements of subparagraph 20(1)(c)(i) of the Income Tax Act, have been met by the appellant;

(a) It is clear from the evidence that no money was borrowed by the appellant on which it might be said interest was payable. Assuming that Pacific International Equities Corp. did become entitled to receive $2.6 million from the appellant by way of dividends and that the appellant's obligation to pay them was substituted by another obligation constituted by the alleged promissory note, any interest that became payable by the appellant thereon became payable by virtue of a debtor-creditor relationship, rather than by virtue of a borrower-lender relationship, between the appellant and Pacific International Equities Corp. or its assignee, Ottawa Elgin Investments Ltd.

(b) In the respondent's submission, the borrowing requirement of subparagraph 20(1)(c)(i) of the Income Tax Act contemplates, at least initially, that a borrower-lender relationship come into existence between the claimant and another person; it is impermissible to ignore this plain requirement and substitute therefor a mere debtor-creditor relationship. See: Stock Exchange Building Corp. v. M.N.R., [1955] S.C.R. 235, [1955] C.T.C. 5, 55 D.T.C. 1014, at pages 242-43 (C.T.C. 9, D.T.C. 1015); and The Queen v. MerBan Capital Corp., supra, at pages 258-59 (D.T.C. 5412-13).

(c) In addition to the requirement that the interest sought to be deducted must be paid or payable pursuant to a legal obligation to pay interest on borrowed money, subparagraph 20(1)(c)(i) of the Income Tax Act further stipulates that such borrowed money must be used for the purpose of earning income from a business or property, and

(i) the use of the borrowed money to earn income from a business or property must be direct: a mere causal connection between the use of the money and any benefit ultimately received is insufficient: Canada Safeway Ltd. v. M.N.R., supra, at pages 724-25 (C.T.C. 342, D.T.C. 1243). The Queen v. Bronfman Trust, supra, at C.T.C. page 126 (D.T.C. 5065).

(ii) the borrowed money must be used for the borrower's own business or property and not that of another person: Canada Safeway Ltd. v. M.N.R., supra, at page 728 (C.T.C. 345-46, D.T.C. 1244-45). D.W.S. Corp. v. M.N.R., supra, at 73 (D.T.C. 5050-51).

(iii) Income from a business or property" in subparagraph 20(1)(c)(i) of the Income Tax Act describes income from a source and I is synonymous with profit or a reasonable expectation of profit, and not revenue, hence if the pursuit for which borrowed funds are used is incapable of producing a profit, it is not a source of income, and the interest paid for borrowed money used in such a pursuit is not used for the purpose of earning income. Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, at page 485 (S.C.R., C.T.C. 313, D.T.C. 5215); Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096 at 143 (D.T.C. 5098) (Ex. Ct.); The Queen v. Bronfman Trust, supra at C.T.C. page 126 (D.T.C. 5067); and D./M.N.R. (Quebec) v. Lipson, [1979] 1 S.C.R. 833, [1979] C.T.C. 247, at page 839 (C.T.C. 250).

(iv) Income" or" profit” for income tax purposes is the difference between receipts from a business or property and the expenditures laid out to earn those receipts, and since tax is imposed on such income or profit, the profits must be made before the tax can come into existence, as the tax is the Crown's share of the profits which have been made. M.N.R. v. Anaconda American Brass Ltd., [1955] C.T.C. 311, 55 D.T.C. 1220 (P.C.) at page 319 (D.T.C. 1224); Roenisch v. The Queen, [1928-34] C.T.C. 69, 1 D.T.C. 199 (Ex. Ct.), at page 70 (D.T.C. 200); and Moloney v. The Queen, [1992] 2 C.T.C. 227, 92 D.T.C. 6570 (F.C.A.), at pages 227-28 (D.T.C. 6570).

(d) On the evidence, the $2.6 million on which the interest of $247,000, $312,000 and $377,681 was accrued as payable was clearly not used by the appellant to earn income from its business or property. This $2.6 million was from the beginning and remained thereafter a mere burden of the appellant, rather than a receipt of funds from whatever source. Nor was this $2.6 million capable of producing a pretax profit for the appellant. While the accrual of the interest on the alleged promissory note might have produced a financial benefit for the appellant, this could only have been so if that interest was deductible for income tax purposes; in other words, such a benefit could only come out of the Crown's share of the appellant's profits — an endeavour that might more appropriately be described as an attempted raid on the Crown's treasury rather than as a business undertaking.

Ministerial Policy in making Income Tax Assessments

38. Interpretation Bulletins and Information Circulars issued by the Department of National Revenue, Taxation, contain Departmental interpretations of various provisions of the Income Tax Act. They do not have the force of law and cannot alter it. They might, in areas of ambiguity as to the meaning of provisions of the Income Tax Act, be of assistance in interpreting them: Harel v. Deputy Minister of Revenue (Quebec), [1978] 1 S.C.R. 851, [1977] C.T.C. 441, 77 D.T.C. 5438 at pages 858-59 (C.T.C. 447-48, D.T.C. 5441-42); Nowegijick v. The Queen, [1983] 1 S.C.R. 29, [1983] C.T.C. 20, 83 D.T.C. 5041, at page 37 (C.T.C. 24, D.T.C. 5044)

39. The respondent submits that in light of the ample and authoritative interpretation of subparagraph 20(1)(c)(i) of the Income Tax Act already submitted, there can be no doubt whatever as to its meaning. Any Interpretation Bulletins and Circulars relied upon by the appellant can therefore not be accorded any higher status than the expression of opinions regarding the legal meaning of that provision that can have little weight in the adjudication of assessments made under it. See: Scott v. M.N.R., [1989] 1 C.T.C. 2305, 89 D.T.C. 218 (T.C.C.), at page 2307 (D.T.C. 220).

40. Furthermore, none of the Interpretation Bulletins and Information Circulars address the fact situation in the present case, so that their status is in any event academic to the adjudication of this Appeal.

41. The respondent submits that the "Advance Tax Rulings”, "Roundtable Discussions" and Information replies given to anonymous taxpayers' inquiries can similarly be nothing more than Ministerial or Departmental opinions as to the applicability of particular provisions of the Income Tax Act to particular hypothetical facts and expressions of intentions about how assessments may be made. The matter is, however, in any event academic to the adjudication of the present appeal, as none of these documents relied upon by the appellant specifically address the facts in the present case and could therefore not be said to be binding on the Minister of National Revenue.

42. Assuming, however, that it could be said that in making the assessments under appeal the Minister of National Revenue somehow contravened any general assessing policy that “bound” him, it is submitted that such a finding would be totally irrelevant to the adjudication of the correctness of these assessments.

43. For it has been amply established that an appeal from an income tax assessment is an appeal from the amount of the tax that has been assessed, and not from the reasons of the Minister of National Revenue in making it, or from his calculation of the tax or otherwise from the thought processes that actuated him in arriving at it, and the Court's jurisdiction is limited to adjudicating upon the correctness of the amount of the income tax that has been assessed. Harris v. M.N.R., [1964] C.T.C. 562, 64 D.T.C. 5332 (Ex. Ct.), at page 571 (D.T.C. 5337); Vineland Quarries and Crushed Stone Ltd. v. M.N.R., [1970] C.T.C. 12, 70 D.T.C. 6043 (Ex. Ct.) at pages 15-16 (D.T.C. 6045); M.N.R. v. Minden, [1962] C.T.C. 79, 62 D.T.C. 1044 (Ex. Ct.), at page 89 (D.T.C. 1050); The Queen v. Riendeau, [1991] 2 C.T.C. 64, 91 D.T.C. 5416 (F.C.A.), at page 65 (D.T.C. 5417); The Queen v. Consumers’ Gas Co., [1987] 1 C.T.C. 79, 87 D.T.C. 5008 (F.C.A.), at pages 83-84 (D.T.C. 5012); The Queen v. Bowater Mersey Paper Co. Ltd., [1987] 2 C.T.C. 159, 87

D. T.C. 5382, (F.C.A.), at page 161 (D.T.C. 5383); The Queen v. Simard-Beaudry Inc., [1971] F.C. 396, 71 D.T.C. 5511 (T.D.), at page 5515 (F.C. 403); Okalta Oils Ltd. v. M.N.R., [1955] S.C.R. 824, [1955] C.T.C. 271, 55 D.T.C. 1176, at page 825 (S.C.R.,

C. T.C. 273, D.T.C. 1177); The Queen v. Garry Bowl Ltd., [1974] C.T.C. 457, 74 D.T.C. 6401 (F.C.A.); and Income Tax Act, subsections 152(1), 152(3), 152(8), 165(1), 165(3), section 169 and subsection 171(1).

44. The respondent submits that redress from ministerial conduct that is alleged to be contrary to Ministerial policy or undertakings given is available, if it is available at all, only by way of judicial review in the Federal Court of Canada. However, the Federal Court Act expressly deprives that Court of any judicial review jurisdiction with respect to income tax assessments, and the Tax Court of Canada has no judicial review jurisdiction at all, its jurisdiction being confined to an adjudication of the amount of tax assessed, as is that of the Federal Court of Canada. Federal Court Act, R.S.C. 1986, c. F-8, sections 18, 29 as amended by S.C. 1990, c. 8, sections 18, 18.5; M.N.R. v. Parsons, [1984] C.T.C. 352, 84 D.T.C. 6345, at pages 352-53 (D.T.C. 6346) (F.C.A.); McMillen Holdings Ltd. v. M.N.R., [1987] 2 C.T.C. 2327, 87 D.T.C. 585 (T.C.C.), at page 2336 (D.T.C. 591-92).

Subsection 245(a) — Artificiality

45. The respondent submits in the alternative that if the appellant could be said to meet the requirements for the deductibility of the interest accrued on the alleged promissory note that are imposed by subparagraph 20(1)(c)(i) of the Income Tax Act, its deductibility was nevertheless barred by subsection 245(1) of the Act, because it was a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce its income.

46. A transaction which lacks commercial reality and is entered into solely for the purpose of avoiding the payment of income tax may attract the sanction of subsection 245(1) of the Income Tax Act. Stubart Investments Ltd. v. The Queen, [1984] 1S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, at page 579 (C.T.C. 316, D.T.C. 6323); and Consolidated Bathurst Ltd. v. The Queen, [1987] 1 C.T.C. 55, 87 D.T.C. 5001 (F.C.A.), at page 62-63 (D.T.C. 5006).

47. Thus any artificiality in a transaction may taint the deductibility of a disbursement or expense resulting from it. Shulman v. M.N.R., [1961] C.T.C. 385, 61 D.T.C. 1213 (Ex. Ct.), at page 400 (D.T.C. 1221); aff'd 62 D.T.C. 1166 (S.C.C.); Harris v. M.N.R., [1966] S.C.R. 489, [1966] C.T.C. 226, 66 D.T.C. 5189, at page 505 (C.T.C. 241, D.T.C. 5198); and Seramco Ltd. Superannuation Fund Trustees v. Income Tax Commissioner, [1976] 2 All E.R. 28, [1977] A.C. 287 at page 35 (A.C. 297-98) (P.C.).

48. To begin with, the respondent submits that a serious doubt exists whether the appellant's directors had any intention to declare a dividend, or if there was, whether there was an intention to pay it or to pay interest thereon. Certainly, no interest was never in fact paid. While Mr. Abdulezer testified that the principal amount of the alleged promissory note was "repaid" by 1988, there is no concrete evidence before the Court that this was what in fact happened.

49. The appellant did not have the means to pay such a dividend short of borrowing the funds or selling most of its assets, neither of which in fact occurred. This dividend demonstrably put the capital account of the appellant into a deficit position, contrary to the prohibition of such a result imposed by subsection 79(1) of the Quebec Companies Act. Exhibit R-2 (Statement of Retained Earnings (Deficit)) Companies Act, R.S.Q., c. C-38, subsection 79(1).

50. The respondent submits that the appellant's obligation, if any, to pay such a dividend was unenforceable against it. For the courts will not enforce a right founded on breaches of public policy or of a statute. Chitty on Contracts, 24th ed., pages 416-22.

51. Nor was the enforceability of such an obligation enhanced by its replacement by the alleged promissory note. For it is the respondent's submission that the alleged promissory note was not a promissory note at all, but rather a mere acknowledgement or an indebtedness.

52. À promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed or determinable future time, a sum certain in money to, or to the order of, a specified person or to its bearer. Bills of Exchange Act, R.S.C. c. B-4, subsection 176(1).

53. A mere implication that payment may be made is insufficient to constitute an instrument a promissory note. Palmer v. McLennan (1873), 22 U.C.C.P. 565, at page 572 (C.A.).

54. Semble, a mere acknowledgement of indebtedness. Poirer v. Dumoulin (1936), 61 Que. K.B. 429 and 431-32 (C.A.); Choquette v. Viau (1925), 63 Que. S.C. 529, at pages 530-31; Byles on Bills of Exchange, 25th ed., page 325.

55. In the respondent's submission, the alleged promissory note in the present case is clearly a mere acknowledgement of indebtedness, as there is no express promise to pay the amount in question.

56. Assuming, however, that the alleged promissory note was in fact and law a promissory note, Ottawa Elgin Investments Ltd. to which it was purportedly endorsed was not a holder in due course, as it, in the person of Mr. Charles Bedzow, had notice of the illegality of the dividend declared by the appellant (also in the person of Mr. Charles Bedzow).

57. All these transactions, beginning with the alleged declaration of the dividend and ending with the accrual and nonpayment of interest were on the evidence not entered into for the purpose of commercial gain, but rather for the purpose of consolidating the profits and losses of the appellant, Pacific International Equities Corporation and Ottawa Elgin Investments Ltd. in order to avoid the payment of income tax.

58. For all these reasons the respondent therefore submits that these transactions giving rise to the deduction of the interest were artificial, within the meaning of subsection 245(1) of the Income Tax Act.

59. The respondent appreciates that in order for disbursements or expenses to be prescribed by subsection 245(1) of the Income Tax Act it is not sufficient that they arise from artificial transactions, they must also unduly, i.e., significantly in a quantitative sense, or artificially, reduce the claimant's income. The Queen v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106, at page 360 (D.T.C. 5113-14) (F.C.A.).

60. In the present case, the interest deductions of $247,000 and $312,000 converted what would otherwise have been pre-income tax profits of the appellant in the amount of $129,752 in its 1985 taxation year and $262,904 in its 1986 taxation year to losses of $117,248 and $49,096, respectively. In its 1987 taxation year the interest deduction of $377,681 reduced the appellant's pre-income tax profits from the $425,291 they would otherwise have been to $47,610. In the respondent's submission such large eliminations or reductions of the appellant's pre-income tax profits are quantitatively significant and are therefore undue.

61. For all of the foregoing reasons the respondent submits that the interest in issue is not deductible in computing the appellant's income for its 1985, 1986 and 1987 taxation years, and that the appellant's appeal should accordingly be dismissed with costs. ALL FOR WHICH is respectfully submitted.

According to the evidence adduced, it is obvious that the relationship between the appellant company and Ottawa-Elgin is a debtor-creditor relationship. There is no evidence whatsoever to show that the appellant company borrowed money to be used for the purpose of earning income from a business or property because:

1. Nothing shows that there was a borrower-lender relationship;

2. Nothing shows that the borrowed money was used directly in the appellant owned business;

3. On the contrary, what happened was for the benefit of another taxpayer;

4. The Income Tax Act describes income from a source and is synonymous with profit or unreasonable expectation of profit.

So if borrowed funds used is incapable of producing profits, it is not a source of income and consequently not used for the purpose of earning income. As may be seen, the appellant is far from meeting the requirements of paragraph 20(1)(c). The Court should not BO too far from basic principle in income tax. The exemption provisions of a taxing act must be construed strictly, taxation is the rule and exemption the exception, Sheppard Pen v. M.N.R. (1953), 53 D.T.C. 1223. In order to benefit from paragraph 20(1)(c) the appellant should fall squarely within the full corners of the said section.

In the light of the decision cited by counsel for the respondent, the appeal is dismissed. In view of my decision on paragraph 20(1)(c) there is no need to deal with the other issues, to know:

1. Was the appellant in its 1985, '86, '87 taxation years a Canadian controlled private corporation within the meaning of paragraph 125.7(b) of the Act so as to be entitled to claim the deduction provided in subsection 125(1) of the Income Tax Act.

2. Were the transactions giving rise to the deduction of the interest, artificial and unduly reducing the appellant's income.

Consequently, for the above reasons, the appeal is dismissed with costs.

Appeal dismissed.