Her Majesty the Queen v. H. Boris Antosko and Stanley F. Trzop, [1990] 1 CTC 208, 90 DTC 6111

McNair, J.:—These actions are appeals by the plaintiff, pursuant to sections 172 and 175 of the Income Tax Act, from a judgment of the Tax Court of Canada delivered on July 23, 1985, which allowed the defendants' appeals from reassessments of their income for the 1977 taxation year and, in the case of the defendant Stanley F. Trzop, the 1980 taxation year as well. By consent, the actions were tried together on common evidence. The central issue posed is whether the defendant taxpayers are entitled to deduct interest payments received by them in the taxation years in question, pursuant to the deduction provisions of subsection 20(14) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended.

Atlantic Forest Products Ltd., whose name was subsequently changed to Resort Estates Ltd. (hereinafter sometimes referred to for convenience as "the Company"), was the owner and operator of a plant for the production of charcoal briquettes at or near Minto, New Brunswick. Loans were made to the Company by the Province of New Brunswick through its governmental agency, New Brunswick Industrial Finance Board (hereinafter sometimes referred to for convenience as "the Board”). The Board became the controlling shareholder of the Company, holding 80 per cent of its issued and outstanding shares, as part security for loans. On or about September 1, 1976, the Board ceased to exist as a statutory corporation and its role was assumed by the Department of Commerce and Development of the Province of New Brunswick.

In February and March of 1971 the Board was authorized by orders in council to guarantee a bank loan of $3,000,000 from the Bank of Nova Scotia to the Company. On March 31, 1971 Atlantic Forest Products Ltd. executed in favour of New Brunswick Industrial Finance Board a fixed and floating charge debenture securing the Board's guarantee of the $3,000,000 bank loan. The debenture contained the usual covenants, one of which was a covenant on the part of the Company to repay all outlays made by the Board to protect its security thereunder, together with interest thereon at the current rate. The Company covenanted to repay the guaranteed loan according to a repayment schedule contained in recitals to the debenture. There was a further proviso that in the event of default by the Company in repayment of the principal instalments due under the guaranteed loan and interest thereon, the Board could pay to the bank such amounts in default and any payments so made by the Board would constitute a further charge on the lands and premises charged by the debenture.

Over the period from January 27,1972 to July 23,1973 the Board made direct loans to the Company totalling $1,425,000, all of which were authorized by orders in council. These direct loans were evidenced by four demand promissory notes from the Company to the Board for the following principal amounts and interest, such interest being payable monthly, namely:

In September of 1974 the Company defaulted on its obligations to the Bank of Nova Scotia in respect of the guaranteed loan with the result that the Board was constrained to make good on its guarantee. On October 3, 1974 the province on behalf of the Board paid to the Bank of Nova Scotia the sum of $3,375,000 in full of the outstanding principal and interest payable by the Company to the bank. By March 1, 1975 the total principal indebtedness of the Company to the Board was approximately $5,000,000, together with accrued interest thereon. The situation looked bleak indeed, when help suddenly appeared in the persons of Messrs. Antosko and Trzop, both of whom were professional engineers with an entrepreneurial flair and former university classmates. They were willing to provide the necessary expertise and working capital to revitalize the Company and get it back on a viable track. The result was an agreement dated March 1, 1975 made between the Board and Mr. Antosko and Mr. Trzop as purchasers, whereby the latter acquired all the Board's common shares in the capital stock of the Company at the price of $1. In return, the Board covenanted to cause the Company to be debt free, save for the present indebtedness of approximately $5,000,000 and accrued interest thereon owing by the Company to the Board. The Board further undertook to postpone the repayment of this indebtedness for a period of two years so long as the purchasers commenced and continued to make reasonable efforts to operate the Company in a good and businesslike manner during this period. Upon expiration of the two-year period, the Board committed itself to sell to the purchasers for the sum of $10 "the mortgages, chattel mortgages, debenture and other like securities in the principal amount of approximately $5,000,000 and interest accruing thereon", provided the purchasers complied with their obligation to operate the Company in a businesslike manner during the postponement period. On July 6, 1977 the Board sold to Mr. Antosko and Mr. Trzop for the consideration aforesaid the total indebtedness of the Company to the Board in the approximate principal amount of $5,000,000 and accrued interest thereon. On the same day, the Minister of Commerce and Development of the Province of New Brunswick executed assignments to them of the debenture and a realty mortgage, followed by the assignment of a chattel mortgage, all of which had been given as security for the Company's outstanding indebtedness to the Board.

The income tax returns of each defendant for the 1977 taxation year reported $38,335 as accrued interest income on securities purchased and the deduction of the same amount pursuant to subsection 20(14) of the Act. By notices of reassessment dated December 16, 1980 the Minister of National Revenue disallowed these deductions of $38,335 from the taxpayers' incomes for the 1977 taxation year.

In computing his income for the 1980 taxation year, the defendant Stanley F. Trzop similarly sought to deduct the accrued interest amount of $283,363. By notices of reassessment dated November 4, 1982 and November 9, 1983 the Minister disallowed the deduction of that amount.

Essentially, the Minister based his reassessments on the following factual assumptions, namely:

(1) the Board, as transferor of the obligations and accrued interest, did not include in its income the amounts sought to be deducted for accrued interest;

(2) in computing their incomes for the taxation years in question, the defendants were not entitled to deduct the amounts of accrued interest as the transferor of the obligations did not include those amounts in its income for the year;

(3) all accrued interest on the obligations of the Company transferred by the Board to the defendants became payable coincidental to the transfer, except to the extent of interest accruing for the last monthly period commencing before the date of transfer and ending after that date; and

(4) the proportion of the interest accruing for the last monthly period commencing before the date of the transfer and ending after that date that the number of the days in the portion of the period that preceded the day of transfer was of the number of days in the whole period was $3,325.

The legal bases of the reassessments are contained in paragraph 12(1)(c) and subsection 20(14) of the Income Tax Act, which read as follows:

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(c) any amount received by the taxpayer in the year or receivable by him in the year (depending upon the method regularly followed by the taxpayer in computing his profit) as, on account or in lieu of payment of, or in satisfaction of, interest.

20. (14) Where, by virtue of an assignment or other transfer of a bond, debenture or similar security (other than an income bond or an income debenture), including for greater certainty an assignment or other transfer after June 18, 1971 of a bill, note, mortgage, hypothec or similar obligation, the transferee has become entitled to interest in respect of a period commencing before the time of transfer and ending after that time that is not payable until after the time of transfer, an amount equal to that proportion of the interest that the number of days in the portion of the period that preceded the day of transfer is of the number of days in the whole period

(a) shall be included in computing the transferor's income for the taxation year in which the transfer was made, and

(b) may be deducted in computing the transferee's income for a taxation year in the computation of which there has been included

(i) the full amount of the interest under section 12, or

(ii) a portion of the interest under paragraph (a).

Notwithstanding that the appeal was by the Crown, the case proceeded on the normal footing that the taxpayer still had the initial onus of demolishing the assumptions on which the reassessments were based. Defendants' counsel argued forcibly that there was an assignment to the taxpayers of a debt on which interest was accruing, despite the two-year deferral, to which they became fully entitled following upon the actual transfer on July 6, 1977. In his submission, this clearly met the situation envisaged by subsection 20(14) of the Act. Furthermore, he stressed the fact that the interest on the outlay of $3,375,000 paid on the guaranteed bank loan became fixed at the rate of 11 /2 per cent per annum and was treated as accruing daily thereafter from the date of payment of the debt. He further submitted that the interest under the promissory note portion of the debt similarly accrued on a daily basis. Defendants' counsel made the further point that nowhere in subsection 20(14) is there any description of the transferor with the result that he could very well be a tax- exempt entity, such as the Canadian Red Cross Society or the Municipality of Metropolitan Toronto or, for that matter, the Government of Canada. Elaborating further on this premise, he urged that it would be patently wrong to construe the section as requiring that paragraphs 20(14)(a) and 20(14)(b) be read together so that the permissive right to deduct interest on the part of the transferee would be entirely dependent on a mandatory requirement for the inclusion of such interest in the income of the transferor. This submission found favour with the judge of the Tax Court of Canada, Hon. R. St-Onge, and indeed seems to have been the point on which the case before him turned.

Plaintiff's counsel took the position that the debenture debt, which was assigned to the defendants on July 6, 1977, was non-interest bearing and that the only interest payable at or after the transfer was the demand note portion of the debt. Plaintiff's counsel put it this way: the obligation is still there, despite the two-year postponement, and "the interest on the notes is accumulating". He made the alternative argument that the relevant period here was not the two and one-half year period from March 1, 1975 to July 6, 1977, but rather the period commencing with the respective anniversary dates of the four demand notes in the month of June, 1977 and ending immediately after July 6, 1977. This was his explanation for the interest amount of $3,325 pleaded in paragraph 13(f) of the statement of claim. In any event, the principal point urged by plaintiff's counsel is simply that subsection 20(14) does not apply to the facts of the present case because the amounts sought to be deducted as accrued interest were not shown to have been included in the transferor's income. In support of this, plaintiff's counsel relied on two cases decided by the former Tax Review Board, namely, Courtwright v. M.N.R., [1980] C.T.C. 2632; 80 D.T.C. 1609 and Hill v. M.N.R., [1981] C.T.C. 2120; 81 D.T.C. 167.

In Courtwright the Chairman of the Tax Review Board, Hon. L.J. Cardin, said at page 2635 (; D.T.C. 1612):

It appears to me that subsection 20(14) of the Act expresses the elementary principle of not taxing the same interest twice, viz in the hands of the transferor and in those of the transferee. For the section to apply it must be read and interpreted as a whole and paragraph 20(14)(b) of the Act can, in my view, only be applied if paragraph 20(14)(a) of the Act has been complied with. In the appeal at bar there is no evidence that the accrued interest was included in the transferor's income and it cannot be deducted by the transferee notwithstanding the validity of the assignment of the bonds.

In Hill the same Chairman, in considering the possible application of subsection 20(14) to the facts of that case, said at page 2126 (D.T.C. 171):

In my opinion, as important as is the evidence of the physical transfer and the assignment of the bonds to the transferee before subsection 20(14) of the Act can be properly applied, so too is evidence that the transferor has included the accrued interest in his income for the year in which the transfer was made before the transferee can rightly deduct from his income the same amount of interest that had accrued to the transferor up to the date of the transfer. There is no evidence that, at the time, the bonds were allegedly transferred or assigned to the appellant that the transferor had included in his income the interest earned by him up to the date of transfer which, as I read paragraph 20(14)(a) of the Act, is mandatory.

I digress for a moment to consider the area of fact, particularly in reference to several findings said to be essential to the proper disposition of the case. In my view, the evidence establishes that interest became payable under the debenture on the date of the Board's pay out of $3,375,000 on October 3,1974 in respect of the guaranteed bank loan, and that this amount carried interest at the rate of 11 /2 per cent per annum from the date of such payment. I accept Mr. Harriott's evidence that this interest was treated both by the Board and its successor, Department of Commerce and Development of New Brunswick, as accruing daily from the date of payment of the guaranteed bank loan on October 3, 1974. Mr. Harriott had no idea of the actual amount of accrued interest due when he wrote his letter of March 23, 1977 to the defendants’ solicitors, Messrs. Cain & Cain, giving a breakdown, inter alia, for the amount of $4,972,967 then outstanding under the debenture and the demand promissory notes. The financial statements of Atlantic Forest Products Ltd. as at September 30, 1977 reported in the note 5 explanation of long-term debt that the “loans of $6,192,033 include accrued interest of $1,124,065”. Obviously, the amount of interest accrued on the debenture portion of the debt alone would have been very substantial. I also find on the evidence that interest at the varying rates stipulated in the four demand promissory notes must be taken to have been accruing daily from their respective dates.

To come back again to the essentials of the case before me, defendants' counsel strenuously argues that the words of paragraphs 20(14)(a) and 20(14)(b) need not be read together in total context, but can and should be construed disparately, otherwise the ameliorative provisions would be meaningless in a case where the transferor of the debt obligation was a tax-exempt entity. Applying this construction methodology, it follows that the defendant taxpayers meet the requirement of proving their entitlement to accrued interest which was deferred for a given period and became payable to them after the transfer of the debt obligation and that you do not have to look to an amount relating to accrued interest for a period as you would in the case of a bond or similar type of security.

With respect, I must disagree. It seems to me that this innovative approach totally ignores the words-in-total-context approach to statutory interpretation adopted by the Supreme Court of Canada in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; [1984] 1 C.T.C. 294; 84 D.T.C. 6305 and approved by the Federal Court of Appeal in Lor-West Contracting Ltd. v. The Queen, [1986] 1 F.C. 346; [1985] 2 C.T.C. 79; 85 D.T.C. 5310. Accepting the modern principle of statutory interpretation expounded by these cases, it seems to me that one cannot blithely ignore the mandatory requirement of paragraph 20(14)(a) that the amount of accrued interest must be included in the transferor's income before the transferee of the debt obligation can deduct it under paragraph 20(14)(b). In my view, the section was designed to provide for the apportionment of accrued interest as between the transferor and transferee of a bond or other debt obligation where the same is transferred between interest dates, thus avoiding the incidence of double taxation. In my opinion, the defendant taxpayers are disentitled from relying on the deduction provision afforded by paragraph 20(14)(b) because there is no evidence that the amounts of interest sought to be deducted thereunder were included in the income of the transferor of the debt obligation during the taxation years in question, as required by paragraph 20(14)(a). In short, I adopt the reasoning of the Tax Review Board in both the Courtright and Hill cases, supra.

For the foregoing reasons, the plaintiff's appeals are allowed with costs, but on the basis of one set of costs only.

Appeals allowed.