Her Majesty the Queen v. Melford Developments Inc, [1981] CTC 30, 81 DTC 5020

Urie, J:— This is an appeal from a judgment of the Trial Division vacating assessments made by the Minister of National Revenue which required payment of tax and penalties for the 1975, 1976 and 1977 taxation years. These assessments arose as a result of the respondent’s failure to deduct and remit tax of $9,000 in each of the years 1975 and 1976 on the sum of $60,000 paid by the respondent in each of those years to a non-resident of Canada and of the sum of $4,500 in 1977 on the $30,000 paid by it in 1977 to that non-resident.

The decision was determined at trial on an agreed statement of facts. Summarized, those facts follow. The respondent, which is in the business of developing real property for resale, arranged to borrow the sum of $6,000,000 (Canadian) in 1973 from the Bank of Nova Scotia. The lender required a guarantee for the loan. As a result one was obtained for the full amount of the indebtedness from Bayerische Vereinsbank Incorporating Bayerische Staatsbank AG (hereinafter called “Vereinsbank”), a German commercial bank. For providing the guarantee Vereinsbank charged a fee calculated at the rate of 1% per annum of the principal sum, payable in quarterly instalments of $15,000 each. Vereinsbank was not a resident of Canada nor did it have a permanent establishment of any kind in Canada. In remitting the moneys required to be paid by it to Vereinsbank, the respondent did not deduct or withhold any tax from the quarterly payments in any of the periods which are the subject of the assessments in issue, as it is alleged by the appellant it was required to do by virtue of Part XIII of the Income Tax Act, RSC 1952, c 148 as amended by s 1 of c 63, SC 1970-71-72.

It is common ground that unless the provisions of the Canada— Germany Tax Convention entered into in 1956, made part of the Canadian law by the enactment of the Canada-Germany Income Tax Agreement Act, 1956, SC 1956, c 33, exempt Vereinsbank from liability for Canadian income tax Part XIII of the Income Tax Act imposed a duty on the respondent to withhold tax on each payment made to the bank at the rate of 15% and to remit such withheld amounts to the Receiver General of Canada. The issue, then, is whether the Convention exempted Vereinsbank from Canadian tax liability on such payments and thus exempted the respondent from deducting and remitting the tax otherwise payable. The learned trial judge held that it did.

The relevant sections of Part XIII of the Income Tax Act follows:

PART XIII

212.(1) Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(b) interest except . .

214. (15) for the purposes of this Part,

(a) where a non-resident person had entered into an agreement under the terms of which he agrees to guarantee the repayment, in whole or in part, of the principal amount of a bond, debenture bill, note, mortgage, hypothec or similar obligation of a person resident in Canada, any amount paid or credited as consideration for the guarantee shall be deemed to be a payment of interest on that obligation.

215. (1) When a person pays or credits or is deemed to Nave paid or credited an amount on which an income tax is payable under this Part, he shall, notwithstanding any agreement or any law to the contrary, deduct or withhold therefrom the amount of the tax and forthwith remit that amount to the Receiver General of Canada on behalf of the non-resident person on account of the tax and shall submit therewith a statement in prescribed form.

(6) Where a person has failed to deduct or withhold any amount as required by this section from an amount paid or credited or deemed to have been paid or credited to a non-resident person, that person is liable to pay as tax under this Part on behalf of the non-resident person the whole of the amount that should have been deducted or withheld, and is entitled to deduct or withhold from any amount paid or credited by him to the non-resident person or otherwise recover from the non-resident person any amount paid by him as tax under this Part on behalf thereof.

It should be noted that the non-resident tax rate of 25% in respect of interest is reduced by the Convention to 15%.

It is also common ground that Vereinsbank was not taxable under Part I of the Income Tax Act because it was not resident in Canada. Neither was it employed in nor did it carry on business in Canada, nor did it dispose of taxable Canadian property at any time during the taxation years in question. However, the appellant contends that the above quoted sections provide the basis for Vereinsbank’s liability for tax and for the respondent’s liability to deduct and remit the tax to the Receiver General arising from any of the quarterly payments made to the guaranteeing bank.

On the other hand, the respondent contends that the guarantee fees paid to Vereinsbank were “industrial and commercial profits” within the meaning of that term in the Convention and were thus exempt from Canadian tax liability. Consequently, the respondent had no duty to withhold and remit tax pursuant to subsection 215(1) of the Income Tax Act.

The Canada—Germany Income Tax Agreement Act, 1956 contains, inter alia, the following provisions:

2. The Agreement entered into between Canada and the Federal Republic of Germany, set out in the Schedule, is approved and declared to have the force of law in Canada.

3. In the event of any inconsistency between the provisions of the Act, or the Agreement, and the operation of any other law, the provisions of this Act and the Agreement prevail to the extent of the inconsistency.

The Convention, annexed as a schedule to the above Act, discloses that among the taxes which are the subject of the Convention are Canadian income taxes.

Article ll(2) provides that:

In the application of the provisions of this Convention by one of the contracting States any term not otherwise defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws in force in the territory of that State relating to the taxes which are the subject of this Convention.

Article 111(1) provides the foundation for the respondent’s claim that Vereinsbank is exempt from Canadian tax liability by reason of the fact that the fees for guaranteeing the respondent’s loan received by it are “industrial or commercial profits” from an enterprise which does not carry on a trade or business in Canada through a permanent establishment situated therein. That Article reads as follows:

Article 111(1):

(1) The industrial or commercial profits of an enterprise of one of the territories shall not be subject to tax in the other territory unless the enterprise carries on a trade or business in the other territory through a permanent establishment situated therein. If it carries on a trade or business in that other territory through a permanent establishment situated therein, tax may be imposed on those profits in the other territory but only on so much of them as is attributable to that permanent establishment.

The appellant, on the other hand, takes the position that Vereinsbank is excluded from that exemption by virtue of Article 111(5) which reads:

(5) Paragraphs (1) and (2) shall not be construed as preventing one of the contracting States from imposing pursuant to this Convention a tax on income (eg dividends interest, rents or royalties) derived from sources within its territory by a resident of the other territory if such income is not attributable to a permanent establishment in the first-mentioned territory.

The learned trial judge held that the quarterly instalments for the guarantee fees were in the nature of “industrial and commercial profits” within the meaning of Article 111(1). As I understood him, counsel for the appellant did not contest that finding. However, his submission was that by virtue of paragraph 5 of Article III the income received by the Vereinsbank being income arising from “interest” payments “derived from sources within its territory by a resident of the other territory” (ie Germany) was excluded from the exemption arising from paragraph 1 of Article III. That contention was founded on his view that the effect of subsection 214(15), which deems the payment of guarantee fees to be payments of interest on the obligation is to deem the fee itself to be interest.

I am unable to agree with this contention. Whatever is the meaning of the phrase concluding the subsection, namely, “shall be deemed to be a payment of interest on that obligation" (presumably that obligation referring to the repayment of the mortgage) it is clear that it does not deem that the guarantee fee is “interest” but only that the payment of it shall be deemed to be “a payment of interest." Clearly the deeming of the payment to be what it is not does not change the character or nature of the thing that was paid. It could never in fact be a payment of interest because it was always a payment of a fee as consideration for the provision of the guarantee.

Even if subsection 214(15) could be read to mean that guarantee fees are deemed to be interest and not just a payment of interest, it would not in fact be interest. In the case of The Queen v Norfolk County Council (1891), 60 QBD 379 at 380 and 381 it was said that:—

generally speaking, when you talk of a thing being deemed to be something, you do not mean to say that it is that which it is deemed to be. It is rather an admission that it is not what it is deemed to be, and that, notwithstanding it is not that particular thing, nevertheless, for the purposes of the Act, it is to be deemed to be that thing.

That being so, there being no definition of “interest” in the Convention, by virtue of Article 11(2), supra, the term for the purposes of the Convention must have the meaning attributable to it in Canada. In re: Farm Security Act, [1947] SCR 394 at 411 interest was defined as follows:

Interest is, in general terms, the return or consideration or compensation for the use or retention by one person of a sum of money belonging to, in a colloquial sense, or owed to another.

This definition was adopted in Attorney General for Ontario v Barfried Enterprises Ltd, [1963] SCR 570 at 575. Accepting this as a proper definition of interest it is difficult to see how guarantee fees can be characterized as “interest”. A lender who receives interest from the money he lends, has, until the money is repaid, lost control over his money. For that loss of control and the risk inherent therein he is paid interest. On the other hand, a guarantor retains complete control of his money until, if ever, he is called upon to honour his guarantee. The fee he receives for providing the guarantee cannot, therefore, be characterized as interest for provision of money on loan, over which money he has lost control. It is strictly a fee which he receives for assuming a risk for which he may never be called upon to indemnify the lender.*

On the basis of these authorities, therefore, I am of the opinion that the payment of the guarantee fees was not a “payment of interest’’. That being so, a fortiori, the guarantee fees cannot be said to be “interest’’.

Furthermore, even if the Appellant’s submission is accepted that subsection 214(15) has the effect of converting guarantee fees into interest, for thew purpose of the Income Tax Act, it is my opinion that Article Ill, paragraph 5, of the Convention does not encompass such a conversion. I hold this view for two reasons.

First, as earlier stated it is common ground that the guarantee payments in question are “industrial or commercial profits”. Paragraph 5 of Article III provides that notwithstanding this Canada could, pursuant to the Convention, impose tax on income derived from Canadian sources by a resident of Germany if the income is not attributable to a permanent establishment in Canada. In parenthesis, examples of the kinds of income envisaged as being encompassed by the paragraph are set out viz dividends, interest, rents or royalties. The italic words above—pursuant to the Convention —provide the key to the meaning to be ascribed to the paragraph. In my view the word “pursuant” in the context can only mean “within the limits of” or “as circumscribed by” the Convention. There may be other limiting words which could assist in defining the meaning of the word, but I think those illustrate it. If that is so then one must look to the rest of the Convention to ascertain the kinds of income which Canada could exclude by its tax laws from the exemption for industrial or commercial profits provided by paragraph 1 of Article III.

It will immediately be seen that Article VI deals with dividends, Article VII with “interest on bonds, securities, notes, debentures, or any other form of indebtedness, (exclusive of ...”, Article VII] with copyright and industrial property and Article XIII on income from immovable property. All of the types of income referred to in those Articles are refferred to parenthetically in paragraph 5 of Article III and as such they exemplify the kinds of income which Canada could tax notwithstanding that each might also be considered “industrial or commercial profits”. The paragraph does not enable Canada to declare that a kind of income that was accorded exemption in the Convention as such profits and is not specifically provided for in the Articles that follow shall be taxable. Such a unilateral action would not be possible, in my view, because it would be in violation of terms of a binding agreement freely entered into by sovereign states. Such an agreement can only be varied or amended by agreement of the parties not by the action of one party in changing its tax laws by the enactment of a section such as subsection 214(15) in 1974 some eighteen years after the agreement was entered into.

In summary then it is my opinion that the paragraph 5 of Article III is referrable to the kinds of income specifically dealt with later in the Convention which are of a type paranthetically referred to in the paragraph. Actual in-

Compare—CIR v Holder, [1932] All ER 265 at 271 and Bennett & White Construction Co Ltd v MNR, [1949] CTC 1; 4 DTC 514.

terest is one of those. Deemed payments of interest, or even something which is not interest but is deemed to be interest, are not included.

The second reason which I believe leads to the conclusion that paragraph 5 does not assist the appellant is that I think that what is referred to in Article 11(2) of the Convention as the meaning of terms in the meaning of the terms in the statutes in force when the Convention was negotiated. That accords with what is generally recognized as the rule that is used in determining the meaning of words or terminology embodied in an agreement (and the Convention here in issue is essentially an agreement between contracting states) which is that such words or terminology ought to be given the meaning ordinarily ascribed to them in the contracting states at the time the agreement was entered into. I find it difficult to believe that, it would have been intended that some years after the negotiation of the Convention, one of the parties could, without further negotiation or discussion or without entering into an amendment to the Convention, enlarge, restrict or otherwise vary the meaning of the words or terminology as accepted by the parties from the taxing statutes as they existed at the time of the negotiation and execution of the Convention. That is, in effect, what the appellant urges us to do by enlarging the meaning of interest as it was and is ordinarily understood, through the application of subsection 214(15) of the Act, enacted eighteen years after the Convention, and so reading it in conjunction with paragraph 5 of Article III of the Convention. I do not think that we ought to accept that submission.

I am, therefore, of the view that the learned trial judge did not err in concluding that the fees paid for Vereinbank’s guarantee were not taxable in Canada and that, thus, subsection 215(1) did not impose any obligation on the respondent to deduct and remit to the appellant taxes withheld from the fees paid to Vereinsbank.

Accordingly, I would dismiss the appeal with costs.

The Chief Justice:—I agree with Mr Justice Urie’s reasons for concluding that the guarantee fees in question in this appeal are exempted from tax under the Income Tax Act by the Canada—Germany Income Tax Agreement, 1956 and that the appeal fails and should be dismissed with costs.