Associates Corporation of North America v. Her Majesty the Queen, [1980] CTC 80, 80 DTC 6049

Mahoney, J:—The issue is whether payments, received by the plaintiff, which are deemed by paragraph 214(15)(a) of the Income Tax Act SC 1970-71-72, c 63 as amended by SC 1974-75-76, c 26, subsection 119(2) to be a payment of interest, are, in the circumstances, exempted from taxation under the Income Tax Act by the Canada-United States of American Tax Convention Act, 1943, SC 1943, c 21. The facts are not in dispute. The evidence consists entirely of the material transmitted to the Court’s Registry by the Minister of National Revenue pursuant to subsection 176(2) of the Income Tax Act and an agreed statement of facts.

The amount in issue, $440,019.39, represents 15% of the guarantee fees earned by the plaintiff in Canada between November 18, 1974, when subsection 214(15) came into effect, and December 31, 1976. The assessments were made under Part XIII of the Income Tax Act whereof subsection 214(15) is a provision.

The text of the agreed statement of facts follows:

THE PARTIES HERETO in addition to the documents agreed upon and submitted herewith, admit the facts hereinafter specified, provided that these admissions are made for the purpose of this cause only and may not be used against either party on any other occasion or by anyone other than the parties hereto.

1. The plaintiff is a US resident corporation incorporated under the laws of the State of Delaware, one of the United States of America.

2. During the calendar years 1974, 1975 and 1976, the plaintiff did not have any permanent establishment in Canada.

3. During the 1974, 1975 and 1976 calendar years, the plaintiff carried on an enterprise in the United States of America.

4. Associates Acceptance Company Limited is a Canadian resident corporation established under the laws of Canada (presently known as Associates Capital Corporation, having changed its name on April 29, 1977.)

5. During the 1974, 1975 and 1976 calendar years, the plaintiff owned all the shares of Associates Acceptance Company Limited.

6. During the 1974, 1975 and 1976 calendar years, the plaintiff, as part of its enterprise and pursuant to written agreements between the plaintiff and Associates Acceptance Company Limited dated January 1,1970 and January 1, 1976, copies of which are attached hereto as Appendices A and B respectively, provided repayment guarantees with respect to all notes and debentures issued by Associates Acceptance Company Limited. An example of such a note is attached hereto as Appendix C.

7. As consideration for providing repayment guarantees, the plaintiff received guarantee fees of 1 /2% of the amounts guaranteed from time to time, which percentage was reduced to 1% by the agreement of January 1, 1976 referred to in paragraph 6 above.

8. During the 1974, 1975 and 1976 calendar years the plaintiff received the amounts of $1,284,684, $1,404,489 and $1,311,114 respectively, as guarantee fees paid by Associates Acceptance Company Limited, which amount were receipts from the carrying on by the plaintiff of its business activities.

9. During the 1974, 1975 and 1976 calendar years the plaintiff did not make any

amounts of money available to Associates Acceptance Company Limited.

10. During the 1974, 1975 and 1976 calendar years Associates Acceptance Company Limited did not default on any of its borrowings which were guaranteed by the plaintiff. The plaintiff was not required or called upon to make any payments pursuant to the guarantees nor did the plaintiff make any such payments.

It is unnecessary to recite any part of the appendices but it should be explained that the guarantee fee was calculated quarterly, at the prescribed rate per annum on the average daily guaranteed borrowing outstanding during the quarter, and paid on the last business day each year.

The guarantee fees fall squarely within the contemplation of paragraph 214(15)(a).

For the purposes of the this Part,

(a) where a non-resident person has 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; and

They are thereby rendered subject to tax by paragraph 212(1)(b).

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 . ..

None of the exceptions apply. If it were not for the Canada-US Tax Convention, the guarantee fees would be clearly taxable to the plaintiff as interest. The effective rate of tax is 15% rather than 25% by virtue of subsection 10(6) of the Income Tax Application Rules and Article XI of the Convention.

The material provisions of the Act implementing the Convention are sections 2 and 3.

2. The Convention and Protocol entered into between Canada and the United States of America, which are set out in the Schedule to this Act, are hereby approved and declared to have the force of law in Canada.

3. In the event of any inconsistency between the provisions of this Act or of the said Convention and Protocol and the operation of any other law, the provisions of this Act and the Convention and Protocol shall, to the extent of such inconsistency, prevail.

Material provisions of the Convention follow:

ARTICLE I

An enterprise of one of the contracting States is not subject to taxation by the other contracting State in respect of its industrial and commercial profits except in respect of such profits allocable in accordance with the Articles of this Convention to its permanent establishment in the latter State.

ARTICLE II

For the purposes of this Convention, the term “industrial and commercial profits’’ shall not include income in the form of . .. interest . ..

Article XXII provides that the accompanying Protocol is to be considered “an integral part of the Convention’’. The Protocol provides, in paragraph 7(b), as follows:

(b) the term “interest’’, as used in this Convention, shall include income arising from interest-bearing securities, public obligations, mortgages, hypothecs, corporate bonds, loans, deposits and current accounts;

The definition of “interest” in the Protocol is not, by its terms, exhaustive. This is not, however, to say that it can be unilaterally expanded by Canada to embrace income that is not interest at all.

In Bennett and White Construction Co Ltd v MNR, [1949] SCR 287; [1949] CTC 1; 4 DTC 514, the Supreme Court of Canada dealt with the precise question of the nature of payments by a borrower to the guarantors of its bank loans in the context of the Income Tax Act. In separate, but concurring judgments, it was held:

While the amounts paid to the guarantors were described as interest in the various resolutions which authorize their payment, this was clearly inaccurate. Interest is paid by a borrower to a lender: a sum paid to a third person as the consideration for guaranteeing a loan cannot be so described.* [1]

The disbursements of [sic] the guarantors here in question were made not as interest on the money borrowed but as the purchase price for the guarantee that made borrowing under the line of credit possible.! [2]

Counsel for the defendant was entirely correct in conceding that the word “interest” is not sufficiently elastic in its meaning to embrace the guarantee fees in issue here.

The guarantee fees paid to the plaintiff are not interest within the terms of the Canada-US Tax Convention. Paragraph 214(15)(a) of the Income Tax Act deeming them to be interest is inconsistent with the Convention and, by virtue of section 3 of the Act that makes the Convention part of Canada’s domestic law, paragraph 214(15)(a) cannot apply to guarantee fees subject to the Convention. The fees in issue were a component of the plaintiff’s industrial and commercial profits which were not taxable by Canada since the plaintiff was a United States enterprise having no permanent establishment in Canada.

Lest it be thought that such a result renders paragraph 214(15)(a) a nullity, I should note that the tax conventions concluded by Canada since its enactment in 1974 all contain expanded definitions of “interest” which may well not be inconsistent with the paragraph. For example, the Canada- France Income Tax Convention, which became the domestic law of Canada July 29,1976, contains, in Article Xl, a definition of “interest” that includes “income assimilated to income from money lent by the taxation law of the State in which the income arises”.

The assessments will be vacated. The plaintiff is entitled to its costs.