The
Chairman:—The
appeals
of
Merban
Capital
Corporation
Limited
from
an
assessment
in
respect
of
the
1974
taxation
year
and
Michael
F
K
Carter
and
George
H
Montague
from
assessment
in
respect
of
the
1973
and
1974
taxation
years
were
heard,
by
agreement
on
common
evidence.
Facts
There
is
no
dispute
as
to
the
basic
facts
which
are
set
out
in
the
notice
of
appeal
of
Merban
Capital
Corporation
Limited,
which
are
applicable
to
the
appeals
of
Michael
F
K
Carter
and
George
H
Montague,
and
which
read
as
follows:
A.
Statement
of
Facts
1.
The
appellant
is
a
corporation
incorporated
under
the
laws
of
the
Province
of
Ontario.
2.
By
agreement
dated
September
21,
1972
between
the
Appellant
and
Reinhold
Kapchinsky,
Gerhard
Kapchinsky
and
Helmut
Kapchinsky,
the
appellant
obtained
an
option
to
purchase
375,000
common
shares
without
nominal
or
par
value
of
Kaps
Transport
Limited,
a
corporation
whose
shares
were
publicly
traded
at
an
aggregate
price
of
$10
per
share,
which
included
commission
payable
to
a
broker.
3.
By
agreement
dated
September
21,
1972,
between
the
appellant
and
Reinhold
Kapchinsky
the
appellant
obtained
an
option
to
purchase
a
further
75,000
common
shares
without
nominal
or
par
value
of
Kaps
Transport
Ltd
at
a
similar
option
price
of
$10
per
share.
4.
On
October
10,
1972
the
appellant
exercised
its
options
to
purchase
the
Kaps
Transport
Ltd
shares,
thereby
incurring
an
obligation
to
pay
the
sum
of
$4,500,000.
5.
In
order
to
obtain
the
necessary
financing
for
itself
and
its
fellow
investors
in
the
purchase,
namely
Casamont
Limited
and
Reinhold
Kapchinsky,
the
appellant
entered
into
an
agreement
with
the
Toronto-Dominion
Bank
by
letter
dated
October
13,
1972
which
provided
as
follows:
(a)
the
appellant
would
incorporate
a
new
company,
261825
Investments
Limited
(the
name
of
which
was
subsequently
changed
to
MKH
Investments
Limited)
to
own
all
of
the
shares
of
Merban-Kaps
Holdings
Limited,
a
company
incorporated
under
the
laws
of
Ontario,
which
existed
solely
to
own
the
said
450,000
common
shares
of
Kaps
Transport
Limited;
(b)
common
shares
of
261825
Investments
Limited
would
be
issued
for
an
aggregate
consideration
of
$1,250,000
in
cash
to
the
following
persons
in
the
following
amounts:
|
Cash
|
Percentage
of
|
|
Name
|
Subscription
|
Common
Shares
|
|
Appellant
|
$1,021,500
|
81%
|
|
Reinhold
Kapchinsky
|
$
125,500
|
10%
|
|
Casamont
Limited
|
$
112,500
|
9%
|
(c)
the
Toronto
Dominion
Bank
would
purchase
at
par
$1,000,000
aggregate
principal
amount
6%
income
debentures
of
Merban-Kaps
Holdings
Limited
due
30
months
from
the
issue
date
and
secured
by
the
hypothecation
of
the
said
450,000
shares
of
Kaps
Transport
Limited;
(d)
the
Toronto-Dominion
Bank
would
lend
to
261825
Investments
Limited
the
amount
of
$2,250,000
to
bear
interest
at
the
prime
rate
charged
from
time
to
time
by
the
Bank
to
commercial
borrowers
plus
1%
payable
semi-annually
and
to
be
repayable
30
months
from
the
date
of
advance.
This
loan
would
be
secured
by
the
hypothecation
of
all
the
outstanding
shares
of
Merban-Kaps
Holdings
Limited
and
by
the
guarantee
of
that
company
and
the
hypothecation
of
the
said
450,000
shares
of
Kaps
Transport
Limited;
(e)
subject
to
the
limitations
provided
below,
Merban
Capital
Corporation
Limited,
Reinhold
Kapchinsky
and
Casamont
Limited
will
undertake
to
pay
or
cause
to
be
paid
to
The
Toronto-Dominion
Bank:
(i)
interest
on
the
said
loan
of
$2,250,000
as
and
when
such
interest
falls
due,
and
(ii)
on
the
due
date
of
the
6%
income
debenture
of
Merban-Kaps
Holdings
Limited,
or
on
the
date
any
part
thereof
is
retired,
an
amount
equal
to
the
difference,
if
any,
between
the
interest
which
has
become
due
with
respect
to
the
debentures
or
part
thereof
retired
as
the
case
may
be,
and
an
amount
equal
to
6%
per
annum
thereof
calculated
from
the
date
of
the
issue
of
the
debentures.
6.
By
agreement
dated
October
16,
1972
the
appellant,
Casamont
Limited,
Reinhold
Kapchinsky,
collectively
described
in
the
agreement
as
the
“Guarantors”
agreed
with
the
Bank
that:
1.
they
will
pay
or
cause
the
borrower
to
pay
all
interest
on
the
loan
(as
well
after
as
before
maturity
and
both
before
and
after
default
with
interest
on
overdue
interest
at
the
same
rate)
as
and
when
the
same
shall
from
time
to
time
become
due
and
payable
in
accordance
with
the
terms
and
conditions
of
the
loan
agreement;
and
(b)
they
will
pay
or
cause
to
be
paid
to
the
Bank
on
the
due
date
of
a
6%
income
debenture
of
Merban-Kaps
(the
“Debenture”)
of
even
date
herewith,
issued
to
the
Bank,
or
on
the
date
any
part
thereof
is
retired,
an
amount
equal
to
the
difference,
if
any,
between
the
interest
due
with
respect
to
the
Debenture
or
part
thereof
retired,
as
the
case
may
be,
and
an
amount
equal
to
6%
per
annum
thereof.
2.
The
aggregate
liability
hereunder
shall
be
limited
to
$500,000,
$500,000,
[sic]
and
such
liability
shall
be
several
as
among
the
Guarantors
in
the
following
percentages,
namely,
81%
for
Merban,
10%
for
Kapchinsky
and
9%
for
Casa-
mont.
7.
The
debtors
were
unable
to
pay
the
interest
as
and
when
it
fell
due
and
the
appellant
was
required
to
pay
interest
in
the
amount
of
$405,000.
8.
The
appellant
deducted
the
said
$405,000
as
an
expense
incurred
in
its
1974
taxation
year
and
reported
a
non-capital
loss
for
the
year.
The
Minister
of
National
Revenue
disallowed
the
deduction,
thereby
reducing
the
appellant’s
calculation
of
its
non-capital
loss
carry
forward
and
the
appellant
received
a
nil
assessment,
from
which
the
appellant
was
not
entitled
to
appeal
under
the
provisions
of
the
Income
Tax
Act.
9.
By
letter
dated
July
27,
1978,
the
appellant
requested
a
determination
of
loss
under
subsection
152(1.1)
of
the
Income
Tax
Act
and
by
the
notice
of
confirmation
by
the
Minister
as
aforesaid:
The
Honourable
the
Minister
of
National
Revenue
having
reconsidered
the
notice
of
determination
and
having
considered
the
facts
and
reasons
set
forth
in
the
notice
of
objection
hereby
confirms
the
said
notice
of
determination
as
having
been
made
in
accordance
with
the
provisions
of
the
Act
and
in
particular
on
the
ground
that
the
non-capital
loss
in
the
amount
of
$220,457
has
been
properly
determined
within
the
provisions
of
subsection
152(1.1)
of
the
Act
and
on
the
ground
that
$405,000
claimed
as
a
deduction
on
account
of
interest
paid
is
not
an
allowable
deduction
from
income
within
the
meaning
of
paragraph
18(1)(a)
and
20(1)(c)
of
the
Act.
In
his
reply
the
respondent
made
the
following
assumptions:
A.
Statement
of
Facts
1.
In
assessing
the
appellant
for
tax
for
the
1974
taxation
year
the
respondent
disallowed
deductions
claimed
as
interest
paid
on
borrowed
funds.
2.
In
so
assessing
the
appellant,
the
respondent
found
or
assumed
that:
(a)
George
H
Montague,
Michael
Carter,
Andrew
Sarlos
and
Graywinds
Investment
Limited
arranged
for
a
trust
to
be
set
up,
Casamont,
the
proportionate
beneficial
interest
being
held
as
follows:
|
Andrew
Sarlos
|
40%
|
|
George
Montague
|
30%
|
|
Greywinds
Investments
Ltd
|
20%
|
|
Michael
Carter
|
10%
|
|
100%
|
(b)
Casamont
Trust
purchased
approximately
9%
of
the
outstanding
and
issued
shares
of
M
MK
H
Investments
Ltd
(“MKH”);
(c)
MKH
borrowed
approximately
$2,250,000
from
the
Toronto-Dominion
Bank.
Casamont
Trust
and
two
other
shareholders
of
MKH;
namely,
the
appellant
(owner
of
81%
of
MKH)
and
Ronald
Kapchinisky
(owner
of
10%
of
MKH),
guaranteed
up
to
$500,000
interest
per
year
on
the
said
bank
loan,
the
proportionate
amounts
of
the
bank
loan
interest
guarantee
being
as
follows:
|
Appellant
|
$405,000
|
|
Kapchinisky
|
50,000
|
|
Casamont
Trust
|
45,000
|
|
$500,000
|
(d)
in
1974,
the
appellant
claimed
interest
expense
in
the
amount
of
$405,000
relating
to
the
guarantee
of
bank
loan
interest,
which
was
actually
called
by
the
bank
in
that
year
in
that
amount;
(e)
the
said
amount
paid
by
the
appellant
in
that
year,
as
referred
to
in
the
immediately
preceding
paragraph,
was
not
paid
pursuant
to
a
legal
obligation
to
pay
interest
on
borrowed
money
for
the
purpose
of
earning
income
from
a
business
or
property,
and
as
such
was
not
allowed
as
a
deduction
in
computing
its
income
by
the
respondent.
Submissions
The
appellant’s
submissions
as
set
out
in
his
notice
of
appeal
are:
B.
Reasons
Submitted
in
Support
of
Appeal
The
amount
paid
to
the
Bank
by
the
appellant
is
a
permissible
deduction
under
the
provisions
of
the
Income
Tax
Act
in
computing
its
income
for
the
1974
taxation
year
for
the
following
reasons:
1.
the
amount
deducted
was
in
respect
of
‘‘an
outlay
or
expense
.
.
.
made
or
incurred
by
the
(appellant)
for
the
purpose
of
gaining
or
producing
income
from
(its)
business
or
property’’
and
is
therefore
properly
deductible
under
paragraph
18(1)(a);
or
2.
the
amount
was
“paid
in
the
year
.
.
.
pursuant
to
a
legal
obligation
to
pay
interest
on
.
.
.
borrowed
money
used
for
the
purpose
of
earning
income
from
a
business
or
property”
and
is
therefore
property
deductible
under
the
provisions
of
subparagraph
20(1
)(c)(ii);
or
3.
the
amount
is
“an
expense
incurred
in
the
year
.
.
.
in
the
course
of
borrowing
money
used
by
the
(appellant)
.
..
for
the
purpose
of
earning
income
from
a
business
or
property”
and
is
therefore
properly
deductible
under
the
provisions
of
subparagraph
20(1
)(e)(ii).
The
respondent
made
the
following
submissions:
7.
The
respondent
submits
that
the
amounts
claimed
by
the
appellant
as
interest
deductions
in
its
1974
taxation
year
were
not
deductible
pursuant
to
the
Income
Tax
Act,
specifically
paragraph
20(1)(c)
because
they
were
not
amounts
paid
in
the
year
pursuant
to
a
legal
obligation
to
pay
interest
on
borrowed
money
used
for
the
purpose
of
earning
income
from
a
business
or
property,
within
the
meaning
of
that
paragraph
of
the
Income
Tax
Act.
Issue
The
issue
is
whether
or
not
the
amount
of
$405,000
claimed
by
the
appellant,
Merban
Capital
Corporation
Limited,
as
interest
expense
is
deductible
and
consequently
whether
the
non-capital
loss
of
the
taxpayer
is
$627,457
or
$222,457.
Finding
of
Facts
On
the
basis
of
the
evidence,
the
issue
arose
as
a
result
of
a
series
of
transactions
initialed
by
Merban
Capital
Corporation
Limited
(hereinafter
referred
to
as
“Merban”),
in
an
attempt
to
realize
possible
substantial
though
speculative
gains
from
the
acquisition
of
Kaps
Transport
Limited,
the
principal
shareholders
of
which
were
the
Kapchinsky
brothers.
The
latter
company,
a
Canadian
public
company
which
operated
a
fleet
of
heavy
equipment,
was
considered
to
have
had
a
most
promising
business
future
due
to
the
proposed
construction
of
an
oil
or
gas
pipeline
to
be
constructed
in
the
western
provinces.
It
would
appear
from
the
evidence
that
the
business
potential
of
Kaps
Transport
Limited
had
been
thoroughly
studied
by
Merban’s
management
consultants,
auditors,
lawyers
etc.
The
objects
of
Merban’s
incorporation
are
in
part
as
follows:
(a)
To
carry
on
business
as
investors,
capitalists,
financiers,
brokers
and
financial
agents
and
to
undertake
and
carry
on
and
execute
financial,
commercial,
trading
and
other
operations
which
may
seem
to
be
capable
of
being
conveniently
carried
on
in
connection
with
any
of
these
objects
or
calculated,
directly
or
indirectly,
to
enhance
the
value
of
or
facilitate
the
realization
of
or
render
profitable
any
of
the
corporation’s
property
or
rights;
(b)
To
carry
on
the
business
of
promoting,
organizing,
establishing,
administering,
developing,
operating,
managing,
advising,
assisting
financially,
investigating,
purchasing,
acquiring,
disposing
of
and
otherwise
dealing
in
and
with
any
corporation,
company,
syndicate,
enterprise
or
undertaking;
(Exhibit
A-7)
A
very
substantial
amount
of
capital
was
required
for
the
acquisition
of
Kaps
Transport
Limited
and
a
series
of
transactions
were
initiated
by
Mer-
ban
to
that
end.
A
chronological
summary
of
the
transactions
might
prove
useful
here:
1.
On
Septemer
21,
1972
by
agreement
with
other
investors,
Merban
acquired
an
option
to
purchase
375,000
shares
of
Kaps
Transport
Limited
@
$10
per
share,
(Exhibit
A-8)
2.
Merban
and
Reinhold
Kapchinsky
acquired
another
option
to
acquire
another
75,000
shares
of
Kaps
Transport
Limited
at
$10
per
share,
(Exhibit
A-9).
3.
On
October
10,
1972
both
options
were
exercised
and
an
amount
of
$4,500,000
had
to
be
raised.
(The
investors
interested
in
the
financing
of
the
Kaps
Transport
Limited
purchase
other
than
Merban,
included
Reinhold
Kapchinsky
and
Casamont
Limited,
of
which
the
appellant
Michael
F
K
Carter
was
a
10%
shareholder
and
George
H
Montague
a
30%
shareholder.)
4.
Merban
began
negotiations
with
the
Toronto-Dominion
Bank
and
dealt
particularly
with
Mr
E
C
Mercier,
the
vice-president
general
manager
of
the
accounts
division
of
the
Toronto-Dominion
Bank
located
in
Toronto.
5.
Mr
Mercier,
convinced
of
the
profit
potential,
recommended
that
the
Bank
invest
in
Kaps
Transport
Limited.
In
a
memorandum
to
the
Bank
dated
September
28,
1972,
Mr
Mercier
states:
(Exhibit
A-10
pages
3
&
4)
“Merban
have
asked
us
for
a
commitment
in
principle
on
the
deal
and
I
would
recommend
giving
this,
subject
to
our
appraisal
of
their
reports
next
week
and
possibly
a
visit
with
them
to
Edmonton
to
review
the
Company’s
management
facilities.
I
would
recommend
that
our
participation
be
structured
as
a
term
loan
for
3
years
of
$2.5
million
(equal
to
$5.56/Kaps
share)
at
Prime
+
/2
%
and
a
$1
million
6V2
%
preferred
share
investment
put
up
by
TD
Capital
Group.
This
latter
stock
would
have
the
option
to
acquire
the
150,000
Kaps
shares.
Its
dividend
would
be
paid
from
the
$0.15
per
share
dividend
($675,000)
received
on
the
450,000
Kaps
shares
held
by
the
Company.
Merban
would
put
up
$1
million
in
common
equity
and
also
commit
to
pay
the
interest
on
the
term
loan.”
6.(a)
The
financing
of
the
purchased
shares
was
arranged
as
follows:
Merban-
Kaps
Holdings
Limited
was
incorporated
to
hold
the
450,000
shares
of
Kaps
Transport
Limited
to
be
acquired.
(b)
The
outstanding
shares
in
Merban-Kaps
Holdings
Limited
would
be
held
by
another
newly
incorporated
company
261825
Investment
Limited
later
renamed
MKH
Investments
Limited,
(MKH).
(c)
The
common
shares
in
MKH
were
to
be
issued
for
a
total
consideration
of
$1,250,000
as
follows:
|
Merban
|
$1,021,500
|
|
Reinhold
Kapchinsky
|
$
125,500
|
|
Casamont
Limited
|
112,500
|
7.
The
Bank
would
buy
$1,000,000,
6%
income
debentures
of
Merban-Kaps
Holdings
Limited
due
in
30
months
secured
by
hypothecation
of
the
450,000
Kaps
Transport
shares.
The
Bank
would
lend
MKH
$2,250,000
at
prime
rate
plus
1%,
secured
by
hypothecation
of
all
outstanding
shares
of
the
borrowing
company.
MKH
thus
obtained
a
total
capital
sum
of
$3,500,000,
which
it
loaned
on
a
promisory
note
to
Merban-Kaps
Holdings
Limited
and
this
company
then
had
funds
at
its
disposition
in
the
aggregate
of
$3,500,000
plus
$1,000,000
or
$4,500,000
for
the
purchase
of
the
shares
in
Kaps
Transport
Limited.
All
the
transactions,
as
stated
above,
were
in
fact
carried
out.
In
this
respect
the
firm
of
Shibley,
Righton
&
McCutcheon
by
letter
to
the
Toronto-
Dominion
Bank
dated
October
16,
1972,
stated:
(Exhibit
A-18)
The
Loan
has
been
duly
authorized
by
the
Holding
Company,
the
promissory
note
in
the
principal
amount
of
$2,250,000
issued
to
the
Bank
by
the
Holdings
Company
as
evidence
of
the
Loan
has
been
duly
executed
and
issued
by
the
Holding
Company
and
is
the
valid
and
binding
obligation
of
the
Holdings
Company
enforceable
in
accordance
with
its
terms;
As
I
understand
it,
the
Holdings
Company
referred
to
above
is
MKH.
By
letter
dated
the
same
day,
MKH
wrote
to
the
Bank
in
which
it
is
stated
in
part,
(Exhibit
A-19):
You
are
to-day
crediting
our
account
with
the
proceeds
of
a
loan
to
us
from
you
of
$2,250,000.
We
have
to-day
deposited
in
our
account
with
you
the
sum
of
$1,250,000
representing
the
proceeds
of
subscriptions
for
1,250,000
of
our
common
shares.
We
have
to-day
agreed
to
lend
the
sum
of
$3,499,996
to
Merban-Kaps
Holdings
Limited
on
a
demand
non
interest
bearing
basis
and
this
letter
will
constitute
our
authorization
to
you
to
transfer
from
our
account
with
you
to
the
account
of
MerBan-Kaps
with
you
the
said
sum
of
$3,499,996.
In
the
agreement
between
Merban-Kaps,
the
Bank
and
MKH
dated
October
16,
1972
(Exhibit
A-21),
the
Bank
had
specifically
agreed
to
lend
the
$2,250,000
to
MKH,
called
the
“borrower”.
On
the
same
date
an
agreement
was
signed
between
Merban,
the
appellant
company,
Casamont
Ltd
and
Reinhold
Kapchinsky,
collectively
called
the
“guarantors”,
and
the
Bank,
Exhibit
A-22
which
reads:
WHEREAS
the
Guarantors
acknowledge
that
they
are
(or
are
entitled
to
become)
the
principal
shareholders
of
“261825
Investments
Limited’’,
a
corporation
incorporated
under
the
laws
of
the
Province
of
Ontario,
(the
“Borrower”)
as
to
the
following
percentages
of
the
common
shares
in
the
capital
of
the
Borrower
presently
outstanding:
|
Merban—
|
81%
|
|
Kapchinsky—
|
10%
|
|
Casamont—
|
9%
|
AND
WHEREAS
by
virtue
of
a
letter
agreement
(hereinafter
called
the
“Loan
Agreement”)
made
as
of
the
13th
day
of
October,
1972,
the
Bank
has
agreed
to
lend
to
the
Borrower,
upon
and
subject
to
the
terms,
provisions
and
conditions
more
particularly
set
forth
therein,
the
principal
sum
of
$2,250,000
(hereinafter
called
the
“Loan”);
AND
WHEREAS
Merban-Kaps
Holdings
Limited
(“Merban-Kaps”)
a
corporation
incorporated
under
the
laws
of
the
Province
of
Ontario,
is
a
wholly-owned
subsidiary
of
the
Borrower;
AND
WHEREAS
the
Bank
agreed
to
make
the
Loan
and
advance
moneys
to
the
Borrower
on
the
express
understanding
and
condition
that
the
Guarantors
would
execute
and
deliver
these
presents.
NOW,
THEREFORE,
in
consideration
of
the
premises
and
of
the
sum
of
One
Dollar
($1)
now
paid
by
the
Bank
to
each
of
the
Guarantors
(the
receipt
whereof
is
hereby
by
them
respectively
acknowledged),
the
parties
hereto
covenant
and
agree
as
follows:
‘1.
Subject
to
the
provisions
of
paragraph
2
hereof,
the
Guarantors
unconditionally
guarantee
to
and
covenant
and
agree
with
the
Bank
that:
(i)
They
will
pay
or
cause
the
Borrower
to
pay
all
interest
on
the
Loan
(as
well
after
as
before
maturity
and
both
before
and
after
default
with
interest
on
overdue
interest
at
the
same
rate)
as
and
when
the
same
shall
from
time
to
time
become
due
and
payable
in
accordance
with
the
terms
and
conditions
of
the
Loan
Agreement;
and
(ii)
They
will
pay
or
cause
to
be
paid
to
the
Bank
on
the
due
date
of
6%
Income
Debenture
of
Merban-Kaps
(the
‘Debenture’)
of
even
date
herewith,
issued
to
the
Bank,
or
on
the
date
any
part
thereof
is
retired,
an
amount
equal
to
the
difference,
if
any,
between
the
interest
which
has
become
due
with
respect
to
the
Debenture
or
part
thereof
retired,
as
the
case
may
be,
and
an
amount
equal
to
6%
per
annum
thereof.
2.
The
aggregate
liability
hereunder
shall
be
limited
to
$500,000,
and
such
liability
shall
be
several
as
among
the
Guarantors
in
the
following
percentages,
namely,
81%
for
Merban,
10%
for
Kapchinsky
and
9%
for
Casamont.
The
expectation
that
Kaps
Transport
Limited
would
realize
sufficient
profit
on
a
short
term
for
MKH
to
meet
its
interest
obligations,
did
not
materialize.
MKH
being
unable
to
pay
the
interest
charges,
the
bank
exercised
its
rights
under
the
contract
and
required
that
the
guarantors,
Merban,
Casamont
Limited
and
Reinhold
Kapchinsky
honour
their
commitment,
which
they
in
fact
did.
The
appellant
Merban
pursuant
to
provisions
of
subsection
152(1.1)
of
the
Income
Tax
Act,
SC
1970-71-72,
c
63,
as
amended,
sought
a
determination
of
its
non-capital
loss.
In
his
determination
of
the
appellant’s
non-capital
loss
for
1974,
the
Minister
contended
that
the
interest
paid
by
the
“guarantors”
was
not
for
income
tax
purposes,
a
deductible
expense
for
the
appellants
Merban,
Michael
Carter
and
George
Montague.
The
appellants
objected
to
the
Minister’s
tax
reassessment
and
the
instant
appeals
were
instituted.
Findings
in
Law
The
principal
question
to
which
counsel
for
the
appellants
referred
was
whether
the
payment
of
$405,000
made
by
the
appellant
was
a
payment
of
interest
or
a
payment
pursuant
to
a
guarantee.
The
principle
enunciated
in
Halsbury
Law
of
England,
Vol
20,
9900,
which
was
cited
by
counsel
for
the
appellants
(produced
as
Exhibit
A-5)
to
the
effect
that
payments
made
pursuant
to
a
guarantee
cannot
be
claimed
as
a
deductible
expense,
has
been
accepted
by
the
Canadian
Courts
and
the
application
of
the
Halsbury
definition
was
confirmed
by
the
Supreme
Court
of
Canada
in
D
P
McLaws
v
MNR,
[1972]
CTC
165;
72
DTC
6149.
In
that
case
the
Supreme
Court
found
that
the
appellant
was
not
under
a
legal
obligation
to
pay
interest
on
borrowed
money
used
for
the
purpose
of
earning
income;
nor
was
“the
interest
paid
on
an
advance
made
to
the
appellant;
it
was
paid
on
the
principal
sum
remaining
unpaid
under
his
guarantee”.
It
is
the
appellants’
contention
that
the
amount
paid
by
them
was
interest
which
they
defined
as
“the
compensation
allowed
by
law
or
fixed
by
the
parties
for
use
or
forbearance
or
detention
of
money”.
Counsel
submitted
that
the
amounts
paid
by
the
appellants
were
outlays
incurred
for
purpose
of
producing
income
within
the
meaning
of
paragraph
18(1
)(a)
of
the
Income
Tax
Act,
SC
1970-71-72,
c
63,
as
amended,
alternatively
that
it
was
an
amount
paid
pursuant
to
a
legal
obligation
to
pay
interest
on
borrowed
money
used
for
the
purpose
of
earning
income
as
set
out
in
subparagraph
20(1
)(c)(ii)
of
the
Income
Tax
Act,
1970-71-72,
c
63,
as
amended
and
as
a
second
alternative,
that
it
was
an
expense
incurred
in
the
course
of
borrowing
money
for
the
purpose
of
earning
income
pursuant
to
subparagraph
20(1)(e)(ii)
of
the
Act.
The
respondent
on
the
other
hand
contended
that
the
appellants’
obligations
were
of
a
subsidiary
nature
and
were
those
of
guarantors
pursuant
to
a
formal
contract
of
guarantee
and
therefore
the
payments
made
to
the
bank
were
not
deductible
as
established
by
the
Supreme
Court
of
Canada
in
D
DP
McLaws
v
MNR
(supra).
The
respondent
submitted
that
the
payments
made
by
the
appellants
were
not
based
on
an
obligation
to
pay
interest
on
a
loan
provided
by
the
bank,
but
was
compensation
for
unpaid
interest
owing
by
MKH,
a
third
party
which
had
left
the
interest
debt
unpaid.
Counsel
for
the
respondent
rejected
the
appellants’
contention
that
one
must
look
at
the
substance
of
the
transactions
and
emphasized
that
corporate
realities
cannot
disappear
because
of
the
alleged
substance
of
the
whole
financial
arrangement.
Counsel
also
contested
the
appellants’
argument
that
the
borrowed
capital
was
used
in
the
appellants’
businesses
for
the
purpose
of
earning
income
and
rejected
the
suggestion
that
the
transaction
was
in
the
nature
of
trade.
Conclusion
I
do
not
believe,
on
the
basis
of
the
evidence,
that
the
original
and
the
subsequent
transactions
which
eventually
led
to
the
acquisition
of
Kaps
Transport
Limited
by
the
appellants
can
realistically
be
seen
as
otherwise
than
as
a
planned
strategy
initiated
by
Merban,
(as
roundabout
as
it
may
have
been),
to
finance
the
purchase
of
a
potentially
profitable
asset,
viz,
Kaps
Transport
Limited.
It
is
true,
as
suggested
by
counsel
for
the
respondent,
that
corporate
veils
should
not
be
lifted
too
readily
nor
should
the
substance
of
a
transaction
always
override
its
form.
However
it
is
also
true
for
tax
purposes
that
the
real
nature
of
a
transaction
is
sometimes
found
in
the
substantive
effect
of
a
transaction
and
not
in
the
outward
appearance
or
phraseology
used
in
the
form
given
to
it.
In
the
instant
appeals,
it
appears
to
me
that
Merban
acted
within
the
objects
of
its
incorporation
for
a
specific
business
purpose
ie,
to
acquire
and
earn
income
from
Kaps
Transport
Limited.
The
negotiations
with
the
Toronto-Dominion
Bank;
the
incorporation
of
holding
companies;
the
purpose
of
debentures
by
Toronto-Dominion
Bank;
the
interchange
of
shares
between
the
related
corporations
and
the
loan
by
Toronto-Dominion
Bank
to
MKH
were
all
part
of
a
financial
arrangement
initiated
by
Merban
to
acquire
Kaps
Transport
Limited.
One
of
the
purposes
of
the
said
financial
arrangement
might
well
have
been
to
limit
Merban’s
liability
but
it
is
equally
plausible,
as
suggested
by
the
appellant
Merban,
that
the
latter
alone
could
not
finance
the
high
cost
of
acquiring
Kaps
Transport
Limited
and
continue
to
operate
in
other
fields.
Nor
do
I
find
that
the
complex
series
of
transactions
are
inconsistent
with
the
concept
of
a
form
of
“trade”,
particularly
when
looked
at
in
the
light
of
the
objects
of
incorporation
of
Merban
quoted
above.
However,
it
is
not
necessary,
in
my
view,
to
determine
the
issue
on
the
above
balance
of
probabilities.
Notwithstanding
that
the
appellant
were
designated
as
“guarantors”
in
the
contract
for
the
loan
to
MKH
by
Toronto-
Dominion
Bank,
the
wording
of
the
appellants’
responsibilities
and
obligations
go
beyond
that
of
simple
guarantors
where,
referring
to
Merban
Capital
Corporation
Limited,
Casamont
Limited
and
Reinhold
Kapchinsky.
(Exhibit
A-22,
page
3)
(i)
They
will
pay
or
cause
the
borrower
to
pay
all
interest
on
the
loan
(as
well
after
as
before
maturity
and
both
before
and
after
default
with
interest
on
overdue
in-
terest
at
the
same
rate)
as
and
when
the
same
shall
from
time
to
time
become
due
and
payable
in
accordance
with
the
terms
and
conditions
of
the
loan
agreement;
(Italics
mine)
The
evidence
established
that
all
concerned,
including
the
Toronto-
Dominion
Bank,
accepted
that
MKH,
Merban-Kaps
Holdings
Limited
and
Merban
were
in
fact
the
same
interest
group
all
of
whom,
albeit
indirectly
in
some
instances,
stood
to
benefit
from
the
acquisition
of
Kaps
Transport
Limited
and
all
were
willing
to
pay
the
interest
on
the
loan
which
made
the
acquisition
possible
and
which
was
reflected
in
the
wording
of
the
loan
agreement,
not
as
a
guarantee
payment,
but
as
a
direct
liability.
I
must
conclude
that
the
payment
made
in
the
1974
taxation
year
by
the
appellant
Merban
of
$405,000
as
interest
due
on
the
loan
of
$2,250,000
was
a
deductible
expense,
as
were
the
payments
made
by
the
appellant’s
Carter
and
Montague
(who
had
a
beneficial
interest
in
Casamont
Trust)
for
the
taxation
years
1973
and
1974.
The
appeals
are
therefore
allowed
and
the
matter
referred
back
to
the
Minister
so
that
he
may:
(a)
adjust
the
appellant
Merban’s
capital
loss
figure
for
the
1974
taxation
year
accordingly
and
take
the
revised
loss
into
account
in
reassessing
the
appellant
Merban’s
taxable
income;
(b)
revise
the
income
of
the
appellants
Carter
and
Montague,
taking
into
account
that
the
interest
payments
made
by
them
in
the
1973
and
1974
taxation
years
are
deductible
interest
payments.
Appeals
allowed.
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