Hudson Bay Mining and Smelting Co. v. R., [1997] 2 CTC 2419, 96 DTC 1246

Bell T.C.J.:

The Appellant appeals from a determination of loss for its 1982 taxation year and from reassessments of its 1983 and 1984 taxation years. For each of those years the Minister of National Revenue (“Minister”) disallowed the deduction of amounts claimed as interest on the basis that they were not amounts paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business within the meaning of paragraph 20(1)(c) of the Income Tax Act (“Act”).

Issue

The Appellant purchased its own debentures in the open market. The issue is whether that part of the purchase price equal to accrued but unpaid interest was interest and, if so, whether it was deductible under paragraph 20(1)(c).

Reassessment

In reassessing, the Minister disallowed the deduction of such amounts treating them as part of the purchase price of the debentures and as being on capital account.

Facts

The Appellant issued Canadian dollar debentures on June 15, 1971 due on June 15, 1991, with interest at the rate of 9% per annum payable on June 15 and December 15 in each year. It also issued U.S. dollar debentures on December 15, 1975 due on December 15, 1995 with interest at the rate of 10 1/2% per annum payable on June 15 and December 15 in each year. In each of the three taxation years under appeal the Appellant, on dates between the interest payment dates, purchased some of these debentures at a discount in the open market as evidenced by documents referred to as “bro- ker advices”. A representative broker advice set forth two different amounts, the first being the discounted principal amount and the second being a computation of accrued interest. The purchase price of the debenture was the total of these two amounts.

The Canadian trust indenture included a covenant by the Appellant with the trustee to establish a sinking fund for the exclusive benefit of debenture holders. They would be paid from this fund on or before June 15 in each of the years 1977 to 1990, both inclusive, an amount sufficient to redeem $800,000 principal amount of debentures together with accrued and unpaid interest. The indenture also provided that the company, when not in default, could purchase debentures in the open market. All debentures so purchased, upon delivery to the trustee with all unmatured coupons, if any, constituted a sinking fund credit equal to the principal amount thereof. The U.S. trust indenture contained sinking fund provisions which appear to have produced a similar result.

Mr. Allen Smith, executive vice-president of F.H. Deacon, Hodgson Inc. at the time of the representative transaction, said that because of an increase in interest rates the price of debentures had been discounted to give an equivalent return. Obviously, it was advantageous for the Appellant to purchase its debentures in the open market for less than the face amount thereof. He further said that a holder was not entitled to payment of interest before the interest payment dates.

Appellant’s Submission

Appellant’s counsel submitted that the amounts in dispute were simply prepayments of interest and were properly characterized as interest. In support of this proposition she referred to the Tax Appeal Board decision in Puder v. Minister of National Revenue (1962), 30 Tax A.B.C. 219, 62 D.T.C. 555. In that case the taxpayer had advanced $45,000 on a mortgage providing for monthly payments of $500 plus interest until the principal was paid. The mortgagor had the privilege of prepaying the balance after paying three years of principal together with a bonus of three months interest. After 15 monthly payments he made a contractual arrangement with the taxpayer to discharge the mortgage and pursuant thereto paid a bonus of “the unearned interest for that portion of the three year period remaining” plus the normal prepayment bonus of three months interest. The monies received by the taxpayer, other than the three months interest, were treated by him as capital. Three of the five Board members decided that the amount was a payment on account or in lieu of or in satisfaction of interest within the meaning of section 6(1 )(b), now paragraph 12(l)(c), of the Act. At page 560, R.S.W. Fordham said that the description of the sum was not determinative and that it would have been income if received in due course under the mortgage. He found that there was no change in its quality merely because it came to the mortgagee in a lump sum ahead of time. He concluded that this constituted no reason for reclassifying it and for changing the designation. It is noted that section 6(1 )(b) under which this amount was included in income required the inclusion of

amounts received in the year or receivable in the year ... as interest or on account or in lieu of payment of or in satisfaction of interest. (emphasis added)

Counsel submitted that the amounts paid by the Appellant were merely prepayments of interest which it would otherwise have had to pay on the interest payment dates.

Counsel also submitted that Hall v. Minister of National Revenue, [1970] C.T.C. 510, 70 D.T.C. 6333, affirmed without reasons by the Supreme Court of Canada [1971] C.T.C. 401, 71 D.T.C. 5217, supported the Appellant’s position. In this case the amount received by the taxpayer on the sale of matured interest coupons was held to be interest. This case also considered the broad language of section 6(1 )(b). Sheppard D.J. said, at page 516 (D.T.C. 6336):

... Section 6(1 )(b) of the Income Tax Act (Canada) is wider and includes as income not only the amounts received or receivable “as interest” but also a payment “in lieu of payment of ... interest” and “in lieu of” must be read as meaning “instead of”.

The rest of Appellant’s submission dealt with whether it had paid interest pursuant to a legal obligation within the meaning of paragraph 20(1) (c) of the Act.

Analysis

In Wigmore v. Thomas Summerson & Sons Ltd., [1926] 1 K.B. 131, the vendor sold a security with interest rights during the currency of an interest period. The vendor was not taxable on the amount of the sale price representing accrued interest. At page 143, the Court said,

The truth is that the seller does not receive “interest” from the buyer, and it is interest which is the subject matter of the taxation. He receives the price of the expectancy of interest, and that is not the subject matter of the taxation. The whole contention on behalf of the Crown depends upon the fallacy that the price of the expectation of interest is interest.

The Wigmore case was referred to in R. v. Immobiliaire Canada Ltd., [1977] C.T.C. 481, 77 D.T.C. 5332 (affirmed.). In that case, a Canadian subsidiary bought from its non-resident parent corporation bonds which had been issued by another Canadian subsidiary. The purchase price paid by the Appellant included an amount equal to accrued interest. The Minister of National Revenue assessed withholding tax on that amount under section 106(l)(b) of the Act, now subsection 212(l)(b). Its wording, respecting interest, was almost identical to that of section 6(1 )(b), namely,

Every non-resident person shall pay an income tax of 15% 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 ... interest.

Addy, J. in defining interest said, at page 485 (D.T.C. 5334):

The word “interest” in that section means interest owing on the bonds, charge, debt or obligation and not that part of the purchase price paid by a third party to the holder of some for a transfer of the right to the accrued interest. The general principle of Wighmore (sic) ... applies.

He goes on to say,

It is, of course, dangerous to rely on cases dealing with the interpretation of a particular section in a foreign taxation statute as so much depends on the exact wording of the section itself, on the accompanying interpretation sections of the particular statute, on the other interpretation statutes of general application in that jurisdiction as well on the particular context where the section under consideration is found. However, all of the last-mentioned cases, like the Wighmore (sic) case, seem to have been decided on the basis of a general principle that, in default of any statutory provision to the contrary, where a person purchases a debt or obligation from a creditor on which there is accrued interest owing, the payment to the transferor of an amount required to purchase the right to the accrued interest does not constitute payment of interest to a transferor because the transferee is purchasing an expectancy to receive interest and not interest.

Returning to Appellant’s argument, it is clear that in the Puder case the amount in issue was interest that had become payable by contractual arrangement and was included in income based upon the broad language contained in section 6(1 )(b). In the Hall case, the amount in issue was received on the sale of matured Canada bond coupons that could have been realized by surrendering the coupons to any agent of Canada. The Court said, at page 513 (D.T.C. 6335),

The Appellant’s coupons sold to the trust company were due and as due had become “recoverable - as interest” and therefore taxable as income under Section 6(1 )(b) ...

In that case the learned judge distinguished Wigmore on the grounds that it dealt with English tax legislation which was narrower than section 6(l)(b). In Immobiliaire, Addy, J., despite the almost identical wording of sections 6(1 )(b) and 106(1)(b), followed the Wigmore principle. Although this appears inconsistent with the Hall decision, the facts are different in that the Court found that the interest was not payable at the time of sale of the debentures. [1] That is the situation in the Appellant’s case. Further, the issue in this case is not whether the recipient of an amount must include it in income but whether the person paying that amount is entitled to deduct it. Paragraph 20(1 )(c), under which the deduction is sought, does not include the broad wording of paragraph 12(1)(c), the provision requiring inclusion in income. For the taxation years in question the only amount deductible under paragraph 20(1 )(c) was interest, that paragraph reading, in part, as follows: an amount paid ... or payable ... pursuant to a legal obligation to pay interest ...

Subsection 20(14)

Although subsection 20(14) was not referred to at the hearing of this appeal I have considered its potential application to the Appellant. It deals with the purchase of certain debt obligations between interest payment dates. It provides that where by a transfer of certain debt obligations the transferee has become entitled to an amount of interest that has accrued but is not payable until after the purchase, such amount shall be included as interest in the transferor’s income and may be deducted by the transferee. This does not apply in the present case because as the Supreme Court of Canada concluded in Dominion Telegraph Securities Ltd. v. Minister of National Revenue, [1947] S.C.R. 45, [1947] C.T.C. 239, 2 D.T.C. 875, a com- pany that acquires its own debt cannot pay interest to itself. Therefore, it, as a transferee, is not entitled to interest. It appears that subsection 20(14) was designed to resolve questions such as the issue in this case. However, as stated, that provision cannot assist the Appellant.

Conclusion

I agree with the reasoning of the Court in Immobiliaire. That part of the purchase price of a debt obligation respecting accrued interest, not yet payable, is not interest but is an amount paid for the expectancy to receive interest. Circumstances such as those in the Puder and Hall cases do not exist here. In both those cases the amounts in issue were owing at the date of payment. In this case the debentures provide for two interest payment dates in each year and it was on those dates only that the Appellant was obliged to pay interest. The Appellant had no obligation to pay interest when it purchased its debentures in the open market between those dates. Finally, subsection 20(1 )(c) does not provide for the deduction of an amount on account or lieu of payment of or in satisfaction of interest. In order to qualify for deduction the amount paid must be interest.

Because of this finding there is no need to consider the Appellant’s arguments respecting legal obligation to pay interest.

Accordingly, the appeal is dismissed with costs to the Respondent.

Appeal dismissed.