Roy J Perini v. Minister of National Revenue, [1976] CTC 2323, 76 DTC 1246

A J Frost:—This is an income tax appeal from notices of reassessment dated October 25, 1973 in respect of the appellant’s 1969, 1970 and 1971 taxation years.

There are two issues in this appeal—the first relates to the question of interest and the second to payments in the 1971 taxation year in the aggregate amount of $41,985.36 on account of alimony allegedly paid pursuant to a written agreement. The second issue was dismissed from the Bench for lack of prosecution, leaving only the question of whether or not amounts of $14,031.19, $28,431.74 and $119,262.60 received by the appellant in the 1969, 1970 and 1971 taxation years respectively were received by him in satisfaction of interest.

Under an agreement of purchase and sale dated November 14, 1968 the appellant sold all the issued shares of All Records Supply Company of Canada Limited ("ARS") to Columbia Records of Canada Limited for a consideration payable in part on closing and in three subsequent payments to be determined in accordance with the formula set out in paragraph 1.3 which reads as follows:

As full payment for the Sale Shares, CRC will pay Seller as follows:

(i) At the closing, $660,000 (all sums herein are expressed in Canadian dollars);

(il) Following receipt of an audited financial statement for the year ended April 30, 1969—a payment equal to the lesser of (A) $400,000 and (B) the result obtained by dividing the post-tax net profits of ARS for such year by $186,000 and multiplying the result by $400,000;

(iii) Following receipt of an audited financial statement for the year ended April 30, 1970—a payment which shall cause the total payments under this clause (iii) and the preceding clause (ii) to equal the lesser of (A) $800,000 and (B) the result obtained by dividing the net aggregate of the post-tax net profits (after deducting losses) of ARS, as determined by said audited financial statement, for the two fiscal years ended April 30, 1969 and 1970 by $372,000 and multiplying the result by $800,000;

(iv) Following receipt of an audited financial statement for the year ended April 30, 1971—a payment which shall cause the total payments under this clause (iv) and the preceding clauses (ii) and (iii) to equal the lesser of (A) $1,200,000 and (B) the result obtained by dividing the net aggregate of the post-tax net profits (after deducting losses) of ARS, as determined by said audited financial statement, for the three fiscal years ended April 30, 1969, 1970, and 1971 by $558,000 and multiplying the result by $1,200,000.

(v) To each payment of principal pursuant to clauses (ii), (iii) and (iv) above there shall be added interest thereon at the rate of 7% per year from the Closing Date to the date of payment. The right to receive payments pursuant to clauses (ii), (iii) and (iv) of this paragraph shall be personal to Seller, may not be transferred by him and shall terminate upon his death and payments shall not be prorated for the period prior to his death. The post-tax net profits (losses) of ARS for purposes of the above payments shall be determined on a pro forma basis as though ARS had filed a separate tax return as a non-associated Canadian corporation for the respective years involved. All audited financial statements referred 10 above shall be prepared by the auditors referred to in paragraph 9.6 hereof.

On January 27, 1972 a letter was received by the Department of National Revenue, Taxation, on the stationery of Columbia Records of Canada Ltd (Exhibit A-2), which reads as follows:

Dear Sir:

I refer to your letter dated January 21, 1972, in which you requested, and I submit herewith, details and information regarding the purchase of shares of All Records Supply Company of Canada Limited by Columbia Records of Canada, Ltd, from Mr R J Perini.

1) A copy of purchase agreement is enclosed.

2) Schedule of Payments per year is as follows:

	Principal	Interest	Total
(a) Nov. 28, 1968	660,000.00	—	660,000.00
(b) July 20/69	311,169.00	14,031.19	325,200.19
(c) Aug. 25/70	233,101.00	28,431.74	261,532.74
(d) Oct. 4/71	597,377.00	119,262.60	716,639.60
	$1,801,647.00	161,725.53	1,963,372.53
I trust this is the information you require.
		Yours very truly,

The value of the shares of ARS sold was based on future earnings, as under the agreement any additional amounts the appellant was to receive were tied to the post-tax net earnings of ARS for each of three successive 12-month periods subsequent to sale as per the audited financial statements of the company. If earnings were flat in any year, no amount would be owing to the appellant. As it was, the appellant received a relatively small amount of “interest” in 1970, a larger amount in 1971, and quite a large amount in the third year due to the fact that earnings consistently increased over the 3-year period. It is important to note that, rather than using past earnings to determine price as is usually the case in valuing the shares of a corporation, the parties decided to await the event of future earnings and then retroactively add “interest” at the rate of 7% per annum back to the closing date of the agreement. Further, the right to receive any payments pursuant to clauses (ii), (iii) and (iv) of paragraph 1.3 of the agreement was made personal to the seller.

The question at issue in this appeal is: What is interest and can it be calculated retroactively?

Counsel for the appellant, in his argument, submitted that “interest” has to have certain attributes before it can be considered to be of an income nature, namely, (1) there must be a principal amount owing, and (2) there must be a day-to-day accrual of interest.

He submitted that the name given to a transaction does not necessarily decide its nature and that the use of the word “interest” in the agreement could not be considered as the determining factor in the case.

In support of his argument, counsel relied heavily on the cases of Reference re Saskatchewan Farm Security Act, 1944, [1947] SCR 394, and Attorney General of Ontario v Barfried Enterprises Ltd, [1963] SCR 570, as authority for the proposition that a principal amount must be owing and interest must accrue on a day-to-day basis.

Mr Justice Judson said in the Barfried case at page 575: “The day- to-day accrual of interest seems to me to be an essential characteristic”, and in the Saskatchewan Farm Security Act case Mr Justice Rand, at page 411, said:

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. There may be other essential characteristics but they are not material here.

and went on to say, at page 412:

But the definition, as well as the obligation, assumes that interest is referrable to a principal in money or an obligation to pay money.

Both these cases deal primarily with constitutional law and with interest as a class of subject under the BNA Act. The cases do not touch on the retrospective effect of a contract providing for interest payments between a lender and purchaser. These statements deal in general terms with the subject of interst and with what seems to be the situation with regard to characteristics other than as compensation for the use or retention of a principal sum of money, but do not touch on the crux of the question to be determined in the instant case, which is: Can interest run retroactively to the date of the agreement from the date of determination of price in the manner provided for by the agreement?

Before considering the question of retroactivity, let us look ai interest, as an economic fact of life, in its very simplest form, unfettered by authority. On this basis, I would say that the fruit of a tree is harvest, the fruit of labour is wages, the return one expects from capital investment in land is rent, and the fruit of capital is interest— all of which are income. The labourer is worthy of his hire and receives wages, the lessor is entitled to his return in the form of rent, and the owner of potentially revenue-producing capital is entitled to an income based on the productive potential of his capital.

In the case at bar, the appellant obviously expected to receive interest on his capital once the amount of principal owing was determined, such amounts to be calculated by using a fixed rate of interest on principal sums. The agreement calls for amounts “as full payment” and goes on to say “there shall be added interest thereon . . .”.

Once principal sums were determined, interest had to be paid on outstanding balances. These balances were not nullities, and interest amounts were in fact paid on them because the payments, of necessity, had to be delayed. In my opinion, these amounts were not adjustments of capital, as, pursuant to paragraph 1.3, all principal sums other than the amount of $660,000 paid on closing were tied to the post-tax net earnings of the company (figure E) as per the audited financial statements. These extra amounts were in the form of interest, and were not paid as adjustments to the price.

In Bond v Barrow Haematite Steel Company, [1902] 1 Ch 353 at 363, Farwell, J said: “Interest is compensation for delay in payment.” In an economic sense, interest is a price paid for the use of capital. With respect to the Saskatchewan Farm Security Act case (supra), Kei lock, J said, at page 417: “There can be no such thing as interest on principal which is non-existent.” Here the principal was not nonexistent: it was only undetermined at the date of the agreement.

In general, there must be a principal sum of money and an agreed rate by reference to which the amount of interest to be paid can be calculated. In the case at bar, the agreed rate was 7% per annum but the amounts owing were to be determined at some time in the future by reference to a stated formula. The principal sums were indeterminate but not non-existent, and accruals could only be retroactively ascertained. As the future cannot be accurately foretold, the principal sums to be paid could not be determined in advance, but this does not mean that there was not a continuing obligation to pay interest on an “if, as and when” basis. When the principal sums were ascertained, the purchaser had to pay interest on the principal sums then owing at the agreed rate of 7%. In my opinion, the only absolute test is an

economic one: Did the purchaser of ARS shares pay a price for the use of the vendor’s capital? On the evidence I find that he did. Only one question remains: Did the retroactive effect of the payments make any real difference when the price of the shares had to be determined by the future earnings? The answer to this question is given in the headnote of Trollope & Colls Ltd et al v Atomic Power Construction Ltd, [1962] 3 All ER 1035, where it says:

Per CURIAM: there is no principle of English law which provides that a contract cannot in any curcumstances have retrospective effect or that, if it purports to have retrospective effect, it is in law a nullity.

In my opinion, the interest was given its true character under the agreement, and was received by the appellant for his taxation years 1969, 1970 and 1971 as interest, ie, as taxable income.

Appeal dismissed.