28 August 1989 Income Tax Severed Letter 5-8509 - Whether prepayment penalty is an expense

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

This is briefing memorandum for our meeting to be held August 30, 1989 with the representatives of XXX

ISSUE

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FACTS

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TAXPAYER'S ARGUMENTS

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We, at least for the moment, concede that the prepayment penalty is an expense made or incurred for the purpose of making the disposition, but assert that the foreign exchange loss is not, as it is part of the repayment of the loan, which repayment itself, may hardly be considered a cost of disposition of property. In support f this conclusion, we may offer the obiter comments of Huressen, J., concurring in the result in R. V. Demers, [[1986] 2 C.T.C. 321] 86 DTC 6411, at page 6413, where he stated:

• "Further if a payment which would otherwise be an outlay within the meaning of a provision results in the taxpayer acquiring property with a value equal to that of the payment, it would be contrary to common sense to treat it as an outlay made "for the purpose of making the disposition". For example, a taxpayer who as a condition of selling his shares in a company repays the latter's loan to him and is given a release for it could not claim this payment as an outlay because it was not made exclusively f-o-r the purposes of the sale, but in order to extinguish the debt. The same would be true of an owner who paid real estate tax arrears when he sold his real property. In both cases, the sale would be the occasion but not the cause of the payment."

XXX decisions in Olympia Floor & Wall Tile (Quebec) Ltee. [[1970] C.T.C. 99] 70 DTC 6085 and Impenco Ltd. v. M.N.R. [[1988] 1 C.T.C. 2339] 88 DTC 1242 are XXX.

In those cases, the taxpayer donated amounts substantially in excess of 20% of its income to certain charities, convinced the that, since the donations were made in the expectation of making sales the prohibition on the deduction of those donations exceeding 20% of its income ought not to apply, and the entire amount expended ought to be deductible as a cost of doing business. (In effect, the payments were not truly charitable donations, which are amounts given without a predominant business motivation.)

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The taxpayer goes on to reinforce its comments on "economic reality" by reference to the Demers case at the Federal Court levle in 1983, l Gordon Mines Ltd. v. M.N.R. [[1968] C.T.C. 262] (1968)CTC 262, The Queen v. Bronfman Trust [[1987] 1 C.T.C. 117] 87 DTC 5059, Imperial General Properties DTC 5373, The Queen v. metropolitan Properties Co. [[1985] 1 C.T.C. 169] (1985) 1 CTC 169, and Cyprus Anvil Mining Corp. v. The Queen (1986) 2 DTC 74, as well as Revenue's position in Interpretation Bulletins IT-417 and 95R.

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The taxpayer has subsequently stated that the decisions fo the Tax Court of Canada in Pollard v. M.N.R. [[1988] 1 C.T.C. 2138] 87 DTC 1110 supports its position. Pollard sold his residence and purchased a new one in the course of changing his employment. In lieu of immediate receipt of a mortgage prepayment penalty of $6,115, the holder of the mortgage agreed to grant a mortgage on the new residence at 1 3/4% in excess of the market rate. The excess interest purportedly equalled the $6,115 prepayment penalty. In concluding- that the amount in question represented a pre-payment penalty, the Tax Court, citing the statement in Interpretation Bulletin IT-178R2 that mortgage prepayment penalties are a cost of selling the old residence, found for the taxpayer, but declined to comment on what portion of the amount was paid in the taxation year under objection, leaving that for the Minister and the taxpayer to determine.

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In conclusion, we find none of the taxpayer's arguments on the foreign exchange loss persuasive.