2 February 1989 Income Tax Severed Letter 7-3004 - [retro-active claim for interest previously waived by the shareholders]

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.

February 2, 1989

TO   VANCOUVER DISTRICT OFFICE
     S. McKenzie
     Chief of Audit
     Attention: C. Hildebrand
                142-12

FROM HEAD OFFICE Rulings Directorate T. Murphy (613)957-2747

SUBJECT:  XXXX and a retro-active
          claim for interest previously waived
          by the shareholders

This is in reply to your June 23, 1988 memorandum concerning the request of XXXX for an interest expense deduction with respect to its shareholder loans for the 1982 to 1985 taxation years.

FACTS

Our understanding of the facts is as follows:

1. Fortress is a Canadian controlled private corporation which owns and operates a

XXXX

TAXPAYER'S OPINION

XXXX

Court cases in support of the retrospectivity principle are Perini Estate v. The Queen, 82 DTC 6080 (FCA) and Miller v. The Queen, 85 DTC 5354 (FCTD).

DISTRICT OFFICE OPINION

In your opinion, the additional interest expense claim of XXXX for its 1982 to 1983 taxation years should be denied. You believe that the waivers did alter the terms of the shareholder loans.

In your opinion, the waivers extinguished the interest payable by XXXX on the shareholder loans in the 1981 to 1989 taxation years.

XXXX

b. A waiver can be express or implied and there is evidence of XXXX

c. If the interest had been waived after the XXXX year end, the proper treatment under GAAP would have been to record the liability and to disclose the subsequent waiver in a note to the financial statements.

XXXX

In your opinion, the taxpayer's argument that the waivers represent a postponement of the interest payable is illogical, as the interest was waived before it was even due. Before a right can be waived, it must exist and in this case, the right to receive interest did not exist at the time the waivers were given. You therefore feel that the waivers were meant to extinguish the accrued interest liability.

In accordance with the principles of common law, you believe that once XXXX waived their right to interest they would be estopped from insisting on this right at a later date. Therefore, as there was no legal obligation to pay interest, XXXX is not entitled to a deduction under paragraph 20(1)(c) of the Act.

With respect to the confirmation of the accrued interest payable on the shareholder loans by XXXX and XXXX and the actual payment of the interest on XXXX you believe that irrespective of these contracts, that retroactive claims for interest expense should not be allowed.

OUR OPINION

XXXX

It is a question of fact whether the waivers postponed or extinguished the debts.

We agree with your view that the waivers were meant to extinguish, rather than postpone, the interest payable on the shareholder loans.

XXXX

We concur with your arguments concerning the time that the waivers were given.

XXXX

a. At common law, a waiver of rights created by and under a contract, not being itself an agreement, does not have to be supported by consideration.

b. We do not agree that the Letters describe forebearance rather than forgiveness for reasons stated earlier.

XXXX

In Miller, the taxpayer entered into a new collective agreement in 1981 which included a salary increase retroactive to the beginning of 1980 together with "interest" on the retroactive amount. The question was whether the amount of $62.51 deducted by the taxpayer under section 110.1 of the Act in 1980 was genuinely a payment of interest. The Court held that the amount was in fact interest. Madame Justice Reed stated (page 5358):

"In both the Perini case and the present case a principal amount was owned pursuant to a commercial relationship between the parties. In both cases there was an obligation to pay the taxpayer, a yet to be determined amount, pursuant to that contractual relationship. It is open to the parties to govern their relationship by retroactive agreements. Trollope & Colk et al, v. Atomic Power Constructions, Ltd. (1962) 3 All E.R. 1035, and it is open to them, when they do so, to provide for interest to be payable on the outstanding sum left due over the relevant period of time."

In Perini, the taxpayer sold shares of a corporation for a fixed sum plus additional amounts determinable in accordance with the future earnings of the corporation. A further amount of "interest" was payable on the additional payments. The Court held that the obligation to make the additional payments was a conditional or contingent liability and that the fulfilment of the conditions made the obligation absolute with retrospective effect. The Court made reference to the Trollope case as support for this result.

In Trollope, the plaintiffs, on February 14, 1959, submitted to the defendants a tender for carrying out, as sub-contractors, civil engineering work for a building owner. Both intended from the outset to enter into a legally binding contract and in June 1959, the defendants, at the request of the plaintiffs, began work on the site. On April 11, 1960 they agreed on the form of the general conditions of the contract. The question was whether there was a contract between the plaintiffs and defendants governing their right as to the work done since June, 1959.

The Court found that the contract dated April 11, 1960, governed the rights of the parties as to their prior work on either of two grounds (1) retrospectivity was necessary to give business efficiency to the contract, or (2) that the tender constituted an offer which when accepted covered the work to be done.

In discussing whether a contract could have retrospective effect, the Court noted that in many important transactions the written contract is expressed to have retrospective effect and noted that if contracts could not be given retrospective effect that many important mercantile contracts would be nullities. The Court stated (page 1040):

"Frequently, in large transactions a written contract is expressed to have retrospective effect, sometimes lengthy retrospective effect: and this in cases where the negotiations on some of the terms have continued up to almost, if not quite, the date of the signature of contract. The parties have meanwhile been conducting their transactions with one another, it may be for many months, on the assumption that a contract would ultimately be agreed on lines known to both parties, though with the final form of various constituent terms of the proposed contract still under discussion. The parties have assumed that when the contract is made - when the terms have been agreed in their final form - the contract will apply retrospectively to the preceding transactions. Often, as I say, the ultimate contract expressly so provides. I can see no reason why, if the parties so intend and agree, such a stipulation should be denied legal effect.

As the April 11, 1960 contract did not expressly state or stipulate a retrospective effect the Court then went on to question whether such an effect could be implied. It was concluded that without retrospective effect the contract would be devoid of business efficiency and so implied retrospective effect to the contract.

In our opinion, the positions taken in the above cases with respect to the retrospectivity issue are not applicable here.

XXXX

In Malkin v. MNR, 42 DTC 587 (Ex. Ct.), the taxpayer received moneys by way of rentals which were later applied by the taxpayer and the tenant toward the purchase price of the rental property pursuant to an agreement they entered into towards the end of the taxation year. The court held that the agreement to apply rent on capital did not remove the rent from the category of income. Justice Maclean stated:

"The appellant had the right, of course, to deal with his income as he saw fit after its receipt by him, but such income would remain taxable income under the taxing statute. The appellant could not by any ex post facto act alter the distinction of these moneys, or the purpose for which they were paid to and received by him. I know of no principal [sic] of law or equity which the appellant can summon to his aid to support his contention."

The principle in the Malkin case is that one cannot retrospectively change what has actually transpired; a principle which is appropriate to the situation at hand. Therefore, in our opinion, the fact that

XXXX

We hope our comments are of assistance to you. We apologize for the delay in replying. As requested, all material submitted with your memorandum are hereby returned to you and we compliment you an a well prepared submission.

R.J. Kauffman A/Chief Leasing & Financing Section Financial Industries Division Rulings Directorate

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