4 June 1990 Ruling 7900953 F - Deductibility of Prepayment Penalty

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.

SUBJECT:   24(1)

This is further to the meeting on March 8, 1990 held at our offices to afford the above taxpayer's representatives their requested opportunity to make representations directly to all Revenue officials involved in the  23

As the balance of our memorandum is rather lengthy, we wish to state at the outset that we continue to agree with your proposal  24(1)

23

In his letter of March 9, 1990, 19(1) raises two matters which are, in reverse order of their appearance therein the deductibility of the prepayment penalty incurred in repaying the debt, and the relationship between subsection 39(2) and paragraph 40(1)(a).  While       19(1) recollection of the facts with respect to our views on the former does not coincide with our own, we have decided to not pursue this issue - a decision which had earlier been agreed to by the most, senior, officials of our Branch.

24(1)

21(1)(b)

40(1) establishes a normal rule for the computation of a gain or loss on the disposition of capital property, which computation is, by the preamble of subsection 40(1), "Except as otherwise expressly provided in this Part".  Subsection 39(1) defines a capital gain or loss from the disposition of a property as that gain or loss determined under subdivision c of Division B of Part 1 of the Act, presumably, in most instances, under the rules in subsection 40(1). Subsection 39(2) overrides the rule in subsection 39(1) where a gain or loss as a result of foreign currency fluctuations relative to Canadian currency has been incurred, deeming the result to be a capital gain or loss, and setting out, in certain cases, the basis for computing the gain or loss.  Rather clearly, even erroneously assuming that the foreign currency loss were a cost for the purpose of subsection 40(1) although, rather obviously, it is not, such loss would have to be removed from the computation of a gain or loss pursuant to subsections 39(1) and 40(1) by virtue of the preamble of subsection 39(2).  There is no question of two provision competing equally for the foreign exchange loss, nor, for that matter, is there in at least two of the cases  19(1) cites to illustrate the concept, as we will show in our comments under item 2 below.              

Our comments on the points made by 19(1) in his letter dated March 1, 1990, intended for discussion at the meeting, but not received by any Revenue official until the day before the meeting, are as follows:

1.     Purpose

     Subparagraph 40(a)(i) of the Income Tax Act permits a deduction in computing a taxpayer's gain from the disposition of a property for outlays or expenses to the extent they were made or incurred by him for the purpose of making the disposition.

       24(1)

     In disagreeing with our view, 19(1) states firstly that costs may be incurred for the purpose of repaying a loan such as legal or accounting fees.  We would not disagree, but suggest that expenses incurred for the purpose of repaying a loan are not limited to legal and accounting fees.

     24(1) he loss is not part of the repayment, of the loan - what is repaid is the amount of the loan outstanding.  The foreign exchange loss is merely the result of a calculation under which the economic loss from currency fluctuations is established. Similarly, we disagree that the foreign exchange loss is itself an "outlay." 24(1) The Bowater matter deals with the nature of certain expenses for tax purposes, and that is the end of its resemblance to the matter at issue.  More germane cases are Neonex International Ltd. v. The Queen 78 DTC 6339 and Riviera Hotel Co. Ltd. v.  The Queen 72 DTC 6142.  In those cases, which admittedly involved different provisions of the law with a somewhat different but probably broader test for deductibility, the Courts found prepayment penalties incurred on repaying debts were not incurred in the course of obtaining new financing despite the fact that the new financing could not be obtained without repaying the old. The Courts found the penalties to have been incurred in the course of repaying the old debts. These cases seem much more on point than Bowater. 24(1)

     Revenue's views does not come from Revenue, and surely  addresses the most general situation.

2.     Olympia Floor & Wall Tile v. M.N.R. 70 DTC 6085  24(1) 

     23

     We see no competition between equally applicable provisions of the law in the other two cases.  In both, the taxpayer paid amounts to charities in the expectation that the payments would result in increased sales by it to companies owned by directors of the charities who would become aware of the taxpayers "generosity". Rather clearly, the payments were not "gifts" as they were made in the expectation of a return to the "donor" and consequently, their deduction was not limited by then paragraph 27(1)(a) of the Act which dealt with deductions for charitable donations.

     24(1)

     24(1) & 21(1)(b)

     Clearly, in Olympia and is sister decision, the courts rejected the view that the payments were gifts.  There was absolutely no conflict also what provision of the statute applied 24(1) & 21(1)(b)

3.     Riviera and Noenex 24(1)

4.     The Demers Case  

     In this case, reported at 86 DTC 6411, Mr. Justice Hugessen  stated that the payment of accrued property taxes on the sale of a real property would not result in a deductible outlay in calculating the gain.

     24(1)

     24(1)

     In any event, the point Mr. Justice Hugessen was rather clearly trying to make was that the extinguishment of a liability did not give rise to a cost of a disposition, as this would not be an outlay meeting the purpose test of subparagraph 40(1)(a)(i).

5.     Reciprocity

     We agree that we, as consumers, may not deduct the cost of groceries which we buy while the grocer must report the related income, and that full reciprocity for all transactions does not exist.  We did not suggest it did.

     We did suggest that it is normal for a taxpayer who does not have to report income from a source to be unable to deduct a loss from the same source.

6.     Non Sequitur

     24(1)

     24(1) The Canadian Institute of Chartered Accountants, at section 1650 of its Handbook requires that such debts be translated to their Canadian dollar equivalent at the balance sheet date.

     21(1)(b)

In conclusion, we continue to support your assessment as currently proposed.

DirectorBilingual Services and Resource Industries DivisionRulings Directorate