Citation: 2013 TCC 416
Date: 20131219
Docket: 2011-2137(IT)G
BETWEEN:
A.P. TOLDO HOLDING CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
D’Arcy J.
[1]
There are two issues in
these appeals. The first issue relates to the deduction of approximately $1.2
million of interest that A.P Toldo Holding Corporation (the “Appellant”)
incurred on borrowed money that it used to redeem some of its common shares.
The second issue relates to the deduction by the Appellant of approximately
$51,000 of fees that relate to legal and accounting services in respect of a
corporate reorganization.
[2]
Mr. Anthony G. Toldo (“Mr.
Toldo”) testified on behalf of the Appellant.
Summary of Facts
[3]
The principal assets of
the Appellant are the shares it holds in four subsidiaries. Through
these four subsidiaries, the Appellant controls eight other corporations. These
companies are worth a great deal of money. I will refer to the subsidiaries and
the companies controlled by the subsidiaries as the “Affiliated Companies.”
[4]
The Appellant’s other
assets included cash, some marketable securities and amounts receivable from
various subsidiaries.
Mr. Toldo testified that the Appellant derives its value from the shares it holds
in the Affiliated Companies.
It appears from the Appellant’s unconsolidated financial statements that the
Appellant did not have any employees during the relevant years.
[5]
Prior to June 2006, Mr.
Toldo, together with his sister, Donna May Curlin (“Donna Curlin”), and his
father, Anthony P. Toldo, owned all of the shares of the Appellant. Donna
Curlin held her shares (the “Subject Shares”) as trustee for the Donna May
Curlin Revocable Trust (the “Donna Curlin Trust”).
[6]
The shareholders held
the shares as follows:
−
Mr. Toldo – 100 common
shares, which allowed one vote per share.
−
Donna Curlin, as
trustee for the Donna Curlin Trust – 100 common shares (the Subject Shares),
which allowed one vote per share.
−
Anthony P. Toldo – 600
special shares, which allowed 3 votes per share.
[7]
Sometime during 2005, a
shareholder dispute arose between the shareholders of the Appellant. It appears
that this dispute also involved shares held by Thomas Curlin, Donna
Curlin’s spouse, in one of the Affiliated Companies (the “Subsidiary’s
Shares”). Mr. Curlin held these shares as trustee for the Thomas Baldwin
Curlin Revocable Trust (the “Thomas Curlin Trust”).
[8]
The parties, through
their respective counsel, negotiated a settlement to the dispute. In
particular, on June 5, 2006, the Appellant entered into a settlement agreement
with a number of parties, including Donna Curlin, Thomas Curlin, Mr. Toldo,
Anthony P. Toldo, the Donna Curlin Trust, the Thomas Curlin Trust and 2103665
Ontario Limited (the “Settlement Agreement”). The Settlement Agreement
addressed two transactions: the sale of the Subject Shares to the Appellant and
the sale of the Subsidiary’s Shares to the Appellant.
[9]
Pursuant to the
Settlement Agreement, Donna Curlin, as trustee for the Donna Curlin Trust,
agreed to sell the Subject Shares to the Appellant for $40 million. In
addition, the Appellant agreed on June 5, 2006 to purchase the Subsidiary’s
Shares from the Thomas Curlin Trust for a cash payment of $6.75 million.
[10]
A few days before the
Appellant purchased the Subject Shares, Donna Curlin, as trustee for the
Donna Curlin Trust, transferred the Subject Shares to 2103665 Ontario Limited
(“2103665”).
[11]
The Settlement
Agreement provided that the sale of the Subject Shares would occur in ten
separate transactions. Each transaction was for the sale of 10 Subject Shares
for $4 million.
[12]
Clauses 3.2 and 3.3 of
the Settlement Agreement set out the timing of the payment of the $40 million for
the Subject Shares and read as follows:
3.2 Purchase Price. The purchase price of the fifty (50) common shares
to be sold pursuant to the first five of the ten share purchase agreements
shall be paid by certified cheques, bank drafts or wire transfers at the time
of closing on the Closing Date. The purchase price of the fifty (50) common
shares to be sold pursuant to the last five of the ten share purchase
agreements shall be paid on the Closing Date by delivering to the 2103665
five (5) promissory notes made by APTHC [the Appellant] payable to the order of
2103665 in the amount of Four Million ($4,000,000) Dollars each due one year
after the Closing Date with interest at the Bank of Nova Scotia Prime Rate on
the Closing Date and payable one year after the Closing Date.
3.3 Closing. The closing of the purchase of the APTHC Purchased Shares [the
Subject Shares] pursuant to each of the ten agreements shall take place on the
Closing Date at ten minute intervals commencing at 1 P.M.. Each transaction
is a separate transaction and one closing shall be completed prior to
commencing and completing the next closing. That process shall continue
until all of the ten transactions are completed.
[Emphasis added.]
[13]
It is clear from the
two clauses that the parties intended that the Appellant pay cash of
$20,000,000 for the first 50 common shares it purchased from 2103665 and issue
promissory notes for $20,000,000 (the “Promissory Notes”) as consideration for
the remaining 50 common shares.
[14]
On June 5, 2006,
2103665 entered into ten share purchase agreements with the Appellant (the
“Share Purchase Agreements”). Mr. Toldo, Donna Curlin as trustee, and Anthony
P. Toldo were also parties to the Share Purchase Agreements. Each of the Share
Purchase Agreements provided for the sale by 2103665 of 10 Subject Shares for a
purchase price of $4 million.
[15]
The ten Share Purchase
Agreements evidence that the sales of the shares occurred in the order
contemplated by the Settlement Agreement. For example, the recitals to the
first agreement note that 2103665 held 100 common shares of the Appellant prior
to selling 10 of the common shares to the Appellant for $4,000,000 cash.
Similarly, the recitals to the second agreement note that 2103665 held 90 common shares before selling 10
additional common shares to the Appellant for $4,000,000 cash, and the
recitals to the sixth agreement note that the Appellant held 50 common shares
before selling 10 additional common shares to the Appellant in consideration of
a $4,000,000 promissory note.
[16]
The unconsolidated
financial statements of the Appellant state that it had the following stated
capital and retained earnings/deficit on December 31 of the noted years.
|
|
2005
|
2006
|
|
Stated capital
|
|
|
|
600 Class
A shares
|
$600
|
$600
|
|
200
common shares (100 in 2006)
|
$200
|
$100
|
|
Retained
earnings (deficit)
|
$6,388,552
|
$(32,660,014)
|
[17]
Since the Appellant
paid $20,000,000 cash for the first 50 of the Subject Shares it purchased for
cancellation, it had a deficit at the time it issued the Promissory Notes as
consideration for the remaining 50 Subject Shares.
[18]
The Appellant did not
tell the Court where it obtained the $20 million cash it paid for the first 50
Subject Shares and the $6.75 million cash it paid for the Subsidiary’s Shares.
[19]
However, it is clear
from the unconsolidated and consolidated financial statements of the Appellant
that the Appellant borrowed approximately $22.6 million from the
Affiliated Companies in 2006. The Appellant’s unconsolidated financial
statements state that the Appellant’s loan payable to its affiliates increased
from $239,560 at the end of 2005 to $22,825,000 at the end of 2006. The
Consolidated Statement of Cash Flows for the Appellant for its 2006 fiscal year
shows that the increase in the loan was funded by the internal cash of the
consolidated group, which totalled over $164 million at the end of 2005.
[20]
Further, the Appellant
classified the $22,825,000 loan from its affiliates as a current liability on
its unconsolidated financial statements, meaning it intended to repay the
amount within 12 months.
[21]
The Appellant cancelled
the 100 Subject Shares after it purchased those shares from 2103665.
[22]
On April 16, 2007, the
Appellant paid $21,035,616.44 in satisfaction of the Promissory Notes. This amount
comprised $20 million of principal and $1,035,616.44 of interest. Mr.
Toldo testified that a portion of these funds came from cash generated by
various subsidiaries and a portion from the Bank of Montreal.
[23]
In 2007, the Appellant
borrowed $17,550,000 from the Bank of Montreal. The Appellant used
approximately $10 million of the loan in its operations and the remainder to
satisfy the Promissory Notes and pay the related interest.
[24]
When preparing its 2006
income tax return, the Appellant claimed a deduction of $687,123 for interest
payable in respect of the Promissory Notes. On its 2007 income tax return, the
Appellant claimed a deduction of $348,493 for interest payable in respect of
the Promissory Notes and $387,862 for interest payable in respect of the loan
from the Bank of Montreal.
[25]
The Minister denied all
of the interest deducted in respect of the Promissory Notes and $166,858 of the
interest deducted in respect of the Bank of Montreal loan. The parties agree
that the denied interest deductions of $1,202,474 relate to the interest paid
on the Promissory Notes and on the money borrowed from the Bank of Montreal to
fund the repayment of the Promissory Notes.
[26]
The Minister also
denied the deductions of $35,568 and $15,627 claimed by the Appellant for 2006
and 2007 respectively in respect of professional fees.
The Appellant’s Position
[27]
The Appellant states,
in its written submissions, that it was entitled under section 9, or
alternatively, under paragraph 20(1)(c) of the Income Tax Act
(the “Act”) to deduct the $1,202,474 of interest as a normal business
expense of a holding company. The Appellant’s written submissions state that
the Appellant is a holding company that is in the business of financing and
earning income from its investments in its subsidiaries. The share redemption
must be looked at in the context of the Appellant’s entire operations and not
seen in isolation and out of the context of its overall business.
[28]
With respect to the
professional fees, the Appellant argues that it incurred those fees in the
course of its business operations and is entitled to deduct them under
paragraph 9(1) of the Act.
The Business Carried On by the Appellant
[29]
Counsel for the
Appellant argued that the Appellant carried on the business of “financing and
banking”.
[30]
Mr. Toldo described the
activities of the Appellant as follows:
A.P.
Toldo Holding Corporation is [a] parent company of many subsidiary companies
and it holds those companies as investments. It also acts as banker to those
subsidiaries and some related-party affiliates. It also has investments outside
the corporate umbrella.
[31]
He described its
financing and banking activities as follows:
Q. You
say A.P. Toldo acts as a banker. What does it do? Can you just expand on that
and its role?
A. As
the banker, from time to time it finances its affiliates. It also receives
deposits or loans from certain of its subsidiaries that may have excess cash.
It would take that excess cash, or cash that it borrows, and lends [sic]
it down to its subsidiaries or affiliates.
Q. What
would be the principal business of this holding company?
A. I
would say the principal business is to hold investments in its subsidiaries and
part of that is to act as financier of those subsidiaries.
Q. You
said it also derives from other investments?
A. Yes.
Q. Investment
income? Where would you get that from?
A. Those
would be very minor in respect to the economic activity of A.P. Toldo
Holding Corporation. That could be bank funds on deposit, where if there is
excess cash, it might be invested in GIC's. There may be some marketable
securities from time to time that are held.
Q. Where
does the holding company derive its value?
A. From
its subsidiaries.
[32]
This is the only
evidence the Appellant provided with respect to its day‑to‑day
activities. I did not receive any evidence with respect to such aspects of the
Appellant’s day-to-day operations as who acted on behalf of the Appellant (it
does not appear to have any employees), whether it played any role in managing
the corporate group, and how it carried on its alleged banking business.
[33]
Counsel for the
Appellant told the Court that the unconsolidated and consolidated financial
statements of the Appellant provided such evidence. I do not agree. In fact,
the unconsolidated and consolidated financial statements, in my view,
contradict Mr. Toldo’s testimony.
[34]
The unconsolidated
financial statements of the Appellant do not in my view reflect the activity of
a corporation that acted as a banker for its Affiliated Companies. The
Appellant simply did not have the financial resources that would have allowed
it to make substantial loans to the Affiliated Companies.
[35]
I recognize that on
December 31, 2005, prior to the Appellant’s purchase of the Subject Shares and
the Subsidiary’s Shares, the Appellant held cash and marketable securities of
approximately $4.5 million. However, such an amount is immaterial when one considers
that the Affiliated Companies had annual sales of approximately $131 million and
that on December 31, 2005 the subsidiaries held cash and cash equivalents of approximately
$160 million.
[36]
I do not know why the
Affiliated Companies held such large amounts of cash. In fact, the Appellant
did not tell the Court what businesses the Affiliated Companies actually
carried on during the relevant years. Whatever businesses they carried on, it
is clear from the consolidated financial statements that the businesses
generated substantial cash. In fact, the cash held by the Affiliated Companies
at the end of 2005, 2006 and 2007 exceeded their annual sales.
[37]
It is my view that if
anyone was in a position to be a banker, it was the Affiliated Companies not
the Appellant. The only loans shown on the unconsolidated financial statements
of the Appellant were loans payable by the Appellant to Affiliated Companies.
These loans increased from $239,560 in 2005 to $22,825,000 in 2006, before
decreasing to $15,485,000 in 2007.
[38]
I did not receive any
evidence with respect to where the Appellant spent the proceeds of these loans.
However, it appears from the financial statements that the Appellant used the
proceeds from the $22.8 million of loans it received from the Affiliated
Companies to make the $20,000,000 cash payment for the first 50 of the Subject
Shares.
[39]
The Appellant’s
unconsolidated financial statements show an amount due from affiliates of
$450,000, increasing to $1,033,847 in 2006 before decreasing to $368,395. The
Appellant did not explain to the Court how these amounts arose. It is not clear
to me what portion, if any, of the amounts represents loans and what portion,
if any, represents receivables in respect of specific transactions.
[40]
I accept that the
Appellant was engaged in a business. However, the objective evidence before me
contradicts the testimony of Mr. Toldo and does not establish, even on a prima
facie basis, that the Appellant carried on a business of loaning money to
the Affiliated Companies or any third party.
[41]
At a minimum, the
Appellant should have presented me with evidence that it lent money on a
regular and continuous basis. For example, I should have received evidence with
respect to such things as the frequency of the loans, which of the Affiliated
Companies received the loans, the internal system for advancing such loans,
repayment terms, and interest rates with respect to the loans.
[42]
I was not even provided
with the amount of interest income earned by the Appellant.
[43]
The unconsolidated financial statements of the Appellant show
revenue from two sources: dividend and interest income and “other income”.
[44]
The Appellant did not
inform the Court of the source of the “other income”. This income was approximately
$176,000 in 2005, before rising to approximately $756,000 in 2006 and falling
to approximately $400,000 in 2007.
[45]
The dividend and
interest income totalled $733,900 in 2005 before rising to $1,244,958 in 2006
and $26,765,155 in 2007. I was not told what component of these amounts was
interest and what component was dividends. It appears that most of the $26.7
million received in 2007 was dividends, since Mr. Toldo testified that the
Appellant used the funds of the Affiliated Companies to discharge the
promissory notes.
[46]
Similarly, it appears
that the majority of the amounts received in 2005 and 2006 were dividends. The
cash and marketable securities shown on the unconsolidated financial statements
were not sufficient to generate the amounts of revenue shown on those
statements.
[47]
However, I simply do
not have the evidence to make an actual determination.
[48]
Mr. Toldo testified
that the Appellant derived its value principally from the shares it held in the
Affiliated Companies. This is consistent with its unconsolidated balance
sheets.
[49]
On the basis of the
above objective evidence, I have concluded that the Appellant is a classic
example of a holding company whose primary function is to hold shares in its
subsidiaries and whose primary source of income is dividends from these shares.
Application of the Law to the Facts
[50]
The relevant provisions
of the Act, namely subsection 9(1), paragraphs 18(1)(a) and
(b) and subparagraphs 20(1)(c)(i) and (ii) are attached hereto as
Appendix A.
Is the Interest Deductible Under Subsection 9(1)?
[51]
I will first address
the Appellant’s argument that the interest is deductible under subsection 9(1).
[52]
The Appellant’s counsel
began his oral argument with respect to section 9 by stating that there is no
absolute or blanket rule that all interest payments are on account of capital.
He stated that the interest deduction “should go in simply under the
authorities of [s]ection 9 as a pure expense incurred for the purposes of . . .
earning income from a business or property.” When asked by the Court to
identify the business the interest payments related to, counsel stated the
following:
The
business relates to the holding company's business which is in a dispute with
shareholders and is settling that dispute with one of the dissident
shareholders to get rid of a problem that it would otherwise consider to be
harmful to its operations. So it is the holding company's business redeeming
its own shares from a dissident shareholder in order to resolve the shareholder
dispute. . . .
[53]
Counsel for the
Appellant then noted that the Appellant was in the business of financing and
banking.
[54]
In its written
submissions, the Appellant states the argument as follows:
The
[Appellant’s] interest expenses were incurred in the course of a corporate
reorganization designed to settle a shareholder dispute and, as such, were
incurred for the purposes of protecting income from the business and enhancing
earnings that would be attributable to the remaining shares after it redeemed
the 100 common shares [the Subject Shares] from 2103665.
. . .
The
Taxpayer submits that the payments were not on account of a capital outlay as
that term is used in paragraph 18(1)(b).
[55]
Subsection 9(1) provides that a
taxpayer’s income for a taxation year from a business or property is the
taxpayer’s profit from the business or property for the year. However,
paragraph 18(1)(b) provides, in part, that in computing its income from
a business or property a taxpayer is not entitled to deduct any amount in
respect of an outlay, loss or replacement of capital, or a payment of account
of capital.
[56]
Paragraph 20(1)(c)
contains specific provisions that allow the deduction of interest. As the
Supreme Court of Canada noted in Gifford v. Canada, this
paragraph does not provide a complete code on interest deductibility. The Supreme
Court stated the following:
. . . In
circumstances where interest is not a payment “on account of capital”, it may
be deducted as long as it meets the other requirements, such as those set out
in s. 8(1)(f) or s. 18(1)(a), and is not precluded by some
other section of the Act.
[57]
While there may be
situations where interest is deductible when a taxpayer is calculating its
profit for the purposes of section 9, the fact situation in front of me is not
one of those situations.
[58]
The interest was not
paid in respect of money borrowed in the course of a money-lending business. I
have found as a fact that the Appellant was not in the business of lending
money.
[59]
Further, I do not
accept the Appellant’s argument that the Appellant purchased the Subject Shares
from a dissident shareholder in order to protect its income by resolving a
shareholder dispute.
[60]
The Appellant’s income
was dependent primarily on the operations of the companies that paid it
dividends: the Affiliated Companies. I did not receive any evidence with respect
to how the dispute involving a shareholder who owned only 12.5% of the voting
shares of the Appellant and held only 5% of the voting rights negatively affected
the operations of the Affiliated Companies and/or the Appellant.
[61]
The purchase of the Subject
Shares for cancellation did not relate to any business carried on by the
Appellant. Rather the purchase represented a large non‑recurring
expenditure. In my view, such a payment is on account of capital.
Is the Interest Paid on the Promissory Notes Deductible
Under Subparagraph 20(1)(c)(ii)?
[62]
Counsel for the
Appellant argued that the interest payments made on the promissory notes were
deductible under subparagraph 20(1)(c)(ii) of the Act since the
Appellant acquired the Subject Shares for the purpose of gaining or producing income
from a business. He identified the business as the business of financing and
banking.
[63]
In addition, the
Appellant argued that the Court should allow the interest deduction on the
basis of the “fill the hole” theory set out in Trans-Prairie Pipelines Ltd. v.
M.N.R.
and Penn Ventilator Canada Ltd. v. The Queen (“Penn Ventilator Canada”).
[64]
Subparagraph 20(1)(c)(ii)
allows the deduction of interest whose deduction would otherwise be denied
under paragraphs 18(1)(a) and 18(1)(b). The provision has the
following elements:
−
The amount must be paid in the
year or payable in respect of the year.
−
The amount must be paid pursuant
to a legal obligation to pay interest on an amount payable for property
acquired for the purposes of gaining or producing income from the property or for
the purpose of gaining or producing income from a business.
−
The income from the property must
be non-exempt and the property must not be an interest in a life insurance
policy.
[65]
The Respondent accepted that the
interest in question was paid or payable in the relevant year.
[66]
Counsel for the Appellant accepted
that the Appellant did not acquire the Subject Shares for the purpose of
gaining or producing income from the shares.
Indeed, the Appellant cancelled the shares.
[67]
Counsel for the Appellant argued
that the interest paid on the promissory notes was deductible under subparagraph
20(1)(c)(ii) on the basis that the Subject Shares were acquired by the
Appellant for the purpose of gaining or producing income from its business. It
appears that counsel was arguing that the Court should consider an indirect use
of the Subject Shares.
[68]
It is my view that, for the
purposes of subparagraph 20(1)(c)(ii), the direct use of shares of a
corporation acquired by the corporation for cancellation can never be to gain
or produce income from a business. This simply cannot happen if the shares are
cancelled after they are purchased by the corporation.
[69]
However, in Penn Ventilator
Canada, this Court allowed a deduction under subparagraph 20(1)(c)(ii)
that was based on an indirect use of common shares purchased for cancellation.
That appeal involved a shareholder dispute implicating several corporations and
other legal entities. In order to settle this dispute, Penn Ventilator
purchased for cancellation some of its common shares. When purchasing those
common shares for cancellation, Penn Ventilator paid a substantial portion of
the purchase price by issuing a promissory note to the vendors.
[70]
In Penn Ventilator Canada,
this Court heard detailed evidence with respect to the significant negative
impact the shareholders’ dispute had on Penn Ventilator’s ability to carry on
its business. For example, the Court discussed how the demands made by the
dissenting shareholders posed a threat to the liquidity of Penn Ventilator and
how the top managers of the corporate group devoted a substantial portion of
their working day to the related litigation.
[71]
Penn Ventilator Canada is based upon a fairly unique fact situation. In my
view, it is only in an exceptional fact situation, such as one in Penn
Ventilator Canada, that the Court should consider an indirect use when
applying subparagraph 20(1)(c)(ii).
[72]
Such a view is consistent with the
Supreme Court of Canada’s decision in the Bronfman Trust case. The Supreme Court
noted, in applying subparagraph 20(1)(c)(i), that the courts should
not ignore the direct use to which a taxpayer puts borrowed money. However, the Court also
recognized that there may be “.
. . exceptional circumstances in which,
on a real appreciation of a taxpayer’s transactions, it might be appropriate to
allow the taxpayer to deduct interest on funds borrowed for an ineligible use
because of an indirect effect on the taxpayer's income-earning capacity. . . .”
[73]
In my opinion, these comments
apply equally to subparagraph 20(1)(c)(ii). The Court should not ignore
the direct use of the acquired property. However, in exceptional circumstances,
it may be appropriate for the Court to allow the deduction because of an
indirect effect that the acquisition of the property had on the taxpayer’s
income-earning capacity.
[74]
The question I must answer is: Do
such exceptional circumstances exist in this appeal?
[75]
If I understand counsel for the
Appellant’s argument correctly, he is stating that, in the current appeal, the
resolution of the shareholder dispute with Ms. Curlin had the requisite
indirect effect on the Appellant’s income-earning capacity. He is also arguing
that I should allow the deduction of the interest under the “fill the hole”
theory.
[76]
Counsel’s argument with respect to
the shareholder dispute is similar to his subsection 9(1) argument. He argued
that the Appellant acquired the Subject Shares for the purpose of gaining or
producing income or protecting income in the business and the residual
outstanding shares of the corporation.
[77]
As I have previously noted, I do
not accept that that the Subject Shares were purchased to protect the income of
the Appellant. Unlike the Court in Penn Ventilator Canada, I was
provided with very little evidence with respect to the operations of the
Appellant and the impact the shareholder dispute had on these operations.
[78]
Counsel for the Appellant
emphasized that I should consider the consolidated operations of the Appellant
and the Affiliated Companies. However, I was not told what businesses the Affiliated
Companies carried on or what impact the shareholder dispute had on these
businesses.
[79]
In summary, the shareholder
dispute involving Ms. Curlin did not constitute an exceptional circumstance.
[80]
The “fill the hole” theory does
not help the Appellant. The basis of the theory was summarized by Bill S.
Maclagan in his paper “Interest Deductibility – an Update”, presented at the
2009 British Columbia Tax Conference, as follows:
. . . The idea in
these cases is that the borrowing (or acquisition of shares and issuance of a
note) merely fills the hole that would be left if assets were sold, funds were
then returned to the shareholders as a return of capital or payment of
dividends and then the corporation went out, borrowed money and reinvested it
back into its business.
[81]
The difficulty for the Appellant
is that, at the time the
Appellant redeemed the 50 Subject Shares in respect of which it issued the
Promissory Notes, it only had $200 of stated capital in respect of the common
shares and no retained earnings. In short, there was no material amount of
capital to return and no retained earnings to pay out. As a result, I do not
have to consider whether there was a “fill the hole” scenario that would
constitute an exceptional circumstance.
Is the Interest Paid on the Bank of Montreal Loan Deductible
Under Subparagraph 20(1)(c)(i)?
[82]
The Appellant did not
refer specifically to subparagraph 20(1)(c)(i). However, the Appellant
obviously feels entitled to deduct an amount under subparagraph 20(1)(c)(i)
in respect of the interest payable on the Bank of Montreal loan to the extent that
the loan proceeds were used to repay the Promissory Notes.
[83]
Subparagraph 20(1)(c)(i)
applies in respect of interest payments on borrowed money that is used for the
purpose of earning income from a business or property.
[84]
The Supreme Court of
Canada in Shell Canada Ltd. v. Canada noted that the following four
conditions must be met:
. .
. The provision has four elements: (1) the amount must be paid in the year or
be payable in the year in which it is sought to be deducted; (2) the amount
must be paid pursuant to a legal obligation to pay interest on borrowed money;
(3) the borrowed money must be used for the purpose of earning non-exempt
income from a business or property; and (4) the amount must be reasonable, as
assessed by reference to the first three requirements.
[85]
The only issue before
the Court is whether the approximately $7,550,000 that the Appellant borrowed
from the Bank of Montreal in 2007 in connection with the redemption of the Subject
Shares was used for the purpose of earning non-exempt income from a business
or property.
[86]
The Appellant borrowed
the approximately $7,550,000 from the Bank of Montreal to satisfy the
promissory notes that it issued on the purchase of the Subject Shares for the
purchase of their cancellation. In point of fact, the Appellant did not use the
borrowed funds directly to earn income from its business or from property.
[87]
My comments with
respect to the lack of exceptional circumstances in this appeal that would
permit the deduction of interest under subparagraph 20(1)(c)(ii) apply
equally to the deduction of interest under subparagraph 20(1)(c)(i).
[88]
The “fill the hole”
theory does not apply and the Appellant did not present the Court with any
other facts that would allow the interest on the borrowed funds to be
deductible on the basis of an indirect use of the borrowed money.
[89]
For the foregoing
reasons, I have concluded that the interest payable on the Promissory Notes and
on the relevant portion of the Bank of Montreal loan was not deductible.
Professional Fees
[90]
I received very little evidence
with respect to the professional fees at issue.
[91]
When assessing the Appellant, the
Minister made the following assumptions:
−
In 2006, the Appellant sought to
deduct $51,963 in legal and professional fees;
−
Of this amount, the Appellant paid
$35,567.69 for advice and legal services with respect to corporate
reorganization activities;
−
In 2007, the Appellant sought to
deduct $32,560 in legal and professional fees; and
−
Of this amount, the Appellant paid
$15,627.33 for advice and legal services with respect to corporate
reorganization activities.
[92]
The Appellant did not provide any
evidence to challenge these assumptions. Mr. Toldo testified that the Appellant
incurred legal fees with respect to the purchase of the Subject Shares and the
loan from the Bank of Montreal. He also stated that the Appellant incurred
accounting fees relating to the purchase of the Subject Shares.
[93]
Mr. Toldo testified that the
Canada Revenue Agency did not identify the actual portion of a specific legal
or accounting bill that was denied as a deduction. It is not clear why, if the
Appellant felt this information was important to its appeal, it did not obtain
such information during the discovery process. Regardless, counsel for the
Appellant informed the Court that the Appellant was not contesting the quantum
of the denied expenses.
[94]
Counsel for the Appellant argued
that the Appellant incurred the professional fees in the course of financing
its business operations and is entitled to deduct those fees under subsection
9(1) of the Act.
[95]
Counsel for the Respondent argued
that the expenses were capital in nature.
[96]
I agree with counsel for the
Respondent. The professional fees were incurred in the course of acquiring a
capital asset, the Subject Shares. Since the fees are associated with a capital
transaction, they must be recognized as having been incurred on account of
capital.
[97]
For the foregoing reasons, the
appeal is dismissed with costs to the Respondent.
Signed at Ottawa, Canada, this 19th day of December
2013.
“S. D’Arcy”
Appendix A
9. (1) Income — Subject to this Part, a
taxpayer's income for a taxation year from a business or property is the
taxpayer's profit from that business or property for the year.
. . .
18. (1) General limitations — In computing
the income of a taxpayer from a business or property no deduction shall be made
in respect of
(a) General limitation — an outlay
or expense except to the extent that it was made or incurred by the taxpayer
for the purpose of gaining or producing income from the business or property;
(b) Capital outlay or loss — an
outlay, loss or replacement of capital, a payment on account of capital or an
allowance in respect of depreciation, obsolescence or depletion except as
expressly permitted by this Part;
. . .
20. (1) Deductions permitted in computing
income from business or property - Notwithstanding paragraphs 18(1)(a),
(b) and (h), in computing a taxpayer's income for a taxation year
from a business or property, there may be deducted such of the following
amounts as are wholly applicable to that source or such part of the following
amounts as may reasonably be regarded as applicable thereto:
. . .
(c) Interest — an amount paid in
the year or payable in respect of the year (depending on the method regularly
followed by the taxpayer in computing the taxpayer's income), pursuant to a
legal obligation to pay interest on
(i) borrowed money used for the purpose of earning
income from a business or property (other than borrowed money used to acquire
property the income from which would be exempt or to acquire a life insurance
policy),
(ii) an amount payable for property acquired for the
purpose of gaining or producing income from the property or for the purpose of
gaining or producing income from a business (other than property the income
from which would be exempt or property that is an interest in a life insurance
policy) . . .
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