Melford Developments Inc v. Her Majesty the Queen, [1980] CTC 141, 80 DTC 6074

Grant, DJ:—This is an appeal by the plaintiff pursuant to subsection 172(2) of the Income Tax Act in respect of assessments of its returns for the years 1975 and 1976 made by the Minister of National Revenue dated August 22, 1977. Upon objection being made by the appellant thereto the same were confirmed by the Minister on November 30, 1978. The appeal is made direct to this court from the decision of the Minister. The question to be decided is as to whether the plaintiff was obliged to deduct withholding tax from amounts paid by it to Bayerische Vereinsbank Incorporating Bayerische Staatsbank AG (“Vereinsbank”), a foreign corporation resident in the Federal Republic of Germany, as a fee for guaranteeing loans made by the Bank of Nova Scotia to the plaintiff in such years and remit the same to the Receiver General of Canada pursuant to the provisions of section 215 of the Act. For the purpose of this appeal the parties have filed an agreed statement of facts which reads in part as follows:

1. The Plaintiff is a corporation created under the laws of the Province of Ontario, with its statutory head office in the City of Toronto, in the Provice of Ontario. The Plaintiff carries on and has for all relevant periods of this appeal, carried on in Canada the business of developing real property for resale.

2. In the course of the Plaintiff’s business it is necessary for it from time to time to negotiate the borrowing of substantial amounts of money in order to finance its business. In 1973 the Plaintiff arranged a loan with the Bank of Nova Scotia at its head office in Toronto, Ontario in the amount of $6,000,000 (Canadian). The terms of this loan included that it was to mature on April 30, 1981. It was necessary however in the course of the Plaintiff’s negotiation of this loan to obtain a guarantee of its obligation in favour of the Bank of Nova Scotia. Accordingly, the Plaintiff obtained this guarantee from Bayerische Vereinsbank Incorporating Bayerische Staatsbank AG (“Vereinsbank”) of the full amount of $6,000,000 (Canadian). Vereinsbank charged a fee for providing this guarantee of 1 % per annum of the principal which fee was payable to the Vereinsbank in quarter-yearly instalments of $15,000 (Canadian) each.

3. As a commercial bank, Vereinsbank transacts any kind of banking which includes commercial banking, investment, acting as a fiduciary, and security and stock exchange business which is carried out both in the domestic (German) and international markets. As part of its banking business the Vereinsbank is very active in underwriting Canadian borrowings and in the ordinary course when it underwrites or guarantees such financings, it charges a fee for doing so.

4. At all material times Vereinsbank was a resident of the Federal Republic of Germany and was not a resident of Canada, nor did it have in Canada a permanent establishment within the meaning of the Schedule to the Canada-Germany Income Tax Agreement Act, 1956.

5. In satisfaction of its obligation to pay the guarantee fee mentioned in paragraph 2 hereof, the Plaintiff paid to Vereinsbank quarterly payments of $15,000 (Canadian) in each of its taxation years that are the subject of this appeal.

6. The Plaintiff did not deduct or withhold any tax pursuant to Part XIII of the Income Tax Act RSC 1952 c 148 as amended by s 1 of c 63, SC 1971-72-73 from the quarterly payments made to Vereinsbank in its 1975 and 1976 taxation years, and did withhold and deduct tax in respect of $30,000 (Canadian) it paid to Vereinsbank in its 1977 taxation year.

It is acknowledged by the plaintiff that the provisions of Part XIII of the Act make Vereinsbank liable to Canadian income tax at the rate of 15% upon the amount paid to it for such guarantee and places a duty upon the plaintiff to withhold the same and remit it to the Receiver General unless the provisions of the Canada-Germany Tax convention entered into in 1956, otherwise provided.

Paragraph 212(1)(b) of the Act, which establishes the obligation of the non-resident to pay Canadian income tax reads:

(1) Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(b) interest except . . .

There are no exception applicable to this appeal. The rate has been reduced to 15% by subsection 10(6) of the Income Tax Application Rules and Article XI of the convention.

Paragraph 214(15)(a) which was an amendment to the Act passed on November 18, 1974, for the purpose of including such a payment under the provisions of paragraph 212(1)(b) (supra) and classified it as interest, reads:

Where a non-resident person has entered into an agreement under the terms of which he agrees to guarantee the repayment, in whole or in part of the principal amount of a bond, debenture, bill, note, mortgage, hypothec or similar obligation of a person resident in Canada, any amount paid or credited as consideration for the guarantee shall be deemed to be a payment of interest on that obligation.

Subsection 215(1) which imposes the obligation to withhold and remit such percentage on behalf of the non-resident to the Receiver General, reads:

When a person pays or credits or is deemed to have paid or credited an amount on which an income tax is payable under this Part, he shall, notwithstanding any agreement or any law to the contrary, deduct or withhold therefrom the amount of the tax and forthwith remit that amount to the Receiver General of Canada on behalf of he non-resident person on account of the tax and shall submit therewith a statement in prescribed form.

The Canada-Germany Income Tax convention, 1956, was made part of the law of Canada by Dominion statute, the Canada-Germany Income Tax Agreement Act, 1956, and contains the following provisions:

2. The Agreement entered into between Canada and the Federal Republic of Germany, set out in the Schedule, is approved and declared to have the force of law in Canada.

3. In the event of any inconsistency between the provisons of this Act, or the Agreement, and the operation of any other law, the provisons of this Act and the Agreement prevail to the extent of the inconsistency.

Paragraph 111(1) of the Convention provides as follows:

1. The industrial or commercial profits of an enterprise of one of the territories Shall not be subject to tax in the other territory unless the enterprise carries on a trade or business in the other territory through a permanent establishment Situated therein. If it carries on a trade or business in that other territory through a permanent establishment situated therein, tax may be imposed on those profits in the other territory but only on so much of them as is attributable to that permanent establishment.

Paragraph four of the agreed statement of facts establishes that Vereinsbank was at all material times a resident of the Federal Republic of Germany and was not a resident of Canada and did not have a permanent establishment within the meaning of the schedule of the Canada-Germany Income Tax Agreement Act, 1956 within Canada. There is no definition of the term “Industrial and commercial profits” in such convention. In such event paragraph 11(2) of the convention refers the interpretation to the laws of Canada. The Crown submits that the payments in question were not industrial and commercial profits of the German bank within the meaning of such paragraph 111(1) of the convention.

In Canadian Pacific Ltd v The Queen, [1976] CTC 221 at 245; 76 DTC 6120 at 6134, Walsh, J, stated:

What we have to interpret in deciding whether this tax credit should be allowed is the terms of the Convention and Protocol itself, and not of the Income Tax Act. The parties are in agreement that the terms of a treaty will override an Act and that it should be construed more liberally. A good expression of this principle is found in the case of William Vincent Saunders v MNR, 11 Tax ABC 399; 54 DTC 524, in which R S W Fordham, QC of the Tax Appeal Board stated at 402 [526]:

The accepted principle appears to be that a taxing Act must be construed against either the Crown or the person sought to be charged, with respect strict- ness—so far as the intention of Parliament is discoverable. Where a tax convention is involved, however, the situation is different and a liberal interpretation is usual, in the interest of the comity of nations. Tax conventions are negotiated primarily to remedy a subject’s tax position by the avoidance of double taxation rather than to make it more burdensome. This fact is indicated in the preamble to the Convention. Accordingly, it is undesirable to look beyond the four corners of the Convention and Protocol when seeking to ascertain the exact meaning of a particular phrase or word therein.

The Shorter Oxford English Dictionary, 2nd ed 1970 provides the following definitions:

“Industrial” adj pertaining to, or of the nature of, industry or productive labour; resulting from industry.

“Commercial” adj 1. Engaged in commerce; trading. 2. of or relating to commerce or trade. 3. such as passes current in the transactions of commerce. 4.—viewed as a matter of profit and loss.

Also see the judgment of Walsh, J in Her Majesty the Queen v Saint John Shipbuilding et al, [1979] CTC 380; 79 DTC 5297.

The guarantee given by Vereinsbank above referred to was part of its ordinary business and the fees paid to it for such service were receipts earned by it in its normal banking operations. If there exists any inconsistency between the Income Tax Act and the provisions of the Canada-Germany Income Tax Agreement Act, 1956, the provisions of such Act and the Agreement which it validates must prevail section 3 of the Act (supra). I am convinced therefore that the various amounts paid by the plaintiff Melford to it for the guarantee of the appellant’s loan from the Bank of Nova Scotia were in the nature of “industrial or commercial profits” within the meaning of paragraph 111(1) of the Convention (supra) and not taxable.

The Crown further submits that such guarantee payments amounted to interest and were therefore exempted from the provisions of Article 111(1) (supra) and that such fees in the hands of the non-resident bank are deemed to be interest by the 1974 amendment contained in paragraph 214(15)(a) (supra). In Associates Corporation of North America v The Queen, Mahoney, J, PC, in a judgment dated January 10, 1980, [1980] CTC 80; 80 DTC 6049, stated at 82 [6051], in relation to facts similar to the present case but dealing with the Canada-US convention:

The definition of “interest” in the protocol is not, by its terms, ‘‘exhaustive”. This is not, however, to say that it can be unilaterally expanded by Canada to embrace income that is not interest at all.

The learned judge further dealt with the nature of such guarantee fees and found that they were a component of the plaintiff’s industrial and commercial profits which were not taxable by Canada since the plaintiff was a United States enterprise having no permanent establishment in Canada. at 82 [6051] he states:

Counsel for the defendant was entirely correct in conceding that the word “interest” is not sufficiently elastic in its meaning to embrace the guarantee fees in issue here.

The Vienna Convention on the law of treaties, of which Canada is a party provides in Article 31 as follows:

1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purposes.

Interest is, in general terms, the return of consideration or compensation for the use or retention by one person of a sum of money belonging to, in a coloquial sense, or owed to, another.

Re Farm Security Act, [1947] SCR 394 at 511. Such definition of interest was approved in: Attorney General for Ontario v Barfried Enterprises Ltd, [1963] SCR 470 and in Yonge-Eglinton Building Limited v MNR, [1972] CTC 542; 72 DTC 6456; Bennett & White Construction Co Ltd v MNR, [1949] CTC 1; 3 DTC 1052; CIR v Holden, [1932] All ER 265.

For the above reasons I have decided that Vereinsbank was not liable to pay income tax on the amounts received by it from the plaintiff in the years 1975, 1976 and 1977 and that therefore the plaintiff was not obliged to withhold and remit income tax from the guarantee fees it paid such foreign bank in such years: The Minister’s assessment should therefore be set aside and vacated. Judgment may go accordingly. The plaintiff should have its costs from the defendant after taxation thereof.