4 June 1990 Income Tax Severed Letter ACC9597 - Deductibility of Prepayment Penalty Incurred in Repaying Debt

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.

MONTREAL DISTRICT OFFICE RULINGS DIRECTORATE
Irving Aaron John Shaw
Section 197-1-I (613) 957-8968

FILE 7-900953

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(l) (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(l) 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(I), "Except as otherwise expressly provided in this Part". Subsection 39(l) 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(l) 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 rot limited to legal and accounting fees.

24(1)
his 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 Bowacer 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 [[1978] C.T.C. 485] 78 DTC 6339 and Riviera Hotel Co. Ltd. v. The Oueen [[1972] C.T.C. 157] 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)

• 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. [[1970] C.T.C. 99] 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(l)(a) of the Act which dealt with deductions for charitable donations.

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 as to 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 [[1986] 2 C.T.C. 321] 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)

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(l)(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)

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.

Director
Bilingual Services and Resource
Industries Division
Rulings Directorate

Document Disclosed Pursuant to the Access to Information Act Document Divulgué en vertu de la loi sur l'accès à l'information