Shell Canada Ltd. v. Her Majesty the Queen, [1999] 4 CTC 143

Binnie J.:

The appellant Shell Canada seeks a ruling that the respondent, having failed to seek leave to cross-appeal under Rule 29 of the Rules of the Supreme Court of Canada (the “Rules”), is precluded from attacking the finding of the Court of Appeal that the “gain” realized in a New Zealand - United States currency transaction entered into by the appellant is a capital gain.

This appeal concerns the proper tax treatment of a sophisticated financing transaction, known as a “weak currency financing scheme”, undertaken by the appellant. In 1988, the appellant required about $100 million (U.S.) for general corporate purposes. The market rate for a direct borrowing of U.S. dollars was 9.1%. Instead of borrowing U.S. dollars directly, however, the appellant entered into two agreements. The first agreement (the “Borrowing Contract”), involved the appellant borrowing $150 million (N.Z.) at an interest rate of 15.4% per annum (which was found to be the market rate for borrowing New Zealand dollars). The second agreement (the “Purchasing Contract”), involved the appellant using the New Zealand funds to purchase $100 million U.S. dollars at the market price.

In order to fulfill the appellant’s requirement for New Zealand dollars, the Purchasing Contract provided for the appellant to purchase enough New Zealand dollars to satisfy the interest payments under the Borrowing Contract and for the appellant to purchase $150 million (N.Z.) for $79 million (U.S.) on the date when the principle came due under the Borrowing Contract. The difference in the cost of the $150 million (N.Z.) at the time the Borrowing Contract was entered ($100 million (U.S.)) and at the time the principle was to be repaid ($79 million (U.S.)) resulted in a $21 million (U.S.) “gain” to the appellant.

In computing its tax liability, the appellant deducted the 15.4% interest it had paid under the Borrowing Contract and characterized the $21 million (U.S.) gain as a capital gain.

The respondent reassessed the appellant by allowing only the cost of directly borrowing U.S. dollars (9.1%) as an interest expense and characterized the “gain” as income.

The appellant appealed to the Tax Court where the court found in favour of the appellant and allowed the full 15.4% to be deducted as an expense. The Tax Court also characterized the gain as a capital gain.

The Court of Appeal reversed the Tax Court’s finding with respect to the interest deduction applying an “economic substance over form” doctrine which essentially dictated that the Borrowing Contract and Purchasing Contract be considered together. This in turn led the Court of Appeal to a determination that the 15.4% interest rate expense claimed failed to comply with three of the requirements that must be satisfied for a claimed expense to qualify as “interest” under the Income Tax Act: it was not interest, it was not used for the purpose of earning income and it was not reasonable. Therefore, the Court of Appeal disallowed any interest expense claimed above 9.1% - the direct cost of borrowing U.S. dollars. It is on that issue that the appellant sought and obtained leave to appeal in this Court.

The Court of Appeal did, however, agree with the Tax Court that the gain of $21 million (U.S.) should be considered a capital gain. The respondent has indicated that it intends to keep that issue alive on the appeal to this Court. The appellant disputes the respondent’s right to do so.

Rule 29 provides as follows:

29. (1) A respondent who seeks to set aside or vary the whole or any part of the disposition of the judgment appealed from shall apply for leave to cross-appeal within 30 clear days after the service of the application for leave, in the case of an appeal for which leave is required, or 30 clear days after the service of the notice of appeal, in all other cases.

(3) A respondent who seeks to uphold the judgment on a ground or grounds not raised in the reasons for the judgment appealed from may do so in the respondent’s factum without applying for leave to crossappeal, and the appellant may serve and file a factum in reply in accordance with Rule 41. (emphasis added)

The gist of the Rule is that where a respondent wishes to vary the judgment appealed from, that respondent must apply for leave to cross-appeal that part of the judgment. Where, however, the respondent seeks to uphold the judgment of the lower court on a ground not raised in the reasons of the judgment appealed from, no leave to cross-appeal is required. R. v. Keeg- stra, [1995] 2 S.C.R. 381 (S.C.C.), at 400.

The respondent’s argument on the capital gain issue would not, if accepted, uphold the judgment of the Court of Appeal. According to that judgment, the appellant may claim an interest expense of 9.1% per annum on the principal amount borrowed under the Borrowing Contract in the computation of its taxable income. The respondent says that if the appeal against that ruling succeeds, the respondent ought to be free to argue that the tax burden thus reduced should nevertheless be restored in whole or in part by recharacterizing the gain on the Borrowing Contract as income rather than capital.

In my view, the respondent would be required to obtain leave to cross appeal before raising this issue at the hearing of the appeal.

In the first place the judgment of the Federal Court of Appeal dated February 18, 1998 refers the matter back to the Minister “to be reassessed in accordance with Reasons for judgment herein”. The Minister’s authority is thus closely circumscribed by the reasons as well as the outcome of the appeal to that court.

Secondly, there is no reason to believe (and the respondent has not offered any proof) that the net effect of reclassifying the $21 million gain as income would be the same as the net effect on the appellant’s tax burden of the reasons for judgment of the Court of Appeal. If the tax burden calculated under the respondent’s alternative argument differs from the tax burden calculated under the Court of Appeal’s judgment, then recharacterizing the gain as income rather than capital would not uphold even the outcome, much less the reasons for judgment of the Federal Court of Appeal.

Accordingly, if the respondent wishes to keep the capital gains issue alive in this Court, she cannot do so without leave. The proper procedure would be to now serve and provide the Court with the proposed leave application with respect to the cross-appeal, accompanied by an application for an extension of time within which to file same, as set out in the Notice to the Profession dated January, 1996. The leave panel may then determine whether it is appropriate to have all aspects of the “weak currency financing scheme” before the Court on the main appeal.

Order accordingly.