Paragraph 12(1)(c) - Interest

An individual, by virtue of being part of a group of class action claimants, was awarded damages in 2004 of $1,200 for each of the eight winter seasons in which she had endured snowmobile noise. In 2010 she received damages pursuant to Article 1619 of the Quebec Civil Code of $8,400 (capital) and $6,148 (interest). Whether the interest was taxable under the Taxation Act turned on when her damages were considered to have become “liquidated.”

This liquidation date did not occur until October 1, 2009, being the later of the date on which the Attorney General of Quebec and the relevant Municipality had abandoned their appeals which had been launched in December 2004 - so that only the awarded interest that was referable to the period after that date was taxable to the individual, and even though the precise quantum of the amount payable to that individual was not established until the judgment of the Court Clerk issued on March 3, 2010. Gagné JCA stated (at paras. 41-43, 48-49, TaxInterpretations translation):

[O]ne cannot speak of interest in the strict sense unless the debt is both certain and liquidated. These two qualities arise at the time when the judgment becomes res judicata, that is, when it is not, and is no longer, subject to appeal. As long as the validity and/or the amount of the debt is the subject to debate on appeal, it cannot constitute a debt that is certain and liquidated or, in other words, a capital sum on which interest may accrue.

On the other hand, the debt does not have to be due and payable to bear interest. It is sufficient (and here I paraphrase Rand J. in … Farm Security …) that there be a use or retention by one person of a sum of money belonging to or owed to another. This, in my view, is a debt that is certain and liquidated.

I conclude that interest and additional compensation become interest proper, and therefore taxable interest, at the time the judgment awarding it became res judicata. In most instances, this will be the time when the debt is due. But not here … .

Once the November 30, 2004 judgment became res judicata, there was a definite sum owing (a liquidated and certain debt) on which actual interest could accrue.

The fact that [the Quebec Attorney General] was unaware of the extent of the members' claims at the time is irrelevant. …[T]he determination of whether an amount received or receivable is interest income must be made from the perspective of the taxpayer.

The plaintiff was a member of a group of class action claimants who in 2004 received a judgement for $1,200 in damages for each of seven winter seasons in which they had suffered from snowmobile noise. In 2010, she and the others received an additional indemnity and interest pursuant to a judgment issued on November 9, 2009 under Article 1619 of the Quebec Civil Code of $8,400 (capital) and $6,148 (interest). Both the plaintiff and the ARQ were in agreement that whether such interest was income turned on whether (to apply the wording in IMP.87-1/R1) “the damages [were] liquidated under a judgment” in 2004 or in or about 2010.

In finding that the liquidation occurred in July 2009, so that the interest was not taxable, Coutlée, J.C.Q. stated (at paras. 29-30, TaxInterpretations translation):

The judgment rendered by the Court Clerk [on March 3, 2010] was only the final link in the implementation of the final judgment of November 30, 2004

However, the November 30, 2004 judgment attained the status of res judicata only on July 3, 2009, being the date on which the Attorney General of Quebec abandoned the appeal which had been launched on December 2004.

SRC was a wholly-owned subsidiary of an immediate subsidiary (News Limited) of the taxpayer. Income derived by SRC was attributed to the taxpayer. Interest income of US$66,023,141 accrued due in the 2010 income year of SRC on a loan owing to it by News Limited, but that interest, was not paid until the 2011 income year of SRC.

Pagone J accepted the contention of the Commissioner that SRC was to be assessed for the interest income which accrued in the 2010, based on the basis that under s. 6-5 of the Income Tax Assessment Act 1997 (Cth) such interest was “derived directly or indirectly from [a] source…during the income year.”

Pagone J stated (at paras. 6, 8, 11, 12 and 33):

… The inquiry into derivation is not into whether an entitlement to receive has arisen or whether an amount has been received, although both entitlement and receipt may be relevant in determining whether there has been derivation. The inquiry is, rather, into when an item of ordinary income can be said to have come home to the taxpayer in a realised or immediately realisable form… .

[I]n Carsden’s case [63 CLR 108]…Dixon J expressed the view that the receipts basis of accounting would alone truly reflect the income of a medical practice if “there [was] but little certainty about the payment of fees.”

The authorities establish that interest income may be derived when accrued and that the taxpayer’s business and income earning activities, and the place of interest income in that business or activities, are relevant considerations to whether interest has been derived, in the sense of having come home, when accrued or only when received. …

SRC[‘s]…assets during that period were essentially cash and receivables, intracompany debts and shares in its subsidiaries.

…[A]n accruals basis of accounting for the interest accruing to SRC provided the correct reflex of SRC’s true income and the applicant is to be assessed on SRC’s interest income which accrued in the 2010 year. That the interest income had been derived upon accrual, … is not denied by the fact that … “SRC made only 2 loan advances in 10 years, and occasionally provided other financial accommodation in other forms”. SRC’s undertaking was substantial and the derivation of interest income was significant and was a means by which it employed a fund of capital from which to derive income or profit. … SRC also accounted for its interest income on an accruals basis and used and relied upon its funds upon accrual. There was no suggestion on the evidence that payment of the accrued interest income from its parent was uncertain. … [T]he lending of money and the provision of financial accommodation for reward to its parent company was part of its business or income earning activities. It may be accepted, without deciding, that SRC did not carry on a business of investment or of lending money, but its income earning activities included the lending of money to, amongst others, its parent on commercial terms for reward and the interest income had come home to SRC in a realised or immediately realisable form upon its accrual.

The taxpayer subscribed for loan stock of a family company at a price equal to its principal amount. Although the loan stock did not bear any amounts described as interest, a premium was payable on any redemption or repayment thereof "equal to 7.25% per annum of the Principal Amount to be repaid or redeemed, accruing on a daily basis." A few days later, he transferred the loan stock to a family trust. His (denied) claim for a loss on this transfer (arising from discounting the principal and premium payable on maturity using a 12.25% discount rate) turned on concluding that no amount on maturity would be "payable…by way of interest" (per s. 3(6) of Sched. 13 to the Finance Act 1996.)

Before concluding (at para. 19) that "the true nature of the payment was that it was interest," Rimer LJ quoted (at para. 18) with approval a statement of the Upper Tribunal that "interest" has "certain characteristics:"

First, it is calculated by reference to an underlying debt. Second, it is a payment made according to time, by way of compensation for the use of money. Third, the sum payable accrues from day to day or at other periodic intervals. Fourth, whilst the payment so accrues, it does not, in order for it to be interest, have to be paid at any intervals: it is possible for interest not to become payable until the principal becomes payable (see Willingale). Fifth, what the payment is called is not determinative; the question must always be one as to its true nature. Sixth, the fact that an interest payment may be aggregated with a payment of a different nature does not 'denature' the interest payment (Chevron Petroleum UK Ltd v. BP Petroleum Ltd [1981] STC 689, at 694, per Megarry V-C).

The son of the taxpayers (Mr and Mrs Pope), who was the beneficiary of a life insurance policy which he had purchased on his own life, was abducted in Angola by rebels in 1998. His death was likely but never conclusively established. Mrs Pope, who had her son's power of attorney, negotiated with the life insurance provider. In 2002, the provider paid the £100,000 principal amount insured, plus an additional amount of £36,425.97. The policy provided for the accrual of interest on the insured amount, but with the rate of interest "being at the Society's absolute discretion."

The Upper Tribunal agreed with the first-tier tribunal's conclusion that the additional amount was an interest payment and not, as the taxpayers had contended, an ex gratia capital payment. The Tribunal cited Lord Wright in National Westminster Ltd. v. Riches (1945), 28 TC 159 (HL), who stated (at p. 189):

[T]he essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had the use of the money, or conversely the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation.

The payment had clearly been made as compensation for the deprivation between 1998 and 2002 of the principal amount. The amount had been determined in accordance with the insurer's usual business practices, and was continually referred to as "interest" in correspondence with Mrs Pope.

The Upper Tribunal went on to find that the interest was not chargeable as income which the taxpayers had received or to which they were entitled because at the time of receipt all beneficial interests in the unadministered estate were held in suspense.

The deemed disposition by the taxpayer, as a result of his ceasing to be a resident of Canada, of a loan made by him to a non-resident corporation on which there was accrued but unpaid interest resulted in him being thereby deemed to receive an amount "in lieu of" the payment of interest. In the Transocean case, amounts paid in respect of the anticipatory breach of a rental agreement were found to be a reasonable substitute for rent payable under the agreement; and similarly, here "the deemed proceeds were a reasonable substitute for the accrued interest". (para. 37)

As a result of the payment of the proceeds of the RRSP of the deceased spouse of the son of the taxpayer to the spouse's estate rather than to the taxpayer (who was the main beneficiary of the RRSP), the taxpayer received judgment against the estate for the amount of the estimated value of the RRSP at the time of the wrongful payment plus an amount stated to be interest (calculated over the seven-year period from the date of such payment to the date of judgment). In finding that the sum referred to as interest constituted interest income to the taxpayer under paragraph 12(1)(c), Angers J. stated (at para. 16) that the sum satisfied the statement in Re: Farm Security Act, [1947] S.C.R. 394 that "interest arises when there is amount due to, or belonging to, another person for the period for which the interest is calculated".

An action by the taxpayer for a total of $68,000 in interest and principal owing to him under a loan to his uncle and a debtor company was settled by the payment to him of $11,500. The settlement agreement was silent as to the allocation of the settlement payments as between principal and interest, and the payors did not make any allocation of the payments as between principal and interest (although a T5 reporting slip was issued to the taxpayer). Accordingly, the taxpayer was entitled to allocate all the amounts received to principal, which the taxpayer did, so that none of the amounts received were interest income to him.

Pre-judgment interest (and some post-judgment interest) included in an award made to the taxpayer as a wages adjustment pursuant to the Canadian Human Rights Act which prohibited the federal government from paying wages that discriminated on the basis of gender, constituted interest for purposes of s. 12(1)(c).

Prejudgment interest received by the taxpayer as part of a damages award for tortious interference by a third party with his employment contract was found not to be interest because, until the time of judgment against the third party, there was no liquidated amount to which he was entitled and, therefore, no amount to which interest could be related.

Interest on a loan made by the taxpayer to a foreign affiliate was includable in its income at the 5% interest rate provided in the loan agreement notwithstanding that such interest was not received by the taxpayer.

The taxpayer purchased conditional sales contracts from Canadian General Motors franchise dealers and was reimbursed by General Motors of Canada Limited ("GMCL") under a "rate support program" for the amount by which the principal or face amount of the purchased contracts exceeded their discounted value. In later taxation years, the rate support program amounts were paid by GMCL directly to the dealers. The taxpayer brought the difference between the discounted amount and the face amount of the contracts into its income over the life of the contracts.

In rejecting a submission of the Crown that the rate support program amounts represented compensation to the taxpayer for lost interest, Rip TCJ. found that the taxpayer was not in a lender-borrower relationship with the retail customers of the dealer and (at p. 1855) "for an amount of money to constitute interest, the amount must be paid by the borrower of the money to a person who loaned money to the borrower".

Payments received by the taxpayer on a note owing by an arm's length debtor were found to be principal rather than interest on the basis of the doctrine that a debtor may direct his payment to be applied as it pleases, and that in the absence of any appropriation made by the debtor (as was the case here) the creditor may apply the money as he thinks fit.

A corporation took title to a Florida residence for which the taxpayer had exclusive use. Although there were large interest-free loans owing by the corporation to the shareholder (the taxpayer), Teskey J held that there was no connection between such loans and the original cost of the house, so that the benefit arising to the taxpayer under s. 15(1) should not be reduced having regard to the interest-free nature of the loans and the making of such a reduction in Youngman. Teskey J went on to state (obiter, at p. 1147) that, even if there had been a reduction in the s. 15(1) benefit, there would have been a matching interest income inclusion:

[T]he Federal Court of Appeal [in Youngman] did not have put to it nor did it consider the implications of barter.

Barter, on occasion, is used by some people to gain goods or services, the benefit of which is not declared as income in an attempt to avoid taxes. An example of this would be if I lend my arm’s length landlord $300,000 interest free and the landlord, in turn, does not charge me rent on the apartment which I occupy, which would normally have an annual rental of $20,000, the tax authorities lose tax on income of $20,000 from both my landlord and myself if the same is not declared. The $20,000 is taxable income in both hands.

The taxpayer purchased significant quantities of treasury bills through its broker and sold them one day prior to maturity. In dismissing the taxpayer's appeal, Dussault, TCCJ. found that the amount received as the sale price represented compensation for interest earned that the purchaser would recover the following day upon payment at maturity and, therefore, could probably be described as received "in lieu of payment of interest"

The purchase price of a government bond reflected interest that had accrued up to the date of the purchase. Nonetheless, when interest was paid on the bond, the full amount of the interest was included in the purchaser's income, rather than just the portion that accrued subsequent to the date of purchase.

A company issued at par £500,000 in notes which did not bear interest and which were repayable in six years time together with a premium of 30%. In the event of an early redemption of a note, the premium was the equivalent of 5% per annum.

The premium was "interest of money".

The Finnish subsidiary of the taxpayer arranged to repay shareholder advances of £319,600 by issuing notes with a face amount of £340,000 and bearing interest at 1% over the Bank of Finland discount rate. It was agreed that the notes would be repaid over a 20 year period and that a 20% premium would be payable on any annual redemption if the profits of the Finnish subsidiary in the year preceding the year of that redemption exceeded a specified level.

The discounts and premiums, when received, were realized on capital account. "Where a loan is made at or above such a reasonable commercial rate of interest as is applicable to a reasonably sound security, there is no presumption that a 'discount' at which the loan is made or a premium at which it is payable is in the nature of interest.... In deciding the true nature of the 'discount' or premium, in so far as it is not conclusively determined by the contract, the following matters together with any other relevant circumstances are important to be considered, viz., the term of the loan, the rate of interest expressly stipulated for, the nature of the capital risk, the extent to which, if at all, the parties expressly took or may reasonably be supposed to have taken the capital risk into account in fixing the terms of the contract.

The taxpayer lent money to its Indian subsidiary under an agreement which provided that interest was to be paid at 3% per annum (a "remarkably low rate for an unsecured loan") and that on repayment of the principal (which would occur in 10 years time, or earlier on the occurrence of certain specified events or on the election of the subsidiary to repay) a premium would be paid whose amount was based on 2% per annum for the first two years during the term of the loan, and 2 1/2% per annum thereafter.

Premiums, when received, were income from foreign possessions rather than payments of capital. "The premiums are part of the consideration given by the borrowers for the use of the capital lent to them, and part of 'the creditor's share of the profit which the borrower ... is presumed to make from the use of the money'." The effect of the premium was to give the lenders a return on their capital ranging between 5% and 5 1/2%.

The taxpayer held US-dollar denominated bonds of the Yugoslavian government which defaulted (although it offered alternative payment arrangements, including in "blocked" dinars). Proceeds of sale realized by the taxpayer on the subsequent sale by him of interest coupons on the defaulted bonds were found not to constitute income from foreign securities out of the U.K., based on the proposition that "the proceeds of sale of a right to receive income in the future...are capital in the hands of the vendor" (per Lord Romer at pa. 699).

The taxpayer, who had sold bonds with coupons attached but not yet due, had not received interest of money for purposes of Schedule D Case 111 Rule 1. Rowlatt, J. state (at p. 581):

The truth of the matter is that the seller does not receive "interest" and "interest" is the subject matter of the taxation. He receives the price of the expectancy of interest, and that is not the subject of taxation....