Borrowed Money

Treatment of bankers' acceptances under

Bills of Exchange Act (p. 878)

A bankers' acceptance is a bill of exchange drawn by a customer upon a bank, payable at some specified future date and accepted by the bank. …Typically, the customer draws a bankers' acceptance payable to the customer's own order and receives it back from the bank after acceptance. The customer then endorses the acceptance either "generally", thus rendering it payable to bearer (see §5203.1) or "specially", making it payable to a named broker. In either event, the acceptance will usually be sold to an investor in the money market. [TaxInterpretations comment: The process now is handled so that the customer is invisible to the purchaser of the bankers' acceptance.]

A bankers' acceptance is the direct and primary obligation of the bank by virtue of the statutory engagement of s. 128 [now s. 127] of the Bills of Exchange Act (see §5502). It is also evidence of the secondary obligation of the drawer in the terms of the statutory engagement set out in s. 130 [now s. 129] of the Bills of Exchange Act (see §5503). The drawer's engagement is to pay the acceptance if the bank does not. The bank is an accommodation party to the instrument since, in the terms of the Act, it "lends its name" (see §5506) to its customer to assist him in raising funds by the sale of the acceptance in the money market. [fn no 2: The bank receives a fee from its customer (called an acceptance fee or "stamping fee" of about ¾ of 1% of the principal amount of the acceptance), as compensation for its services, but otherwise receives no value for the instrument, the proceeds of sale being paid directly to or to the order of the drawer.] As a result, the acceptance is discharged at maturity only if payment is made by the customer as the party accommodated. It may therefore be deduced that if the drawer does not discharge the acceptance before its maturity, the accepting bank must pay it.

No borrowing upon issuance of bankers' acceptance (p. 879)

It is clear both in principle and on authority that there is no borrowing upon the issue of a bankers' acceptance. The investor or ultimate purchaser of the acceptance does not make a loan to the drawer; he acquires an investment security in a transaction of purchase and sale.[f.n. 6: "When one purchases a bearer deposit note or a bankers acceptance, one is in fact purchasing a chose in action – a debt owed by the bank. This is not a loan or advance made [to the bank] by [the investors]", per Gould J. in Air Canada v. Minister of Finance of British Columbia [1979] 4 W.W.R. 643 (B.C.S.C.), at p. 648, revd on other grounds [1981] 2 W.W.R. 97 (C.A.).] The bank does not lend money to the drawer; it lends its credit by accepting the order to pay as an accommodation to its customer, and pays the acceptance at maturity as its own obligation. The customer does not "repay" the bank at maturity; he may provide it with the funds required to discharge the acceptance, or he may indemnify it if it pays its own funds before calling upon him. Therefore it may be seen that there is no borrowing or lending by anyone. This analysis was accepted as correct by the English Court of Appeal in denying a taxpayer's claimed deduction for the costs of raising funds by bankers' acceptances. Since there was no borrowing, the costs of issue were not deductible.

Problems with former s. 20(1)(i) rule (pp. 880-1)

[U]ntil the recent amendments to the Income Tax Act, if the customer sought to claim a deduction under the Income Tax Act for the bank's stamping fee paid by it, it was required to ensure that the term to maturity did not exceed 366 days from the date of acceptance. As the bill drawn by the customer is virtually unsaleable until it is accepted by the bank, the date of acceptance tends, as a practical matter, to be the date of issue, or a day or two before the date of issue.

Under the same statute, the customer was able to deduct the discount on sale as a cost of issuing the acceptance, only if it had an original term of not more than 366 days.

These technical restrictions of the Income Tax Act were difficult if not impossible to accommodate to the demands of the money market. Accordingly, they were repealed with respect to bankers' acceptances drawn after June, 1984. Briefly, the tax treatment is now to regard the drawer's costs of issuing bankers' acceptances as costs of borrowing money, which are deductible under sub-s. 20(1). In accordance with fundamental principle, it must now be shown that the proceeds were required by the taxpayer for the purposes of earning income from business on property. Under the old law that was less clear, if required at all. One technical point that the recent amendments have not corrected is the misdescription of bankers' acceptances as "post-dated bills". We discuss the technical meaning of that term in §6101. Although a typical bankers' acceptance is not technically postdated, it is payable at a specified date in the future as a postdated bill is, and the intention was clearly to include bankers' acceptances within the term erroneously used by the Income Tax Act.

Roly poly arrangements (p. 881)

The foregoing amendments to the Income Tax Act put an end to a short-lived market development called a "roly poly". While eligible bankers' acceptances were still limited to terms of 366 days or less, a usage arose for the drawer to covenant with the holder in a separate letter agreement to draw one or more renewal acceptances on the same terms and for the holder to receive each renewal in satisfaction of the one it replaced up to a stated maximum number of renewals. In this fashion it was thought to be possible to fix the interest rate for periods much longer than one year while still technically complying with the tax law.