Federal Court Decisions

Date: 2000-08-30

Docket: T-1641-90

BETWEEN:

     GENERAL ELECTRIC CAPITAL EQUIPMENT FINANCE INC.

     Plaintiff

AND:

     HER MAJESTY THE QUEEN

     Defendant

     REASONS FOR JUDGMENT

ROULEAU, J.

[1]      This action, pursuant to subsection 172(2) of the Income Tax Act , is to determine whether the plaintiff has been properly assessed for failure to withhold tax.

[2]      The facts in this matter, as set out in detail in the Agreed Statement of Facts filed with the Court, may be summarized as follows:

1. The plaintiff was incorporated in 1959 under the laws of Canada with the name International Harvester Credit Corporation of Canada Limited ("IHCC").          2. HCC was a wholly-owned subsidiary of Navistar International Corporation Canada, formerly, International Harvester Canada Limited ("IHC"), an Ontario corporation, which in turn was a wholly-owned subsidiary of Navistar International Corporation, formerly International Harvester Company ("IHCo), a Delaware corporation.

    

3. On December 18, 1986, IHC sold all of the issued and outstanding shares of IHCC to Genelcan Limited, a Canadian subsidiary of General Electric Company (the "IHCC sale"). The name of IHCC was changed in 1985 to Navistar Financial Corporation Canada Inc. and after the sale of Genelcan Limited was further changed to General Electric Capital Equipment Finance Inc., the plaintiff.

    

4. IHCC carried on the business of financing retail and wholesale sales in Canada of International Harvester products. In the course of raising capital for its financing purposes, IHCC issued the following subordinated promissory notes:

    

Original Issue Date	Original Maturity Date	Beneficial Owner of Note	Principal Amount of Note
March 15, 1977	March 16, 1982	Harbour*	$ 5,000,000
March 15, 1979	March 16, 1984	Harbour	$10,000,000
January 15, 1980	January 16, 1985	IHAC**	$10,000,000
August 8, 1980	August 9, 1985	IHOF***	$15,000,000

* Harbour Assurance Company of Bermuda Limited (resident of Bermuda)

** International Harvester Acceptance Corporation Limited (resident of Bermuda)

***International Harvester Overseas Finance Corporation (resident of United States)

5. Each of the notes was issued in the name of Chemical Bank as holder on behalf of the respective beneficial owners of the Notes. On August 3, 1984, the IHOF note was transferred to International Harvester Export Company ("IHExport"), a corporation resident in the United States. Harbour, IHAC, IHOF and IHExport were all either directly or indirectly owned subsidiaries of IHCo.

    

6. Prior to its expiry, the maturity date was extended for one year as follows:

a) Harbour Note 1 extended to March 17, 1987, by confirmation issued by Chemical Bank on March 16, 1982;

b) Harbour Note 2 extended to March 15, 1986, by extension agreement executed by IHCC and Chemical Bank;

c) IHAC Note extended to March 15, 1986, by extension agreement executed by IHCC and Chemical Bank;

d) IHOF Note extended to March 15, 1986, by extension agreement executed by IHCC and Chemical Bank.

    

7. From the respective dates of issue of these notes until 1984, IHCC paid interest on the notes without payment of withholding tax.

    

8. In 1984, IHCC received Notices of Assessment with respect to the withholding tax which Revenue Canada maintained ought to have been withheld on account of interest payments made on the notes. As a result of these assessments, IHCC paid the applicable withholding tax set off against the principle amount of each of the notes as follows:

Designation of Note	Amount of Withholding Tax Set Off Against Principal	Balance of Principal on Note
Harbour Note 1	$ 924,141	$ 4,075,859
Harbour Note 2	$ 955,099	$ 9,044,901
IHAC Note	$ 931,276	$ 9,068,724
IHOF Note	$1,144,181	$13,855,819

9. By separate agreements each dated February 18, 1985, the respective beneficial owner of each of the notes sold them to Harneth B.V., a Netherlands corporation which was an indirect wholly-owned subsidiary of IHCo.

    

10. In each case, interest on the applicable note was payable at such rate so as to result in the holder receiving, after application of any applicable withholding tax, a net return equal to the rate of interest set forth on the face of that note. This resulted in the following gross-up of interest rates:

Designation of Note	Face Rate of Interest on Note	Grossed-Up Rate of Interest
Harbour Note 1	Bank of Montreal prime + 3/4%	117.647% of interest otherwise payable
Harbour Note 2	10.375% per annum	12.21%
IHAC Note	12.25%	14.41%
IHOF Note	13.25%	15.59%

11. On December 18, 1986, the closing date of the sale of IHCC to Genelcan Limited, none of the notes were repaid. Genelcan delivered to IHC an undertaking to the effect that it would "pay or cause [IHCC] to pay in full all amount owing on account of outstanding principal and accrued and unpaid interest in respect of the [notes] held by Harneth B.V., at the time, in the manner and at the places set forth, respectively, in such [notes]".

    

12. By Notice of Assessment dated July 7, 1989, the Minister of National Revenue assessed the plaintiff for the amount of $419,069 on the alleged grounds that the plaintiff failed to withhold and remit 15% non-resident tax under the provisions of the Income Tax Act.

    

13. On October 4, 1989, the plaintiff filed a Notice of Objection to the Assessment.

    

14. By letter dated March 13, 1990, the Minister of National Revenue notified the plaintiff that the Assessment was confirmed.

[3]      In accordance with subsection 212(1) of the Income Tax Act, interest payable by a resident of Canada to a non-resident is subject generally to withholding tax at the rate of 25%. However, pursuant to the exemption provision contained in paragraph 212(1)(b)(vii), interest payable by a resident of Canada to an arm"s length non-resident pursuant to an obligation entered in after June 23, 1975, and with a term of greater than five years, is exempt from withholding tax. These provisions read as follows:

212.(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 the non-resident person as, on account or in lieu of payment of, or in satisfaction of,      (b)interest except      (vii) interest payable by a corporation resident in Canada to a person with whom that corporation is dealing at arm"s length on any obligation where the evidence of indebtedness was issued by that corporation after June 23, 1975 if under the terms of the obligation or any agreement relating thereto the corporation may not under any circumstances be obliged to pay more than 25% of          (B) . . . the principal amount of the obligation, within 5 years from the date of single debt issue or that obligation, as the case may be,

212.(1) Toute personne non-résidente doit payer un impôt sur le revenu de 25% sur toute somme qu"une personne résidant au Canada lui paie ou porte à son crédit, ou est réputée en vertu de la partie I lui payer ou porter à son crédit, au titre ou en paiement intégral ou partiel:      b) d"intérêts, sauf:      (vii) les intérêts payables sur un titre par une société résidant au Canada à une personne avec laquelle cette société n"a aucun lien de dépendance, lorsque le titre de créance a été émis par cette société après le 23 juin 1975, si, selon les modalités du titre ou d"une convention s"y rapportant, la société ne peut, en aucun cas, être tenue de verser plus de 25%:          (B) ... du montant du principal de l"obligation, dans les 5 années suivant la date de l"émission couvrant une dette unique ou de cette obligation, selon le cas,

[4]      In the present case, the plaintiff maintains that the Minister erred in concluding that the exemption provision in paragraph 212(1)(b)(vii) of the Income Tax Act did not apply to the payment of interest in question. It argues that the statutory criteria for exemption are present insofar as each of the notes was issued by IHCC after June 23, 1975, and IHCC was not obliged to pay more than 25% of the principal amount of the obligation evidenced by the notes within five years from the date of issue thereof.

[5]      I am satisfied that the plaintiff has been properly assessed for failure to withhold tax as required by section 215 of the Income Tax Act and the action should therefore be dismissed.

[6]      The evidence clearly shows that the original notes were so materially altered by the agreements of February 18, 1985, as to result in completely new obligations pursuant to paragraph 212(1)(b)(vii) of the Act. Most significantly, the rate of interest of each note was changed, so that the net return to the holder of each note after payment of withholding taxes, was equal to the rate of interest set out in the note. In addition, the maturity date of each note was changed as was the principal amount of each note. In other words, the effect of the February 18, 1985 agreement between IHExport, Harneth, IHC and IHOF was to change the interest rate, the manner of calculating the interest rate, the parties and the maturity date of each note. The only reasonable conclusion is that the changes to the obligations and to the notes underlying them constitute the creation of a new obligation within the meaning of that term as it is used in paragraph 212(1)(b) of the Act.

[7]      Furthermore, the indebtedness of the plaintiff to Harneth was not one pursuant to which the issuer was not obliged to pay more than 25% of the principal amount of the obligation within five years of the issue date. The exception contained in subparagraph 212(1)(b) cannot apply in this case therefore since the sale of the notes to Harneth B.V. created a new obligation in respect of each of the notes insofar as more than 25% of the principal amount of each obligation became payable within five years from February 18, 1985.

[8]      Although the parties submitted a number of authorities pertaining to the doctrine of novation, I found them to be of little value in the determination which the Court was required to make here.

[9]      For these reasons, the action is dismissed.

JUDGE

OTTAWA, Ontario

August 30, 2000