Federal Court of Appeal Decisions

     A-514-93

CORAM:      HUGESSEN J.A.

         DENAULT J.A.

         MacGUIGAN J.A.

BETWEEN:

     PARTHENON INVESTMENTS LTD.

     Appellant

     - and -

     THE MINISTER OF NATIONAL REVENUE

     Respondent

     REASONS FOR JUDGEMENT

     (Delivered from the Bench at Montreal, Quebec, on Friday, May 30, 1997.)

MacGUIGAN J.A.

The principal issue in this case has to do with the application of par. 20(1)(c) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, the relevant part of which is as follows:

20.(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto: . . .

(c)      an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing the taxpayer's income), pursuant to a legal obligation to pay interest on

(i)      borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy).

(ii)      an amount payable for property acquired for the purpose of gaining or producing income from the property the income from which would be exempt or property that is an interest in a life insurance policy) . . .

     On 13 November 1984 the appellant declared a dividend of $2.6 million to its parent company, Pacific International Equities Corp. ("Pacific Canada"), a Canadian resident corporation. It paid Pacific Canada by delivering to it a promissory note in the amount of the dividend, bearing interest at 12% a year. On the same day Pacific Canada assigned the promissory note to Ottawa-Elgin Investment Limited ("Ottawa-Elgin"), another of its wholly owned subsidiaries, which was at the time in a non-capital-loss position, in partial settlement of a debt between Pacific Canada and Ottawa-Elgin. The appellant also undertook in the same agreement to "repay" the note and the accrued interest to Ottawa-Elgin on the latter's demand.

     The Minister of National Revenue disallowed the appellant's deductions of interest on the promissory note for the taxation years in question on the basis that the appellant did not fall within par. 20(1)(c) of the Act. The Tax Court Judge dismissed the appellant's appeal from the Minister's reassessments, holding that (Appeal Book, I, 169-170):

According to the evidence adduced, it is obvious that the relationship between the Appellant company and Ottawa-Elgin is a debtor-creditor relationship. There is no evidence whatsoever to show that the Appellant company borrowed money to be used for the purpose of earning income from a business or property because:

1) Nothing shows that there was a borrower-lender relationship;

2) Nothing shows that the borrowed money was used directly in the Appellant owned business;

3) On the contrary, what happened was for the benefit of another taxpayer;

4) Income Tax Act describes income from a source and is synonymous with profit or unreasonable expectation of profit.

     We are all agreed that the learned Tax Court Judge was right in holding that the appellant did not borrow money on which it could deduct interest as required by subpar. 20(1)(c)(i) of the Act. In the words of Locke J. in Minister of National Revenue v. T.E. McCool Limited (1949), 49 D.T.C. 700, 712, in interpreting the same provisions, "in order to qualify under the statute the taxpayer would have to be in the position of a borrower and some other person would have to be a lender." More recently, Stone J.A. has made the same point for this Court in The Queen v. MerBan Capital Corporation Limited (1989), 89 D.T.C. 5404, 5413:

What is fatal to the Respondents' case in my view is that paragraph 20(1)(c) requires that for interest to be deductible it must be paid pursuant to money borrowed by the taxpayer and not by someone else. The taxpayer must have created a borrower-lender relationship which gives rise to interest being paid.

     The appellant's witness Abdulezer acknowledged that there was no such borrowing by the appellant from "outside the family" (Appeal Book, App. I, I, 96-97, 115, 158), and like the Trial Judge, we are unable to interpret the promissory note as anything more than evidence of a debtor-creditor relationship. The unsubstantiated use of the word "repay" rather "pay" in the tripartite document is not enough to prove otherwise, nor is the mere fact of a novation, if there was a novation, sufficient in itself to establish that the new arrangement was a borrowing.

     The appellant's alternative argument under subpar. 20(1)(c)(ii), viz. that the interest on the promissory note was deductible since the entitlement to receive the declared dividend was property acquired, has also no evidentiary foundation. The evidence suggests that the promissory note was issued to pay the dividend rather than to acquire property.

     The other issue raised in this case is one on which both parties are agreed that the Tax Court Judge should have decided, viz., whether the appellant was during the taxation years under appeal a Canadian controlled private corporation within the meaning of par. 125(7)(b) of the Act so as to be entitled to claim the deductions provided for small Canadian businesses in s. 125(1) of the Act. Par. 125(7)(b) defines a Canadian-controlled private corporation as follows:

"Canadian-controlled private corporation" means a private corporation that is a Canadian corporation other than a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation) or by any combination thereof:;

     It is common ground on the facts in the case at bar that all of the voting shares of the appellant were owned by Pacific Canada, and that all of the voting shares of Pacific Canada were owned by Pacific International Equities Inc. ("Pacific U.S.), an American corporation, which in turn was owned approximately two-thirds by F.M.E. Investments Limited and one-third by H.S.M. Investments Limited, both Canadian resident corporations. It was also common ground that control meant de jure control.

     The respondent took the position that the fact that the appellant was indirectly owned by Pacific U.S. was enough to make it ineligible under the provision, since it was thus indirectly controlled by Pacific U.S., constituting a weak link in the chain of control, as it were, even though it was also - and ultimately - controlled by Canadian resident corporations.

     There is a Tax Review Board decision supporting the respondent's position: Les Produits Alimentaires Anco (1961) Inc. v. The Minister of National Revenue (1979), 79 D.T.C. 573. The Board, using the old strict method of interpreting tax statutes which was overruled in Stubart Investments Limited v. The Queen, [1984] C.T.C. 294, came to the conclusion that, because the text of the provision was written negatively and because of the breadth of the phrase" in any manner whatever," it was enough to exclude a Canadian corporation that it was controlled at any stage by a non-resident corporation. In keeping with this approach, the respondent argued that the appellant was controlled indirectly both by an American-resident and by a Canadian-resident corporation.

     It seems to us that one cannot thus divide up the notion of de jure control. Control has about it a character of exclusivity, of finality, and cannot allow for two masters simultaneously.

     In the case at bar control rests, ultimately, in the hands of Canadian residents. We do not see an interpretation in terms of ultimate control as an addition of the word "ultimately" to what would otherwise be a rule of plain meaning, but rather as emphasizing that the concept of control has necessarily latent within it the notion of ultimate control. In our view, therefore, the appellant must succeed on this part of its appeal.

     The appeal should be allowed in part, the judgment of the Tax Court Judge set aside, and the matter returned to the Minister for reassessment on the basis that the appellant was a Canadian-controlled private corporation throughout the taxation years under appeal.

     Success being divided, there should be no order as to costs.

     (Mark R. MacGuigan)

     J.A.

     A-514-93

CORAM:      HUGESSEN J.A.

     DENAULT J.A.

     MacGUIGAN J.A.

BETWEEN:

     PARTHENON INVESTMENTS LTD.

     Appellant

     - and -

     THE MINISTER OF NATIONAL REVENUE

     Respondent

Heard at Montreal, Quebec, on Thursday, May 29, 1997.

Judgment rendered from the Bench at Montreal, Quebec, on Friday, May 30, 1997.

REASONS FOR JUDGMENT OF THE COURT:      MacGUIGAN J.A.