Thyssen Canada Ltd. v. The Queen, 84 DTC 6539, [1984] CTC 600 (FCTD), rev'd 87 DTC 5038, [1987] 1CTC 112 (FCA)

Rouleau, J:—The issue is whether money paid as additional charges by the plaintiff to its parent corporation in Germany was interest paid on outstanding debts to specified non-residents within the meaning of subsections 18(4) and (5) of the Income Tax Act, RSC 1952, c 148 as amended by SC 1970-71-72, c. 63, s 1 and SC 1973-74, c 14, s. 4; subsections 18(4) and (5) are reproduced in the attached Appendix.

Subsections (4) and (5) of section 18 refer to what is known as the Thin Capitalization rules. The purpose of those rules is to “disallow the deduction of interest payable by a corporation, resident in Canada, to specified non-resident shareholders of the corporation to the extent that debt owing by the Canadian corporation to such non-resident persons exceeds three times the equity of the corporation” (Ward’s Tax Law and Planning, Vol 1, 1983, p 4-162).

The plaintiff, in the business of importing and selling specialty steel products, is a wholly-owned subsidiary of Thyssen Stahlunion GMBH of Dusseldorf, West Germany, a corporation incorporated under the laws of the Federal Republic of Germany.

By Notices of reassessment dated April 18, 1979, the Minister of National Revenue disallowed an interest deduction of over $1,000,000 claimed by the plaintiff concerning transactions with Thyssen Stahlunion GMBH from its 1973 through 1975 taxation years. The disallowed charges have been apportioned in the following manner:

The plaintiff carries little or no inventory in Canada, its function is primarily that of sales agents. Canadian customers purchase steel from the plaintiff who in turn forwards the order to Germany. An invoice is then submitted to Thyssen Canada by its parent, setting out a base price which is to be payable by the plaintiff immediately upon delivery of the steel in Canada. These invoices were seldom, if ever, paid upon receipt of the goods in this country but rather usually paid 30, 60 or 90 days after arrival. It coincided with the payment from the customer. This initial payment would be for the basic price of the steel, FOB the port of departure. Once the invoice was paid to Thyssen Germany, they in turn would calculate what is called “Verzugszinsen” which, roughly translated, means late-payment charge and is the accepted usage of the word in Germany. The invoice does not indicate any contractual obligation for late-payment charges, but I accept the evidence that this was the agreed practice between them. A debit note would be issued for the amount to the plaintiff and paid. The plaintiff treated the additional charges as interest and withheld and remitted the nonresident tax of 15 per cent.

The plaintiff, in its accounting procedure, referred to this payment as interest and argues that it should be characterized as late-payment charges. The defendant claimed it became subject to subsections (4) and (5) of section 18 of the Act.

Thyssen Canada deals with somewhere between 100 and 150 customers. It is familiar with the payment habits of the majority of its customers; when submitting a price to the Canadian customer, the plaintiff adds to the basic price of the product a commission, transportation charges, duty, exchanges, terminal charges, trucking costs, insurance, seaway tolls and many other items together with interest of 30, 60 or 90 days, depending on its knowledge of the customer’s payment method. The document or worksheet used by the plaintiff in calculating the customer’s price was filed and marked as Exhibit A-4 to this action.

As evidenced at the trial, the plaintiff treated the late charges it levied against its customers as income for tax purposes and claimed as an expense the late payment charges levied by the German parent. The Minister of National Revenue disallowed the deduction on the basis that the late charges were interest paid on outstanding debts to specified non-residents and that the sums paid far exceeded the three to one ratio allowed under the Act.

There is no doubt that the objectives of the provisions of section 18 are clearly justifiable. If the capital needs of a Canadian corporation were to be satisfied through the acquisition of shares by a non-resident, the income of that corporation at the end of the year would be subject to full corporate tax. But if there were no thin capitalization rules and if the financing needs of the Canadian corporation had been satisfied by way of loan from the non-resident shareholder, the profits of the corporation, otherwise taxable, could be reduced by the interest expense paid on the loans. The interest payments abroad would only attract the lower rate prescribed by Part XIII of the Act, avoiding therefore the higher corporate rate.

The plaintiff contends that the late payment charges are not interest and that subsection 18(4) is therefore inapplicable. The plaintiff submits that if the Court were to hold that the surcharges were properly construed as interest then the interest would be deductible as forming part of the capital cost of acquiring property or costs of sales pursuant to subparagraph 20(l)(c)(ii) of the Income Tax Act which reads as follows:

20. (1) Notwithstanding paragraphs 18(l)(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 his income), pursuant to a legal obligation to pay interest on

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

In the case of Lebern Jewellery Co Ltd v MNR, [1976] CTC 2422; 76 DTC 1313, the Chairman of the Tax Review Board heard and disposed of a case which I feel is on all fours with the case at bar. The issue in that case was essentially the same: the proper characterization of late payment charges levied by a supplier of watches in Switzerland. I now reproduce with some abridgment the salient parts of that decision:

It is alleged that the terms of payment for . .. were normally 60 days net. However, payments made beyond the 60-day period always included an extra payment to cover the cost of carrying the appellant’s [Lebern] account beyond the normal 60-day term.

. . . it seems to me that, whatever percentage of the invoiced price is received by the suppliers in respect of late payments by the purchaser, this constitutes a part of the agreed selling price of their products. For the appellant [Lebern], any additional amount paid to the suppliers for late payment is a surcharge agreed upon between the vendor and purchaser, and is therefore included in the cost to the appellant [Lebern] of the goods purchased. This is an ordinary commercial and business practice which is used to facilitate payment in contracts for the purchase and sale of goods required to carry on a business, and, in my opinion, the said amounts are related directly to the costs of doing business for both the vendor and purchaser and are only incidentally related to the vendor’s income.

Admittedly, taxing statutes must be interpreted restrictively.

Although I am not, of course, bound by that decision, it is nevertheless difficult not to consider the very persuasive reasoning of the Chairman.

During trial, considerable emphasis was placed on documents submitted by the plaintiff.

One document is an Internal Order Sheet which outlined all the items the plaintiff considered and calculated before submitting a price to the customer. I am satisfied and I find that it is clearly established by that document that the late-payment charges were incorporated into the actual cost and/or selling price of the goods. As intimated in the Lebern case, (supra), and with which I agree, the inclusion of those charges is “an ordinary commercial and business practice which is used to facilitate payment . . .”.

The others are copies of the auditor’s report for the taxation years in question. The report in showing “cost of sales” only included the basic amount payable to Thyssen Germany on its initial invoice; the interest (late-payment charges) was entered under the item “other income” and there was deducted therefrom interest (late-payment charges) forwarded to the parent company. In addition to the “interest” submission, the Minister of National Revenue argued that this was suspect accounting procedure. I am satisfied that since they carried no inventory there is nothing inappropriate in the accounting method adopted by not showing the interest charges due the parent in “cost of sales” (ie, since 1976 they add delayed-payment charges into their “cost of sales” and there has been no reassessment by the Minister).

Thus I have come to the conclusion that the late-payment charges were not interest within the meaning of subsections 18(4) and (5) of the Act. Though one may call it interest, it is not necessarily determinative or conclusive of what it actually is. To hold otherwise would be to give too strict a construction to the subsections in question, and would go beyond the objective of the Act. Here the transactions between Thyssen Stahlunion (Germany) and Thyssen Canada on the one hand, and Thyssen Canada and its customers, on the other hand, did not artificially create a change in the plaintiffs income for tax purposes. As evidenced, the plaintiff included in its income the late charges paid by its customers. For the Court to disallow the deduction by the plaintiff of the surcharges levied by and paid to the German parent corporation would be tantamount to double taxation (15 per cent withholding), which is not, in absence of any such clear provision, the purpose of the Income Tax Act.

I would further like to make reference to the case of Stubart Investments Limited v The Queen, [1984] CTC 294; 84 DTC 6305, where Mr Justice Estey, speaking on behalf of the Court states as follows at 315-16 [6322-6323]:

In all this, one must keep in mind the rules of statutory interpretation, for many years called a strict interpretation, whereby any ambiguities in the charging provisions of a tax statute were to be resolved in favour of the taxpayer; the taxing statute was classified as a penal statute. See Grover & lacobucci, “Materials on Canadian Income Tax”, 5th ed, (1981), pp 62-65.

At one time, the House of Lords, as interpreted by Professor John Willis, had ruled that it was “not only legal but moral to dodge the Inland Revenue” (51 Canadian Bar Review 1 at p 26), referring to Inland Revenue Commissioners v Levene, [1928] AC 217, at p 227. This was the high water mark reached in the application of Lord Cairns* pronouncement in Partington v Attorney-General (1869), LR, 4 HL 100 at p 122:

I am not at all sure that, in a case of this kind — a fiscal case — form is not amply sufficient; because, as I understand the principle of all fiscal legislation, it is this: if the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute, what is called equitable construction, certainly such a construction is not admissible in a taxing statute where you simply adhere to the words of the statute.

Cited with approval in this Court in The King v Crabbs, [1934] SCR 523 [1 DTC 272] at p 525.

The converse was, of course, also true. Where the taxpayer sought to rely on a specific exemption or deduction provided in the statute, the strict rule required that the taxpayer’s claim fall clearly within the exempting provision, and any doubt would there be resolved in favour of the Crown. See Lumbers v MNR (1943), 2 DTC 631 (Ex Ct), affirmed [1944] SCR 167, [2 DTC 652]; and W A Sheaffer Pen Co Ltd v MNR, [1953] Ex. CR 251 [53 DTC 1223]. Indeed, the introduction of exemptions and allowances was the beginning of the end of the reign of the strict rule.

Professor Willis, in his article, supra, accurately forecast the demise of the strict interpretation rule for the construction of taxing statutes. Gradually, the role of the tax statute in the community changed, as we have seen, and the application of strict construction to it receded. Courts today apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge, he may be held liable. See Whiteman and Wheatcroft, supra, at p 37.

I concur with this view that the statute cannot be strictly interpreted in these circumstances.

I would therefore allow the appeal with costs and vacate the Minister’s assessments for the 1973, 1974 and 1975 taxation years.

Appendix

During the relevant taxation years, subsection 18(4) read as follows:

Limitation re deduction of interest by certain corporations

(4) Notwithstanding any other provision of this Act, in computing the income for a taxation year of a corporation resident in Canada from a business or property, no deduction shall be made in respect of that proportion of any amount otherwise deductible in computing its income for the year in respect of interest paid or payable by it on outstanding debts to specified non-residents that

(a) the amount, if any, by which

(i) the greatest amount that the corporation’s outstanding debts to specified non-residents was at any time in the year,

exceeds

(ii) 3 times the aggregate of

(A) the corporation’s paid-up capital limit (within the meaning of subsection 89(1)) at the commencement of the year,

(B) the amount that the corporation’s designated surplus would be immediately after the commencement of the year, if control of the corporation (within the meaning of Part VII) had been acquired by another corporation at that time,

(C) the corporation’s tax-paid undistributed surplus on hand at the commencement of the year,

(D) the corporation’s 1971 capital surplus on hand at the commencement of the year,

(E) the corporation’s capital dividend account (within the meaning of subsection 89(1)) immediately after the commencement of the year, and

(F) the amount, if any, by which the corporation’s paid-up capital limit (within the meaning of subsection 89(1)) at the end of the year exceeds the limit referred to in clause (A),

is of

(b) the amount determined under subparagraph (a)(i) in respect of the corporation for the year.

Subsection 18(5) read as follows (This subsection was amended during the relevant taxation year. The subsection as amended is also reproduced):

Meaning of certain expressions in ss (4)

(5) In subsection (4), “outstanding debts to specified non-residents’’ of a corporation at any particular time in a taxation year means the aggregate of amounts each of which is an amount outstanding at that time as or on account of a debt or other obligation to pay an amount.

(a) that was payable by the corporation to a person who was, at any time in the year,

(i) a shareholder of the corporation who, either alone or together with persons with whom the shareholder was not dealing at arm’s length, owned 25 per cent or more of the issued shares of any class of the corporation and who was

(A) a person not resident in Canada, or

(B) a non-resident-owned investment corporation, or

(ii) a person described in clause (i)(A) or (B) who was not dealing at arm’s length with a shareholder described in subparagraph (1), and

(b) on which any amount in respect of interest paid or payable by the corporation is or would be, but for subsection (4), deductible in computing the corporation’s income for the year.

Meaning of certain expressions in ss (4)

(5) In subsection (4), “outstanding debts to specified non-residents’’ of a corporation at any particular time in a taxation year means the aggregate of amounts each of which is an amount outstanding at that time as or on account of a debt or other obligation to pay an amount,

(a) that was payable by the corporation to a person who was, at any time in the year,

(i) a shareholder of the corporation who, either alone or together with persons with whom the shareholder was not dealing at arm’s length, owned 25 per cent or more of the issued shares of any class of the corporation and who was

(A) a person not resident in Canada, or

(B) a non-resident-owned investment corporation, or

(ii) a person described in clause (i)(A) or (B) who was not dealing at arm’s length with a shareholder of the corporation, if the shareholder, either alone or together with persons with whom he was not dealing at arm’s length, owned 25 per cent or more of the issued shares of any class of the corporation, and

(b) on which any amount in respect of interest paid or payable by the corporation is or would be, but for subsection (4), deductible in computing the corporation’s income for the year.

History — Subpara 18(5)(a)(ii) substituted by 1973-74, c 30, subsec 2(1), applicable with respect to taxation years commencing after February 19, 1973. Subpara 18(5)(a)(ii) formerly read:

(ii) a person described in clause (i)(A) or (B) who was not dealing at arm’s length with a shareholder described in subparagraph (i), and

* ♦ ♦ * *

Meaning of certain expressions in ss (4)

(5) In subsection (4), “outstanding debts to specified non-residents’’ of a corporation at any particular time in a taxation year means

(a) the aggregate of amounts each of which is an amount outstanding at that time as or on account of a debt or other obligation to pay an amount

(i) that was payable by the corporation to a person who was, at any time in the year,

(A) a shareholder of the corporation who, either alone or together with persons with whom the shareholder was not dealing at arm’s length, owned 25 per cent or more of the issued shares of any class of the corporation and who was

(I) a person not resident in Canada, or

(II) a non-resident-owned investment corporation, or

(B) a person described in subclause (A)(1) or (II) who was not dealing at arm’s length with a shareholder of the corporation, if the shareholder, either alone or together with persons with whom he was not dealing at arm’s length owned 25 per cent or more of the issued shares of any class of the corporation, and

(ii) on which any amount in respect of interest paid or payable by the corporation is or would be, but for subsection (4), deductible in computing the corporation’s income for the year,

but does not include

(b) where the corporation is a subsidiary of a non-resident life insurance corporation, the aggregate of amounts each of which is an amount outstanding at that time as or on account of a debt or other obligation to pay an amount to the life insurance corporation and such debt or other obligation has, by virtue of an election made under subsection 138(9), been included by the life insurance corporation in its taxation year that included the particular time as property held by it in the year in the course of carrying on an insurance business in Canada and the life insurance corporation has included the revenue therefrom in computing its income for the year from carrying on an insurance business in Canada.

History — Subsec 18(5) substituted by 1974-75, c 26, subsec 7(4), applicable to 1972 et seq.