Financing Expenditures

Before going on to find that foreign exchange losses realized by the taxpayer on repaying its debentures were capital losses under subsection 39(2) LeBel J. stated (at para. 32):

"Similarly, any foreign exchange loss on the debentures would be a payment on account of capital because the characterization of a foreign exchange gain or loss generally follows the characterization of the underlying transaction ... ."

In finding that interest paid by the taxpayer (an employed broker of an investment dealer) on a loan taken out by him in order to purchase the customer list of a departing employee was a payment "on account of capital", Major J. noted that in other jurisdictions, the question considered was whether interest payments were of a capital nature whereas in Canada, deduction was prohibited if a payment was "on account of capital" and stated (at p. 6127):

"This distinction means that under our Act it is only necessary to consider what the proceeds of the loan are to the borrower when they are received, and does not require an examination of what those loan proceeds are spent on. If the money adds to the capital then the payment of interest on that loan will be considered to be a payment 'on account of capital'. If the loan proceeds constitute the inventory of the borrower, as is the case with moneylenders, then the payment of interest would be deductible."

The taxpayer, which was engaged in the business of merchant banking, but which treated its share investments as being on capital account, incorporated a single-purpose subsidiary ("MKH") which in turn incorporated another subsidiary ("Holdings"). MKH and Holdings borrowed money from a bank in order to help fund most of the purchase price for the acquisition by Holdings of the shares of a public company, and the taxpayer provided the bank an indemnity (which the Crown alleged was in substance a guarantee) in respect of the payment of interest on the loans.

Iacobucci, C.J. overturned the trial judge's finding that the taxpayer was the primary obligor with respect to the payment of the interest and accordingly found (at p. 5412) that such payments by the taxpayer pursuant to its obligation (irrespective of whether it was characterized as "a guarantee or indemniy or even a hybrid") were non-deductible capital expenditures:

[T]hey were payments to enable subsidiaries MKH and Holdings to make related loans and investments - in this context assets or advantages for an enduring benefit - and so represented costs of financing such subsidiaries which in a number of cases have been held to be capital in nature. (p. 5412)

Interest is a capital outlay the deduction of which is prohibited by s. 18(1)(b) unless its deduction is expressly permitted by some other provision of the Act.

Interest expenses would not be deductible in the absence of the express statutory allowance in s. 20(1)(c).

The by-laws of a Quebec credit union required the taxpayer to pay to the credit union a non-refundable sum equal to 4 1/2% of the amount paid by him in subscribing for some of its shares. It was held that since he would never have to repeat this payment so long as he remained a shareholder, and he obtained by virtue of making the payment "the benefit of investing his capital and deriving an income from it for a good number of years," the payment was a capital expenditure.

Addy, J. stated "that a taxpayer can now deduct an amount from income only on two conditions: first, that it would be normal practice according to generally accepted accounting principles to deduct this sum from an income account, and secondly, that the prohibitory provisions of section 18(1) do not prevent such a deduction."

Finder's fees paid by the taxpayer to banks, lawyers, investment dealers and financial agents for finding numerous investors to purchase debentures (generally with a term of one to five years) issued by it were fully deductible expenese. Heald J. stated (at p. 5411):

[T]he taxpayer's business is borrowing money from the public and lending it out on the security of real estate morgages. In this business, the appellant's stock in trade is borrowed money. Surely any expense involved in acquring the Company's stock in trade is properly deductible. ... One side of the appellant's business is to obtain borrowed funds. The other side is to lend out these borrowed funds on the security of mortgages.

A partnership engaged in the business of buying and selling real estate purchased two properties in 1954, mortgaged the properties and in 1955 sold the properties for consideration that included the assumption by the purchasers of the amounts owing under the mortgages including bonus amounts that were payable to the mortgage lenders.

In both cases, the proceeds of disposition of the properties to the partnership included the full amount of the assumed mortgages including the bonuses payable on maturity. However, in the case of the first property (61 Beatrice Street), where the mortgage proceeds had been used by the partnership on its previous purchase of the property in funding that purchase, the amount of the bonus was deductible from the proceeds of the subsequent sale because the proceeds of the borrowing had been used to acquire an inventory asset and not to expand or add anything of a permanent nature to the assets employed as capital in the business, and because the borrowing was a temporary one given that the partnership did not expect to have the property for long. In the case of the second property (23 Cowan Avenue) the taxpayers failed to establish that the mortgage proceeds had been used by the partnership to acquire the property (a trading asset), so that the amount of the bonus on the assumed mortgage was not deductible.

Rand J. stated (p. 1244):

"It is important to remember that in the absence of an express statutory allowance, interest payable on capital indebtedness is not deductible as an income expense. If a company has not the money capital to commence business, why should it be allowed to deduct the interest on borrowed money?"

Interest payable on interest in default on a debenture of the taxpayer was a capital expenditure. The provision for the payment of such compound interest was "part of the consideration promised by the appellant in order to secure its capital."

Substantial annual fees paid by a construction company to its shareholders or related individuals in consideration for their providing guarantees of bank loans used by the company to finance its construction work were payments on account of capital and, therefore, non-deductible. Estey J. stated (at p. 9 (CTC)) that "this was not a borrowing of money on a temporary or short-term basis such as is necessary and incidental to the ordinary and usual transactions in the course of the appellant's business..."

The taxpayers incurred various expenditures in connection with retiring existing bonds before maturity and issuing replacement bonds at a lower rate of interest and with less onerous conditions as to payment, including the payment of redemption premiums, disbursements on account of exchange, discounts paid to the underwriters on the issuance of the new bonds, and legal and printing expenses. These expenditures were found to be non-deductible by virtue of s. 6(a) of the Income War Tax Act, although Lord Macmillan indicated (at p. 135) that "their Lordships in no way dissent from the view" that their deduction also was prohibited by virtue of s. 6(b). It was found that "the financial re-adjustment of their borrowed capital was an isolated episode, unconnected with the day to day conduct of their businesses" and that "expenditure incurred in relation to the financing of their businesses is not, in their Lordships' opinion, expenditure incurred in the earning of their income within the statutory meaning."