Minister of National Revenue (Appellant)
v.
Mid-West Abrasive Company of Canada Limited
(Respondent)
Trial Division, Sweet D.J.—Toronto, June 1 and
11; Ottawa, August 1,1973.
Income tax—Interest on borrowed money—In what year
allowed as deduction—Interest not paid in year money used
but in later year on lender's demand—Not deductible—
Income Tax Act, s. 11(1 Xc).
In 1960 and 1961 respondent borrowed $210,000 from its
parent company for the purposes of its business. The loans
were covered by promissory notes which stated "Interest
will be paid if requested but not in excess of 6%". Respond
ent, which used accrual accounting, made no provision in its
accounts for payment of interest on the above money until
1966 when the parent company first requested interest at
6%. In 1967 respondent claimed a deduction of $46,512 in
computing its income for tax purposes, that being the
amount of accrued interest on the above loans for the years
1962 to 1965. The Minister disallowed the claim.
Held, the assessment must stand. Under section 11(1)(c)
of the Income Tax Act respondent was entitled to claim a
deduction for interest on borrowed money only in respect of
the year in which the money was used in its business and
not in the year in which the lender requested payment of
interest.
APPEAL from Tax Appeal Board.
COUNSEL:
L. R. Olsson, Q.C., and L. G. Dollinger for
appellant.
M. A. Mogan for respondent.
SOLICITORS :
Deputy Attorney General of Canada for
appellant.
Miller, Thomson, Sedgewick, Lewis and
Healy, Toronto, for respondent.
SWEET D.J.—This is an appeal from the deci
sion of the Tax Appeal Board allowing the
respondent's appeal against the respondent's
income tax assessments for the 1966 and 1967
taxation years.
The issue is whether the respondent was en
titled to make certain deductions in respect of
interest paid to its parent company.
The parties through their counsel have sub
mitted an "agreed statement of facts" as
follows:
The Appellant and the Respondent hereby admit the several
facts respectively hereunder specified but these admissions
are made for the purpose of this appeal only and may not be
used against either party on any other occasion or by any
other than the Appellant and the Respondent. The parties
reserve the right to object to the admissibility of any or all
of the said facts on the ground that they are not relevant or
material to any of the issues to be determined in this appeal.
1. The parties agree that this appeal shall be heard on a
record consisting of the pleadings in the Tax Appeal
Board and in this court, the documents forwarded by the
Minister to the Board pursuant to former Section 89(4) of
the Income Tax Act, the transcript of evidence in the Tax
Appeal Board, the exhibits which were filed at the hearing
before the Board and this Agreed Statement of Facts. It is
agreed that each party may refer to and rely upon the said
transcript and documents and exhibits in addition to this
Agreed Statement of Facts.
2. The Respondent is a company incorporated on the 4th
day of January, 1954, under the laws of Canada and
carries on business in Strathroy, Ontario.
3. The Respondent is a wholly owned subsidiary of MWA
Company (formerly Mid-West Abrasive Company) of
Owosso, Michigan U.S.A. (herein called "the Parent
Company").
4. During the period May, 1960, to December, 1961, the
Respondent borrowed the following sums of money from
the Parent Company:
Amount Amount
U.S. Canadian
Date Dollars Dollars
May 13, 1960 $ 51,579.63 $ 50,000.00
August 18, 1961 28,547.39 30,000.00
September 5, 1961 29,090.63 30,000.00
December 8, 1961 96,080.00 100,000.00
$205,297.65 $210,000.00
5. Each of the loans referred to in paragraph 3 was
evidenced by a promissory note executed and delivered
by the Respondent to the Parent Company bearing the
following endorsement:
Interest will be paid if requested, but not in excess
of 6%.
6. At all relevant times the $210,000.00 (Canadian dol
lars) described in paragraph 4 above and hereafter called
the "borrowed money" was used for the purpose of
earning income from the Respondent's business.
7. In the Respondent's fiscal periods ending December
31, 1962, 1963 and 1964, no amount was accrued or
deducted in its books of account or financial statements
as a liability in respect of interest referable to the bor
rowed money although the Respondent used the accrual
method of accounting in computing its income and the
principal amount of the debt, $210,000.00, was shown.
8. After 1964 the Respondent changed its fiscal year end
to June 30th in order to coincide with the fiscal year of
the Parent Company. In the six-month fiscal period ending
June 30, 1965, again the Respondent did not accrue or
deduct any amount as a liability in respect of interest
referable to the borrowed money.
9. In the early years of its operation, the Respondent
incurred losses which resulted in a cumulative deficit.
Commencing in 1963, however, the company's operations
became profitable and the deficit gradually was reduced
until the Respondent began to accumulate retained earn
ings. The table below sets out the profit (or loss) for the
respective years and the corresponding retained earnings
(or deficit).
Retained
Taxation Profit Earnings
Year (or Loss) (or Deficit)
31/12/61 ($41,709.10)
31/12/62 ($20,213.00) ( 61,922.10)
31/12/63 2,845.18 ( 59,076.92)
31/12/64 43,742.32 ( 15,334.60)
30/06/65 18,291.09 2,956.49
30/06/66 18,861.04 21,817.53.
10. The U.S. Internal Revenue Service imputed interest
income to the Parent Company in respect of the borrowed
money for the 1962, 1963 and 1964 years and required it
to pay tax on such imputed interest without regard to
whether such interest had been accrued by the Parent
Company. No such interest had been paid by the
Respondent or received or accrued by the Parent Com
pany in those years. This action by the U.S. Internal
Revenue Service, coming at a time when the Respondent
had the financial ability to pay interest, appears to have
been the event which caused the Parent Company to
request and the Respondent Company to accept and pay
interest as set forth below.
11. In computing its income for the taxation year ending
June 30, 1966, the Respondent deducted the amount of
$13,246.43 representing interest on the borrowed money
for the period July 1, 1965, to June 30, 1966.
12. In preparing its financial statements for the taxation
year ending June 30, 1966, the Respondent charged
against its "Retained Earnings" as at June 30, 1966, the
amount of $19,869.65 representing interest on the bor
rowed money for the period January 1, 1964, to June 30,
1965. The amount of $19,869.65 was not, however,
deducted in computing the Respondent's income for 1966.
13. No interest was in fact paid by the Respondent to the
Parent Company prior to August 29, 1966. On August 29,
1966, the Respondent remitted to the Parent Company the
sum of $33,116.08, being the sum of the two amounts of
$13,246.43 and $19,869.65, referred to above. Subse
quently, in the 1967 taxation year, the Respondent remit
ted to the Parent Company the sum of $26,642.65 in
respect of interest for the period January 1, 1962, to
December 31, 1963.
14. The Respondent filed its T2 Corporation Income Tax
Return for its 1966 taxation year on the 30th day of
September, 1966. At the same time it filed amended
returns for the twelve month taxation year ending Decem-
ber 31, 1964, and the six month taxation year ending June
30th, 1965.
15. In the amended return for 1964 filed on the 30th day
of September, 1966, the Respondent sought to amend its
computation of income by deducting interest in the
amount of $13,246.43 for that twelve month taxation
year. In the amended return for 1965 filed on the 30th day
of September, 1966, the Respondent sought to amend its
computation of income by deducting interest in the
amount of $6,623.22 for the six month taxation year. The
Department of National Revenue did not take any action
following receipt of the amended returns for 1964 and
1965 and, in particular, did not allow the deduction of
interest for those taxation years.
16. The Parent Company must have informed the
Respondent that it was requesting interest at least in
respect of the amounts of $13,246.43 and $19,869.65
prior to July 13th, 1966 because the auditors' report to the
Respondent in respect of the fiscal period ending June 30,
1966, is dated July 13, 1966, and in Exhibit "B" to that
report the amount of $13,246.43 is deducted in computing
income, and $19,869.65 is charged against retained
earnings.
17. By letter dated September 22, 1966, (Exhibit "A-6"
in the Tax Appeal Board) the Parent Company informed
the Respondent "that demand is being made on your
company for repayment of the advances and interest
at 6% now existing". At a meeting of the Board of
Directors of the Respondent on October 10, 1966, it was
agreed that the Respondent would accept interest charges
on the notes payable to the Parent Company starting with
the year 1962.
18. In computing its income for the taxation year ending
June 30, 1967, the Respondent deducted interest on the
borrowed money in the amounts of $6,692.04 and
$46,512.30. The amount of $6,692.04 represented interest
for the period July 1, 1966, to June 30, 1967. The amount
of $46,512.30 was composed of two separate items: first
ly, the amount of $19,869.65 described in paragraph 12
above; and secondly, the amount of $26,642.65 represent
ing interest on the borrowed money for the period January
1, 1962 to December 31, 1963.
19. In preparing its financial statement for the taxation
year ending June 30, 1967, the Respondent charged
against its "Retained Earnings" as at June 30, 1967, only
the amount of $26,642.65. The remaining $19,869.65 had
been charged in 1966: see paragraph 12 above.
20. In summary, interest referable to the borrowed
money requested in 1966 by the Parent Company in
respect of the fiscal periods commencing January 1, 1962,
was deducted by the Respondent in computing income
and/or charged against retained earnings in the respective
taxation years reflected in the table below.
Deducted in Charged to
Interest Amount of Computing Retained
Period Interest income Earnings
Jan. 1/62 to $26,642.65 1967 Non-recurring
Dec. 31/63 Expense-1967
Jan. 1/64 to 19,869.65 1967 Non-recurring
June 30/65 Expense-1966
July 1/65 to 13,246.43 1966 Implicit with
June 30/66 income
calculation
July 1/66 to 6,692.04 1967 Implicit with
June 30/67 income
calculation
21. By Re-assessments for the 1966 and 1967 taxation
years, Notices of which were mailed to the Respondent on
August 1, 1968, the Appellant disallowed as a deduction
in computing income the following amounts of interest
which had been claimed by the Respondent:
1966 — $13,246.43
1967 — 46,512.30
The Appellant disallowed the sum of $13,246.43 on the
basis that it was not an amount payable or a liability
incurred before June 30, 1966, being the last day of the
1966 taxation year. The Appellant disallowed the sum of
$46,512.30 on the basis that it was not "an amount .. .
payable in respect of the year" within the meaning of
Section 11(1)(c) of the Income Tax Act.
22. Even if the request for interest were made by the
Parent Company after June 30, 1966, but before the date
of the auditor's report, good accounting practice would
require the liability in respect of interest to be disclosed in
the report. The handbook of the CICA states at page
1500:13:
... any event or transaction between the date of the
balance sheet and the date of the auditors' report there
on, which may have a material effect on the financial
position or net income of the business, should be
disclosed.
23. Montgomery's Auditing, Eighth Edition, a well recog
nized text dealing with accounting principles and distribut
ed to all accounting students in the Province of Ontario
states at page 377:
Statement on Auditing Procedure No. 25, issued in
October, 1954, relating to the auditor's responsibility in
connection with the disclosure of events occurring or
becoming known subsequent to the date of statements
concerning which he is expressing an opinion, sets forth
the general rule that such financial statements should be
adjusted to recognize liabilities determined subsequent
to the balance sheet date and prior to the time his report
is submitted.
24. Attached hereto as Schedule I is the transcript of
evidence in the Tax Appeal Board (75 pages) together
with the 15 Exhibits (A-1 to A-10 and R-1 to R-5) which
were filed at the hearing before the Board.
Upon opening counsel for the appellant stated
that the appeal in respect of 1966 was aban
doned. Of the interest stated in paragraph 20 of
the "Agreed Statement of Facts" to be "refer-
able to the borrowed money in respect of the
fiscal periods commencing January 1, 1962"
only the amounts of $26,642.65 and $19,869.65
respectively associated in paragraph 20 with the
"interest period" "Jan. 1/62 to Dec. 31/63" and
the "interest period" "Jan. 1/64 to June 30/65"
remain in issue.
The following were conceded by counsel:
1. The wording "interest will be paid if
requested, but not in excess of 6%" on the
promissory notes was to be taken as though the
wording were "interest will be paid if requested,
but not in excess of 6% per annum."
2. The interest calculations were correctly
mathematically computed at 6% per annum.
3. The demand for interest could be made
retroactive to the dates of the loans.
4. The demand or request for interest was not
made earlier than the calendar year 1966.
Relevant are the following extracts from what
was section 11 of the Income Tax Act:
(1) Notwithstanding paragraphs (a), (b) and (h) of subsec
tion (1) of section 12, the following amounts may be deduct
ed in computing the income of a taxpayer for a taxation
year:
(c) an a aunt 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
(i) borrowed money used for the purpose of earning
income from a business or property (other than bor
rowed money used to acquire property the income from
which would be exempt),
or a reasonable amount in respect thereof, whichever is
the lesser;
A method which could have been "regularly
followed by the taxpayer in computing his
income" is the cash basis accounting method.
Another could have been the accrual accounting
method.
The effect of the judgment of Thurlow J., as
he then was, in Industrial Mortgage and Trust
Company v. M.N.R. [1958] Ex.C.R. 205, which
dealt with the construction to be put upon the
word "method" in what was then section 6(b), is
that the taxpayer was not necessarily confined
to either a cash basis or an accrual basis in the
computation of profits. The following is an
extract from the judgment (pp. 213-4):
As I interpret it, the word "method" is not used in s. 6(b) in
any narrow or technical sense but simply means the system
or procedure which the taxpayer has regularly followed in
computing his profit. The system or procedure, in my opin
ion, may be made up of a number of practices, and I can see
no valid reason why, in a diverse business such as that of
the appellant, such system or procedure could not include
different practices for accounting for revenue from different
activities or sources, depending on the nature of such activi
ties or sources and of the revenues therefrom, and still be
regarded as a "method" within the meaning of that word in
s. 6(b). In my opinion, the practices followed by the appel
lant did amount to a "method" within the meaning of the
section and, as that method had been followed by the
appellant without change for the seven years immediately
preceding 1949 and for 1949 as well, I have no hesitation in
concluding that it was the "method" regularly followed by
the appellant in computing its profit within the meaning of s.
6(b).
I think that case is distinguishable. There are
significant differences between the circum
stances in that case and in this apart from the
circumstance that what was being dealt with
there was interest as a profit item and here
interest is dealt with as a deduction in the com
putation of profits. There the appellant in com
puting its income for 1949, as it had in previous
years, brought into account on a cash received
basis revenue from all sources except interest
on government bonds and a remnant of mort-
gages taken prior to 1942 which it accounted for
on an accrual basis. In assessing the Minister
added to the income reported the amount of
mortgage interest which became due but was
not paid in 1949 on mortgages the interest from
which in 1949 and in previous years had been
brought into revenue on a cash received basis.
Here there is only one lender,—the respondent's
parent company. There the practice had been
followed by the appellant without change for
the seven years immediately preceding 1949
and for 1949 as well.
Moreover, it is my understanding that counsel
for the respondent agrees that the respondent
used the accrual method.
In any event I consider that the wording of
paragraphs 7 and 8 of the agreed statement of
facts impels the conclusion that this case must
be decided upon the basis that at and for all
relevant times the respondent had "regularly
followed" the accrual method in computing its
income and without having adopted any other
method in respect of any phase of its operation.
It seems to me that the relevant portions of
those paragraphs are:
7. In the Respondent's fiscal periods ending December 31,
1962, 1963, and 1964, no amount was accrued or deducted
. in respect of interest ... although the Respondent used
the accrual method of accounting in computing its income
and... .
8. . In the six-month fiscal period ending June 30, 1965,
again the Respondent did not accrue or deduct any amount
... in respect of interest ... .
In paragraph 16 of the agreed statement of
facts there is:
The Parent Company must have informed the Respondent
that it was requesting interest at least in respect of the
amounts of $13,246.43 and $19,869.65 prior to July 13th,
1966.. .
According to paragraph 11 of that statement
in computing its income for the taxation year
ending June 30, 1966 the respondent deducted
$13,246.43 "representing interest on the bor
rowed money for the period July 1, 1965 to
June 30, 1966". However that was not remitted
to the parent company until August 29, 1966
(see paragraph 13 of the statement of agreed
facts). Since August 29, 1966 was subsequent to
the fiscal year ending June 30, 1966 the deduc
tion in respect of the fiscal year ending June 30,
1966 notwithstanding actual payment not
having been made until August 29, 1966 was
consistent only with the accrual method of com
puting profit.
If I understand the position of counsel for the
respondent correctly, he in effect admits that if
the promissory note had provided for interest at
a definite rate and without the requirement of a
request for it the taxpayer, being on an accrual
basis, would have had to claim the deduction for
interest in each year in respect of which the
obligation to pay interest arose or not at all.
Nevertheless, as I understand it his submis
sions include:
The liability to pay interest arose only after
the request for interest was made but that the
amount is calculated on the period the loan was
outstanding; even though the request was for
interest related to prior years as well as subse
quent periods there was nothing to accrue or to
deduct until the request was made; until the
request was made it would not be known wheth
er there would ever be a requirement to pay
interest; although the obligation to pay interest
was limited to 6% the request, if made, could
have been for less than 6%; the phrase "in
respect of the year" determines only the time or
taxation year when an amount of interest may
be deducted and does not determine the amount
which may be deducted.
I do not agree with his submissions.
Counsel for the respondent referred to
M.N.R. v. Benaby Realties Limited [1968]
S.C.R. 12 wherein Judson J. said [at page 16]:
My opinion is that the Canadian Income Tax Act requires
that profits be taken into account or assessed in the year in
which the amount is ascertained.
Apparently the position of counsel for the
respondent is that there is an analogy between
that situation where the subject-matter is profits
and the situation where the subject-matter is
deductions to arrive at profits. In my opinion
this by no means follows. In order to determine
what, if anything, may be deducted in respect of
interest on borrowed money in computing the
income of a taxpayer for a taxation year it is the
wording of the statute which governs. Here the
deduction could only be made if circumstances
brought the taxpayer within the wording of the
relevant legislation,—in this case section
11(1)(c)(i).
Wording to be considered is "an amount paid
in the year or payable in respect of the year" in
section 11(1)(c). In my opinion the words "paid
in the year" are applicable to those taxpayers
who, in computing income, regularly follow the
cash basis accounting method and the words
"payable in respect of the year" are applicable
to those who, in computing income, regularly
follow the accrual accounting method.
The respondent, in my finding, in computing
its income, regularly followed the accrual
accounting method.
In my opinion the words "payable in respect
of the year" are to be read together with the
first two words in paragraph (c), namely "an
amount" so that for those who follow the accru
al method the paragraph is to read, "an amount
... payable in respect of the year". "In respect
of the year" refers, in my opinion, to the year
during which the borrowed money was used and
not to the year in which the lender chose to
make the request for interest. It is my opinion
that following the request the respondent was
obliged to pay interest for the use of the bor
rowed money during the year or years in which
the borrowed money was used by the borrower,
it being conceded that the demand for interest
could be made retroactive to the dates of the
loans. Of course if the request was not effective
retroactively interest would only become pay
able in respect of the period commencing with
the request and the borrower would have the
money interest free up until the time of the
request.
Consistent with the view that the words "in
respect of the year" refer to the year during
which the borrowed money was used and not to
the year in which the request was made is the
nature of interest and the manner in which it
accrues according to the learned author in Hals-
bury's Laws of England, 3rd ed. vol. 27 sec. 6
p. 7:
Interest is return or compensation for the use or retention
by one person of a sum of money belonging to or owed to
another. Interest accrues de die in diem even if payable only
at intervals... .
The author refers to Re Farm Security Act,
1944 [1947] S.C.R. 394, at p. 411; Dunn Trust,
Ltd. v. Feetham [1936] 1 K.B. 22, (C.A.) and Re
Rogers' Trusts (1860), 1 Drew. and Sm. 338.
Consistent also with this is The Apportion
ment Act, R.S.O. 1970', c. 23, s. 3:
All rents, annuities, dividends, and other periodical pay
ments in the nature of income, whether reserved or made
payable under an instrument in writing or otherwise, shall,
like interest on money lent, be considered as accruing from
day to day, and are apportionable in respect of time
accordingly.
If the proper construction of the section did
not confine the deduction which taxpayers who
follow the accrual method (unmodified) may
make in respect of interest to the year in which
the borrowed money was used and if the proper
construction permitted it to be deducted in some
subsequent year (for whatever cause) the result
would be inconsistent with the concept underly
ing the accrual method. In that event one might
have "accrual" in respect of all matters except
interest and have a cash basis for interest. In my
opinion the wording of the section does not
permit such a result except in circumstances
such as existed in Industrial Mortgage and Trust
Co. v. M.N.R. (supra) and in my view such
circumstances do not exist in this case.
In Associated Investors of Canada Limited v.
M.N.R. [1967] 2 Ex.C.R. 96 Jackett P., as he
then was, dealt with a situation arising out of
advances to salesmen. At page 100 in a footnote
he deals with a submission that section 12(1)(a)
of the Income Tax Act must be interpreted as
prohibiting the deduction in the computation of
profit from a business for a year of any outlay
or expense not made or incurred in that year. In
that footnote he says, inter alia,:
In my view, while certain types of expense must be deduct
ed in the year when made or incurred, or not at all, (e.g.,
repairs as in Naval Colliery Co. Ltd. v. C.I.R., (1928) 12
T.C. 1017, or weeding as in Vallambrosa Rubber Co., Ltd.
v. Farmer, (1910) 5 T.C. 529), there are many types of
expenditure that are deductible in computing profit for the
year "in respect of" which they are paid or payable. (Com-
pare sections 11(1)(c) and 14 of the Act.)
Although in that comment there is nothing to
indicate that the distinguished then President of
the Court had in mind the unusual situation
which exists here, namely no interest to be
payable unless requested, as I understand his
comment, its effect is that when a taxpayer
adopts the accrual method interest can only be
deducted in and for the year or years in which it
is earned which would be the year or years
during which the borrowed money was in the
hands of the borrower.
It is my view that when the respondent execu
ted the promissory notes containing "interest
will be paid if requested, but not in excess of
6%" liability for interest was created. The
request for interest did not create the liability.
The respondent assumed liability for interest
and committed itself in respect of interest when
it signed and delivered the notes. The lender
might not have invoked its rights under that
commitment and would not have invoked its
rights if it did not request interest. The lender's
omission to make the request would merely be a
waiver of its rights and a forgiveness of the
respondent's liability for interest which existed
from the beginning. If and when the request is
made it would merely be indicative of the time
the borrower's already existing liability for
interest is to be discharged by payment.
However regardless of what the technical
position regarding the commencement of liabili
ty may be and whether it commenced with the
delivery of the notes or came into existence
upon the request being made, the interest would
nevertheless be in respect of the year or years
in which it was earned, which would be the year
or years in which the borrowed money was used
by the borrower. The interest applicable to the
time prior to the request would not be interest in
respect of the year in which the request for
interest was made.
Counsel for the respondent submitted, too,
that the Minister's construction would result in
the statute discriminating against a taxpayer
entering into a contract respecting borrowing
and interest such as exists here.
If (although here I need not and do not decide
the point) until the request for interest is made
no deduction for interest was available to the
respondent, the fixing, by the request, of the
time when the interest became payable cannot
change the effect of the legislation giving the
right to make a deduction in respect of interest.
That right is limited by the legislation.
In any event I do not see how the respondent
can justifiably complain of discrimination when
it was the decision of the taxpayer to enter into
the type of contract which exists here. Having
decided to enter into that type of contract it
must, of course, abide by the results, whether
beneficial or adverse, flowing from it.
The foregoing is sufficient to dispose of this
matter. I need not, and do not, make any deci
sion here as to whether the treatment of interest
in the respondent's financial statements affects
the situation. Nevertheless the treatment in the
financial statements of the respondent of the
two interest items in issue, namely $26,642.65
and $19,869.65, respectively associated in para
graph 20 of the "Agreed Statement of Facts"
with the "interest period" "Jan. 1/62 to Dec.
31/63" and the "interest period" "Jan. 1/64 to
June 30/65" appears to me to recognize that,
although they were paid in the year ending June
30, 1967, they are expense items applicable to
periods prior to the 1967 taxation year and are
"in respect of" those prior periods.
Contained in the respondent's financial state
ment for the fiscal year ending June 30th, 1966
there is a statement of income and retained
earnings. It has a category "non-recurring
expenses—interest expense—prior year's" and
the amount of that category is $19,869.65. That
is the interest item, $19,869.65, associated in
paragraph 20 of the "Agreed Statement of
Facts" with "interest period" Jan. 1/64 to June
30/65. In that statement of income and retained
earnings that amount, $19,869.65 is deducted
from the figure of $43,775.53 shown in that
statement as "net earnings before Federal and
Provincial income taxes and non-recurring
expenses". After making that deduction and the
other calculations as shown on the statement,
there is developed the figure of $21,817.53
called in the statement "retained earnings—June
30, 1966".
The financial statement for the year ending
June 30, 1966 includes a "tax calculation". That
"tax calculation" does not include as a deduc
tion the $19,869.65 figure. Nevertheless, as I
see it, the deduction of that $19,869.65 from
retained earnings together with the content of
paragraph 20 of the "Agreed Statement of
Facts" could, logically, only be on the basis that
expense had been incurred "in respect of" some
period prior to June 30, 1966 which brought the
retained net earnings below what they would
have been if that expense had not been
incurred, that that expense was interest in the
amount of $19,869.65 and that the period "in
respect of" which it had been incurred was
January 1, 1964 to June 30, 1965. This signifi
cant treatment of the situation in the financial
statement was much more than mere disclosure
of the request for interest. If only disclosure
was intended it could have been made in the
report without actual incorporation of the inter
est item into the figures with the resulting
change as was done.
The financial statement for the year ending
June 30, 1967 also contains a statement of
income and retained earnings. In it and under a
heading "non-recurring expenses" there is an
item called "Interest Expense—Prior year's" of
$26,642.65. That is the $26,642.65 associated in
paragraph 20 of the "Agreed Statement of
Facts" with the "interest period" "Jan. 1/62 to
Dec. 31/63". In that statement that $26,642.65
is deducted from the figure of $42,689.73 stated
to be "net profit before Federal taxes and Pro
vincial taxes and non-recurring expenses".
After making that deduction and the other cal
culations in the statement there is developed a
figure of $18,556.79 called "retained earnings—
June 30, 1967".
The same financial statement contains what is
called a "tax calculation". It commences with
an item of $42,689.73 called "Net Profit before
Federal and Provincial Taxes and non-recurring
expenses, per financial statement". It includes,
as a deduction, $46,512.30 called "Prior Years'
interest on notes payable", which is the sum of
the previously mentioned interest amounts of
$19,869.65 and $26,642.65.
The designations in the taxpayer's own finan
cial statements of those interest items as being
"prior years" and the reduction of the retained
earnings by the amount of the interest item of
$19,869.65 in the financial statement for the
taxation period ending June 30, 1966 do, I
think, indicate the respondent's recognition that,
in actuality, that interest is applicable to and is
in respect of periods prior to the taxation year
1967 and this regardless of the "tax
calculations".
Emphasis is given to this by the following in
the financial statement for the year ended June
30, 1967:
Interest
Mid-West Abrasive Company, Ltd.,
— Current $ 6,692.04
— Prior Years $26,642.65
Although it is not necessary in this case to
have regard to the provision in section 11
which, in any event, has the effect of prohibit
ing any deduction for interest beyond a reason-
able amount, it is of some interest to note that if
the sum of $46,512.30 were interest only in
respect of the year ended June 30, 1967 that
amount together with the interest item of
$6,692.04 not in issue would total $53,204.35.
That, if it were applicable only to the 1967
taxation year would be an inordinate amount of
interest for one year on the total of the money
the respondent borrowed from its parent com
pany ($210,000.00 Can.—see paragraph 4 of the
"Agreed Statement of Facts").
I find that the said interest items of
$26,642.65 and $19,869.65, totalling
$46,512.30, were not amounts payable in
respect of the respondent's 1967 taxation year
within the meaning of section 11(1')(c) of the
Income Tax Act and that they are not amounts
which may be deducted in computing the
income of the respondent for its 1967 taxation
year.
The appeal in respect of and in so far as it
relates to the respondent's 1966 taxation year is
dismissed. In all other respects the appeal is
allowed. The assessment for the respondent's
1967 taxation year is restored.
The matter is referred back to the Minister of
National Revenue for re-assessment according
ly.
The respondent will have its costs of the
appeal payable by the appellant up to and
including June 1, 1973 and the appellant will
have his costs after that date payable by the
respondent.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.