Riviera Hotel Company Limited (Appellant)
v.
Minister of National Revenue (Respondent)
Trial Division, Cattanach J.—Edmonton, March
2; Ottawa, March 22, 1972.
Income tax—Business income, computation of—Money
borrowed for business—Prior loan paid off to obtain new
loan—Bonus paid prior lender for discharge of mortgage—
Whether bonus "incurred in course of borrowing" second
loan—Income Tax Act, s. 11(1)(cb).
In 1960 appellant company borrowed $375,000 to build
an hotel which it thereafter operated. The loan was secured
by a first mortgage on the hotel property with interest at 7
2% per annum but without provision for prepayment of the
principal. In 1966 appellant required further funds for its
hotel business. The mortgagee refused an additional loan
and appellant arranged for a loan from another lender at 6%
per annum if secured by a first mortgage on the hotel
property. To obtain a discharge of the mortgage, appellant
was obliged to pay the mortgagee a bonus of six months
interest, viz, $13,108.
Held, the bonus so paid by appellant was not deductible
under section 11(1)(cb) of the Income Tax Act in computing
appellant's income: it was not an expense incurred by
appellant in the course of borrowing money from the
second lender but rather an expense incurred in the course
of repaying money borrowed from the first lender.
APPEAL from Tax Appeal Board.
T. H. Miller, Q.C. for appellant.
Ian Pitfield for respondent.
CATTANACH J.—This is an appeal from a
decision of the Tax Appeal Board dated Decem-
ber 10, 1970 whereby the assessment of the
appellant by the Minister with respect to its
1966 taxation year was confirmed.
The facts are not in dispute and the issue is
succinctly set out in paragraph 21 of an agreed
statement of facts which reads as follows:
The parties hereto by their respective solicitors, hereby
admit the facts and documents hereinafter set forth provid
ed that:
(a) such admissions are made for the purposes of this
appeal only and may not be used against either party by
any other person or on any other occasion;
(b) the parties hereto reserve their right to object to the
relevancy of any of the said facts and documents; and
(c) either party may adduce further and other evidence
relevant to this appeal and not inconsistent with this
agreement.
1. The Appellant has, at all times relevant to the appeal
herein, carried on business in the City of Edmonton, in the
Province of Alberta as the owner and operator of a hotel.
2. On or about August 5, 1960, the Appellant borrowed
from Credit Foncier Franco -Canadien (herein referred to as
Credit Foncier) the sum of $375,000, the said sum to be
used for the purpose of earning income from the Appel
lant's business.
3. The repayment of the said loan was secured by a
mortgage, a copy of which is annexed hereto as Exhibit 1,
upon lands and premises owned by the Appellant and
described as:
Parcel "A "—Lot Two (2), containing 2.42 acres, more or
less, in Block Eighty-eight (88), in the City of Edmonton,
as shown on Subdivision Plan 6018 K.S. (Allendale N.E.
17-52-24-W.4) Reserving thereout all mines and minerals
Parcel "B"—Lot Two A (2A), containing 0.84 of an acre,
more or less, in Block Eighty-eight (88), in the City of
Edmonton, as shown on Subdivision Plan 6018 K.S.
(Allendale N.E. 17-52-24-W 4) Reserving thereout all
mines and minerals
21. The question for the opinion of the Court is whether
the amount of $13,108.27 paid by the Appellant as herein
described was an expense incurred in the course of borrow
ing money within the meaning of section 11(1)(cb)(ii) of the
Income Tax Act, the deduction of which is not precluded by
sections 11(1)(cb)(iii) and 11(1)(cb)(iv) of the Income Tax
Act, so as to be deductible in computing the Appellant's loss
from its business for the 1964 taxation year.
22. If the Court shall be of the opinion that the said
amount is not deductible in computing the Appellant's
income then Judgment shall be entered for the Respondent
dismissing the appeal with costs. If the Court shall be of the
opinion that the said amount is deductible in computing the
Appellant's income then Judgment shall be entered for the
Appellant allowing the appeal with costs and referring the
assessment back to the Respondent for the purpose of
re-assessing in accordance with the opinion of this Court.
There are five exhibits to the agreed state
ment of facts,
Exhibit 1 is a copy of the mortgage.
Exhibit 2 is proposal for prepayment by the appellant as
mortgagor to the mortgagee.
Exhibit 3 is the acceptance of that proposal by the
mortgagee.
Exhibit 4 is an agreement between the appellant and the
Provincial Treasurer of Alberta.
Exhibit 5 is a debenture of the appellant in favour of the
Provincial Treasurer.
For the purposes of these reasons I do not
consider it necessary to reproduce the exhibits
in detail. Their material effects are reflected in
the agreed statement of facts.
However it is advantageous to summarize the
facts giving rise to this appeal.
The appellant had borrowed the sum of
$375,000 to construct an hotel, with interest at
7;% secured by a first mortgage on the prem
ises. The mortgage did not provide for the pre
payment of the moneys owing thereunder. The
appellant's potential favourable business oppor
tunities dictated the expansion of its hotel
accommodation. To do so required the borrow
ing of further funds. The first lender refused to
advance the further funds. The appellant
arranged to borrow the further funds required
by it from another lender at 6% but this lender
required that the funds to be advanced by it
must be secured by a first charge on the appel
lant's premises. To satisfy this condition the
appellant had to discharge the existing first
mortgage which did not contain a provision for
prepayment. The first lender agreed to permit
the appellant to prepay the entire principal bal
ance owing under the mortgage with interest to
the date of repayment plus a bonus equivalent
to six months interest which amounted to $13,-
108.27. This the appellant did and borrowed
money from the second lender.
The issue is whether the amount of $13,-
108.27 so paid by the appellant to the first
lender as a bonus to enable the appellant to
discharge the mortgage held by the first lender
in order that the appellant might borrow further
funds from the second lender was an expense
of borrowing money within the meaning of sec
tion 11(1)(cb)(ii) of the Income Tax Act, the
deduction of which is not precluded by sections
11(1)(cb)(iii) and 11(1)(cb)(iv) so as to be
deductible in computing the appellant's income.
Section 11(1)(cb)(ii), (iii) and (iv) reads as
follows:
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may be
deducted in computing the income of a taxpayer for a
taxation year:
(cb) an expense incurred in the year,
(ii) in the course of borrowing money used by the
taxpayer for the purpose of earning income from a
business or property (other than money used by the
taxpayer for the purpose of acquiring property the
income from which would be exempt),
but not including any amount in respect of
(iii) a commission or bonus paid or payable to a person
to whom the shares were issued or sold or from whom
the money was borrowed, or for or on account of
services rendered by a person as a salesman, agent or
dealer in securities in the course of issuing or selling
the shares or borrowing the money, or
(iv) an amount paid or payable as or on account of the
principal amount of the indebtedness incurred in the
course of borrowing the money, or as or on account of
interest; ..
In B.C. Elec. Rly. Co. v. M.N.R. [1958]
S.C.R. 133, Mr. Justice Abbott said at page
137:
Since the main purpose of every business undertaking is
presumably to make a profit, any expenditure made "for the
purpose of gaining or producing income" comes within the
terms of s. 12(1)(a) whether it be classified as an income
expense or as a capital outlay.
Once it is determined that a particular expenditure is one
made for the purpose of gaining or producing income, in
order to compute income tax liability it must next be ascer
tained whether such disbursement is an income expense or
a capital outlay.
The leading authority for the proposition that
the cost of financing a business is a capital
expense is in Montreal Coke and Mfg. Co. v.
M.N.R. [1944] A.C. 126. In that case interest
bearing bonds were converted into other securi
ties carrying lower rates of interest. It was
claimed that the expenses of conversion were
incurred "for the purpose of earning income".
The Supreme Court of Canada held that the
payments on that account were not for that
purpose and that, in any event, the expenses
were outgoings of capital and accordingly were
not deductible. This decision was upheld by the
Privy Council on the first ground.
This decision was followed by the Supreme
Court of Canada in Bennet & White Construc
tion Co. v. M.N.R. [1949] S.C.R. 287 where it
was held that commission payments were not
allowable as deductible expenses since they
were incurred in connection with the financing
of the business and were not related to the
income earning process.
Section 11(1)(cb) was added to the Income
Tax Act by section 1(1) Statutes of Canada,
1955, c. 54 applicable to the 1955 and subse
quent taxation years. The obvious purpose of
this section is to permit the deduction of certain
expenses incurred in raising funds by borrowing
or by the issue of capital stock which were
previously not deductible, as indicated in the
two decisions referred to immediately above,
because those expenses were not directly relat
ed to the earning of income or were outlays or
payments on account of capital or replacement
of capital within the meaning of section 12(1)(a)
and (b).
In paragraphs 2, 5 and 10 of the agreed
statement of facts it is agreed between the
parties that the money originally borrowed by
the appellant from the first lender, the addition
al money sought to be borrowed by the appel
lant from the first lender which was refused and
the money subsequently borrowed by the appel
lant from the second lender was for use by the
appellant "for the purpose of earning income
from" its business.
In view of the statement of Mr. Justice
Abbott in the B.C. Elec. Rly. case quoted above
to the effect that since the purpose of any
business is to make, a profit, it follows most
expenditures are made for the purpose of gain
ing or producing income from the business and
deductibility thereof for income tax purposes is
dependent upon the outlay or expense being an
income expense or a capital outlay. I agree that
money which was borrowed by the appellant
from both the first lender and the second lender
was "money used by the taxpayer for the pur
pose of earning income from a business" within
the meaning of those words as they appear in
section 11(1)(cb)(ii).
Accordingly it follows that whether the sum
of $13,108.27 paid out by the appellant in the
circumstances above described is "an expense
incurred in the course of the year in the course
of borrowing money" falls to be determined on
the interpretation of section 11(1)(cb) without
reference to section 12. The words of section
11(1) are, "Notwithstanding paragraphs (a), (b)
and (h) of subsection (1) of section 12, the
following amounts may be deducted in comput
ing the income of a taxpayer for a taxation
year" and paragraph (cb) is included.
In commenting on section 11(1)(cb) my
brother Heald said in Canada Permanent Mort
gage Corp. v. M.N.R. 71 DTC 5409 at p. 5412:
This subsection operates to permit a taxpayer to deduct
expenses incurred in the course of borrowing money used
by the taxpayer to earn income from his business, whether
or not it is prohibited by section 12(1)(a), (b) and (h).
Reverting to the facts in this appeal it is
significant to recall that there were two differ
ent and distinct borrowings. The appellant
sought to obtain further funds from the first
lender. Under the mortgage held by the first
lender principal and interest remained unpaid
and the mortgage contained no provision for
prepayment to the first lender. The appellant,
having made the commercial decision to expand
its hotel facilities by which it expected to earn
still further money from its business, was com
pelled to seek the further necessary funds from
another source. This the appellant succeeded in
doing but subject to the second lender having a
first charge on the appellant's premises. To
meet this condition required by the second
lender the appellant was compelled to pay all
arrears of principal and interest and in addition
was obliged to pay to the first lender the sum of
$13,108.27 as a bonus, computed by the yard
stick of the equivalent of interest for six
months, for the privilege of discharging the
mortgage before maturity.
Basically the position taken by counsel for
the appellant was that the payment of $13,-
108.27 to the first lender was an expense in the
course of borrowing from the second lender.
I do not accept that proposition. The payment
of $13,108.27 by the appellant was not a pay
ment of interest nor a payment in lieu of inter
est to the first lender and it most certainly was
not a payment on account of principal. It was a
bonus.
In Puder v. M.N.R. [1963] C.T.C. 445 Mr.
Justice Thurlow pointed out that a mortgagee
has other rights besides the payment of princi
pal and interest. One of those rights would be to
hold the mortgage until its maturity. The first
lender, in the facts of the present appeal,
undoubtedly wished to avail itself of that right
because it did not include a provision in the
mortgage permitting of prepayment by the
mortgagor.
Despite the pronounced - trend in modern
advertising by money lenders to emphasize the
ease of obtaining money on loans and omitting a
reference to or placing minimal emphasis on the
fact that the lender expects to be repaid, never
theless, as was said by Buckley J. in In re
Southern Brazilian Rio Grande Do Sul Rly Co.
[1905] 2 Ch. 78 at p. 83, "borrowing necessarily
implies repayment at some time and under some
circumstances."
The payment of $13,108.27 by the appellant
to the first lender was not a payment for the use
of the money obtained from the first lender.
This payment was made to the first lender as an
inducement or bonus for the first lender to
forego its right to hold its first mortgage to
maturity and to accord to the appellant the
privilege of paying the balance of principal and
interest under the mortgage, which it was the
appellant's obligation to do ultimately, prior to
the due dates. The payment of the sum of
$13,108.27 was an expense incurred for this
purpose.
The payment was not made in the course' of
borrowing money from the first lender but it
was made in the course of repaying that money.
This being so it follows that the payment to the
first lender cannot be construed as an expense
incurred by the appellant in the course of bor
rowing money from the second lender.
I would add that the foregoing reasoning is
substantially the same as that adopted by the
Chairman of the Tax Appeal Board in Dominion
Electrohome Industries Ltd. v. M.N.R. 62 DTC
256.
In that case the appellant arranged a $1,000,-
000 debenture issue to provide further working
capital. It was a condition that to arrange this
subsequent debenture issue a prior $250,000
debenture issue had to be discharged. In order
to retire the first debenture issue the appellant
was obliged to pay a premium of $6,117. The
appellant sought to deduct this premium as an
expense incurred in the course of borrowing
money used for the purpose of earning income
from the appellant's business within the mean
ing of section 11(1)(cb). The Minister disal
lowed the deduction so claimed.
On appeal to the Tax Appeal Board, the
Chairman held that the premium of $6,117 paid
by the appellant was not deductible and dis
missed the appeal. He said at pages 261-262:
There is no doubt that the payment of $6,117 was made
with a view to increasing, eventually, the appellant's
income. However, in order to benefit by the provisions of
paragraphs (c) or (cb) of section 11(1)—which deal specifi
cally with payments made in connection with borrowing
money for use in a taxpayer's business—a taxpayer must
show that the amount was paid either as interest on bor
rowed money used for the purpose of earning income from
its business or that it was an expense incurred in the year in
the course of borrowing money used for the purpose of
earning income from its business. Clearly the payment of
$6,117 was not made for the use of money borrowed under
the first debenture issue, and it was not an expense arising
in the course of borrowing money for which the debentures
were issued. Instead this payment was made because the
appellant wished to repay and did repay the balance out
standing on the first debenture issue. No provision is made
in the Income Tax Act for the deduction of interest or
bonus paid in the course of repaying borrowed capital.
The reasoning adopted by the Chairman com
mends itself to me as being irreproachable and
it coincides with the reasoning I have adopted
in the present appeal.
In view of the conclusion I have reached,
which is that the expense incurred by the appel
lant herein was not an expense incurred in the
course of borrowing money from the second
lender but was an expense incurred in the
course of repaying the money borrowed from
the first lender and accordingly the expense
does not fall within section 11(1)(cb)(ii), it is not
necessary for me to consider whether the
deduction is precluded by sections 11(1)(cb)(iii)
and (iv).
The appeal is dismissed with costs.
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.