T-437-78
The Queen (Plaintiff)
v.
RoyNat Ltd. (Defendant and Counterclaimant)
Trial Division, Addy J.—Montreal, December 16
and 17, 1980; Ottawa, March 9, 1981.
Income tax — Income calculation — Income bonds — Sale
of shares — Plaintiff appeals Tax Review Board's decision
that certain bonds obtained by defendant qualify as income
bonds under s. 139(1)(t) of the Income Tax Act — Defendant
counterclaims against Board's finding that gains realized from
the disposition of certain shares and bonds were taxable as
ordinary income — Plaintiffs claim involves interpretation
and application of ss. 8(3) and 12(1)(f) of the Act — Payment
in full of the alleged income bonds and the interest, whether or
not borrower made profit, was guaranteed — Whether the
bonds qualify as income bonds and the dividends therefrom
are not taxable — Whether the profits arose from operations
which constituted an integral part of the profit-making activi
ties of defendant — Plaintiffs appeal allowed — Defendant's
counterclaim dismissed — Income Tax Act, R.S.C. 1952, c.
148, ss. 8(3), 12(1)(f), 139(1)(t).
Appeal from the Tax Review Board's decision that the bonds
in question qualified as income bonds under section 139(1)(t)
of the Income Tax Act, and that gains realized from the sale of
shares, options and mortgage bonds were taxable as ordinary
income. The bonds were issued pursuant to trust deeds which
provided that payment of interest as well as payment of princi
pal was guaranteed by third parties. Payment in full by the
guarantor of all interest at the rate stipulated in the bonds was
guaranteed notwithstanding that the principal debtor company
might not have made any profit and would not itself be obliged
to pay interest. The intervention of third parties to guarantee
full payment was a condition for the granting of the loans.
Section 139(1)(t) provides that interest is payable by the debtor
only if a profit has been realized by the debtor in that year. The
first question is whether the bonds qualify as income bonds.
The defendant acquired bonus shares and options to purchase
shares as part of its lending transactions. The defendant con
tends that gains from the sale of such shares are not income
because of the nature of the assets, the lack of speculation and
the fact that the disposition of the shares had nothing to do
with the financing business. Therefore, the second question is
whether the transaction was an adventure in the nature of
trade.
Held, the plaintiff's appeal is allowed and the defendant's
counterclaim is dismissed. The bonds do not qualify as income
bonds and the proceeds from the disposition of shares are
ordinary income. As part and parcel of the whole scheme the
receipt of interest for the money lent is absolutely guaranteed
to the lender, the bonds do not qualify as income bonds. The
proceeds from the disposition of shares are ordinary income.
The payment of interest even when provided for only in the
collateral agreement is, in so far as the payee is concerned, to
be considered as interest provided for in the bond or in the trust
agreement, since the execution of the agreement is a condition
sine qua non of the existence of the whole transaction. With
respect to the second question, the profits arose from operations
or dealings which constituted an integral part of the profit-
making activities of the defendant. The bonus shares were, in
the course of the operation of its business of lending money,
required by the defendant as extra compensation for the addi
tional risks involved in these cases; it intended to make a profit
from the eventual disposition of the shares and did not expect
dividends nor did it receive any. The defendant also failed to
show that fair value was paid for the shares.
Riches v. Westminster Bank, Ltd. [1947] 1 All E.R. 469,
referred to. In the matter of a reference as to the validity
of section 6 of the Farm Security Act, 1944, of the
Province of Saskatchewan [1947] S.C.R. 394, referred to.
Re Euro Hotel (Belgravia) Ltd. [1975] 3 All E.R. (Ch.
Div.) 1075, referred to. Mountstephen v. Lakeman (1871)
L.R. 7 Q.B. 196 (Ex. Ch.), referred to. Lakeman v.
Mountstephen (1874) L.R. 7 H.L. 17, referred to. Western
Credit, Ltd. v. Alberry [1964] 2 All E.R. 938 (C.A.),
referred to. Foreign Power Securities Corp. Ltd. v. Minis
ter of National Revenue [1966] Ex.C.R. 358, referred to.
Minister of National Revenue v. Foreign Power Securities
Corp. Ltd. [1967] S.C.R. 295, referred to. Minister of
National Revenue v. Taylor [1956-60] Ex.C.R. 3, referred
to. Associated Investors of Canada Ltd. v. Minister of
National Revenue [1967] 2 Ex.C.R. 96, referred to.
Stuyvesant-North Ltd. v. Minister of National Revenue
[1958] Ex.C.R. 230, referred to. West Coast Parts Co.
Ltd. v. Minister of National Revenue [1965] 1 Ex.C.R.
422, referred to. Holder v. Commissioners of Inland
Revenue [1932] A.C. (H.L.) 624, distinguished. McLaws
v. Minister of National Revenue 70 DTC 6289, distin
guished. Irrigation Industries Ltd. v. Minister of National
Revenue [1962] S.C.R. 346, distinguished. Canada Per
manent Mortgage Corp. v. Minister of National Revenue
71 DTC 5409, distinguished. Lomax (H.M. Inspector of
Taxes) v. Peter Dixon & Son, Ltd. 25 T.C. 353,
considered.
INCOME tax appeal.
COUNSEL:
Roger Roy and Gaston Forré for plaintiff.
Thomas S. Gillespie for defendant and
counterclaimant.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
Ogilvy, Renault, Montreal, for defendant and
counterclaimant.
The following are the reasons for judgment
rendered in English by
ADDY J.: The action involves income tax
assessed against the defendant for taxation years
1967 to 1970 inclusively, pursuant to re-assess
ments made against it for certain gains realized
from share and option transactions as well as
interest received by the defendant on certain bonds
which, according to the defendant, qualified as
income bonds.
The defendant appealed the re-assessment to the
Tax Review Board. The appeal was allowed in part
in that the Board agreed with the defendant that
the bonds in question qualified as income bonds
under section 139(1) (t) of the Income Tax Act'
(hereinafter referred to as "the Act"). The plain
tiff in the present action appeals against this find
ing. The defendant, on the other hand, counter
claims in this action against the dismissal of its
appeal by the Tax Review Board with respect to
gains realized from the disposition of certain
shares, options and mortgage bonds which took
place in each of the four taxation years.
There exists no dispute between the parties as to
the actual amounts involved in this action but
merely as to how the amounts should be con
sidered for taxation purposes.
Dealing first with the plaintiff's claim regarding
the income from what was found by the Tax
Review Board to be income bonds, the dispute as
to whether the interest received is to be considered
as dividends involves the interpretation and
application of sections 8(3) and 12(1)(f) of the
Act. They read as follows:
1 R.S.C. 1952, c. 148.
8....
(3) An annual or other periodic amount paid by a corpora
tion to a taxpayer in respect of an income bond or income
debenture shall be deemed to have been received by the taxpay
er as a dividend unless the corporation is entitled to deduct the
amount so paid in computing its income.
12. (1) In computing income, no deduction shall be made in
respect of
(/) an amount paid by a corporation other than a personal
corporation as interest or otherwise to holders of its income
bonds or income debentures ..
"Income bond" or "income debenture" is
defined in section 139(1)(t) of the Act as follows:
139. (1) .. .
(t) "income bond" or "income debenture" means a bond or
debenture in respect of which interest or dividends are pay
able only when the debtor company has made a profit before
taking into account the interest or dividend obligation;
The key characteristic of the income bond is
that interest is payable by the debtor only if a
profit has been realized by the debtor in that year.
The bonds to which the action referred were
issued pursuant to six different trust deeds, all
executed in 1966 in favour of various trust compa
nies by the following firms as borrowers: 1. Crystal
Beverages (1963) Ltd.; 2. Agristeel Ltd.; 3. Speed
way Express Ltd.; 4. Springdale Mills (Ontario)
Limited; 5. North American Plastics Co. Ltd.; 6.
Comeau's Sea Food Fishmeal Ltd.
In all of these trust deeds the bonds were
described as income bonds, but, in addition to the
provision normally attached to this type of secu
rity, the payment of the interest on the bonds, as
well as the payment of principal, was guaranteed
by third parties. The loans were made in all cases
pursuant to an offer of finance made by the
defendant whereby the intervention of third parties
to guarantee full payment was made a condition
for the granting of the loans.
The position of the plaintiff is that the interest
payments received by the defendant in respect of
the bonds should be treated as ordinary interest,
because the bonds do not qualify as income bonds,
while the defendant takes the contrary view and
alleges that it should be deemed to have been
received only as dividends, pursuant to section 8(3)
supra, because the bonds truly qualified as income
bonds under section 139(1)(t) notwithstanding the
guarantees from third parties whereby the defend
ant was assured full reimbursement of the loan
and of all interest payable thereunder as well as all
interest merely stipulated in the trust deed and
which would not in fact be payable by the borrow
er if the latter did not make a profit.
In the case of the first above-mentioned trust
deed, i.e., Crystal Beverages, the offer to finance
made by the defendant contains the following
clause:
The Bonds will be secured by:
(a) a first specific charge on all machinery and equipment
(including motor vehicles) now owned and hereafter acquired
by you, and more particularly on all machinery used in the
canning and bottling of beverages and for the mixing and
bottling of chocolate milk;
(b) a second charge on land and building located at Lotus
Street and Henri Durant in the Moncton Industrial Park,
Moncton, N.B. The land consists of approximately 100,000
square feet and the building consists of approximately 52,000
square feet. Both are subject to a first charge by Eastern
Canada Savings & Loan Association, not exceeding
$367,500;
(c) a first floating charge on all your other assets (not
contained in the above specific charges), expressed in such a
manner as not to hinder you from dealing with these assets or
giving security to your bankers in the ordinary course of
business;
(d) the joint and several guarantee for $200,000 of Hugh
John Flemming, Frederick G. Flemming, David Owen, Stan-
ley Shefler and Reno Castonguay. In addition, the guaran
tors shall undertake to pay interest quarterly on the debt at
the rate of 8 3 / 4 % in the event the Company's earnings are not
sufficient to pay the interest due on the Income Bond.
The guarantee itself contains the following
recital:
AND WHEREAS it was a condition precedent to the financing
contained in and secured by the Trust Deed that the Guaran
tors further agree as hereinafter provided;
and the following undertaking:
NOW THEREFORE WITNESSETH, that in consideration of the
sum of One Dollar ($1.00) and in consideration of the premises,
the Guarantors hereby agree and undertake that in the event
the Company does not have income available (as defined in the
Trust Deed) for the payment of interest on such dates as called
for on the repayment Schedule of the First Mortgage Income
Bond then the Guarantors shall pay interest thereon at the rate
of eight and three-quarters per cent (8 3 / 4 %) per annum.
The offer to finance and the guarantee docu
ment of Agristeel contain substantially the same
provisions.
In the case of the Speedway loan the offer to
finance contains the following provision:
4. SECURITY
The Bonds will be secured by:
Guarantee of G.M. MacFie for $100,000. In addition Mr. G.
M. MacFie will pay to RoyNat in the event the Company fails
to pay interest on the Bonds on the interest payment dates
above mentioned, interest at the rate payable thereunder plus
additional interest of 2'/4% per annum calculated on a daily
basis on the principal amount of Bonds outstanding computed
from the last interest payment date on which interest was fully
paid to RoyNat under the terms of the Bonds to the date of
actual payment by the said G.M. MacFie;
It will be noted here that additional interest over
and above what the borrower would have to pay is
also provided for. Instead of a separate guarantee
document the trust deed itself contains an inter
vention by a third party guarantor who under
takes, among other things, as follows:
6. Notwithstanding the foregoing provisions of this section, and
in the event that the Company fails to pay interest on the
Income Bonds on the interest payment dates hereinabove men
tioned, the said Guarantor hereby agrees to pay to the Bond-
holders interest at the rate payable thereunder plus additional
interest of two and one-quarter per cent (2 1 / 4 %) per annum,
calculated on a daily basis on the principal amount of Income
Bonds outstanding computed from the last interest payment
date on which interest was fully paid to the Bondholders, under
the terms of the Income Bonds, to the date of actual payment
by the said Guarantor.
The next two loans, that is, Springdale Mills
and North American Plastics contain substantially
similar provisions. As in the case of the Speedway
loan they do not specifically mention that the
guarantee will take effect if there is insufficient
income but no other reasonable interpretation can
be put on the text. The guarantee is absolute and
the guarantor becomes liable "in the event that the
company (debtor) fails to pay .... "
I find that in all six cases the defendant is
guaranteed payment in full by the guarantor of all
interest at the rate stipulated in the bonds notwith
standing that the principal debtor company might
not have made any profit and would not itself be
obliged to pay interest. I do not accept the conten
tion of counsel for the defendant that Comeau's
Sea Food and the North American Plastics loans
can be distinguished from the other four in this
respect.
If the guarantors were merely guaranteeing pay
ment in full of the income bonds in accordance
with the terms of same, then, it seems obvious that
this would not affect the nature of the bonds nor
prevent any interest paid thereon by the principal
debtor from being treated as a dividend. Counsel
for the plaintiff in fact fully agrees that this would
be the case.
However, the guarantors, assuming that under
the circumstances they can be called guarantors,
undertake to do much more than the principal
debtors: as previously stated, the former in effect
undertake to pay interest at the rate stipulated
even if the debtors are not contractually obliged to
pay it and in some cases they also undertake to pay
additional interest as a bonus.
In the case of Comeau's Sea Food the offer to
purchase also states that the guarantee is a condi
tion precedent to the loan. It seems obvious from
the above that the additional obligations by the
guarantors in each of the six cases are integral to
the whole transaction and it is indeed specifically
referred to as such in the Crystal Beverages,
Agristeel and Comeau's Sea Food loans.
The provisions regarding the special way in
which interest is to be taxed in the case of income
bonds constitute an exception to the general
manner in which interest is normally taxed. There
fore, those provisions must be strictly interpreted
against that taxpayer, the latter being obliged to
establish that the case falls squarely within the
provisions of the section.
"Interest" is not defined in the Act. In Riches v.
Westminster Bank, Ltd. 2 Lord Wright, at page
472, quoted with approval the following statement
2 [1947] 1 All E.R. 469.
of Evershed J. as to the nature of interest:
... it is a payment which becomes due because the creditor has
not had his money at the due date. It may be regarded either as
representing the profit he might have made if he had had the
use of the money, or, conversely, the loss he suffered because he
had not that use. The general idea is that he is entitled to
compensation for the deprivation. From that point of view it
would seem immaterial whether the money was due to him
under a contract, express or implied, or a statute, or whether
the money was due for any other reason in law.
Rand J. in In the matter of a reference as to the
validity of section 6 of the Farm Security Act,
1944, of the Province of Saskatchewan 3 had this
to say, at pages 411 and 412, regarding the nature
of interest:
Interest is, in general terms, the return or consideration or
compensation for the use or retention by one person of a sum of
money, belonging to, in a colloquial sense, or owed to, another.
There may be other essential characteristics but they are not
material here. The relation of the obligation to pay interest to
that of the principal sum has been dealt with in a number of
cases including: Economic Life Assur. Society v. Usborne
([1902] A.C. 147) and of Duff J. in Union Investment Co. v.
Wells ((1929) 39 Can. S.C.R. at 645); from which it is clear
that the former, depending on its terms, may be independent of
the latter, or that both may be integral parts of a single
obligation or that interest may be merely accessory to principal.
But the definition, as well as the obligation, assumes that
interest is referrable to a principal in money or an obligation to
pay money. Without that relational structure in fact and
whatever the basis of calculating or determining the amount, no
obligation to pay money or property can be deemed an obliga
tion to pay interest.
The above passage was quoted with approval in
England by Megarry J. in Re Euro Hotel (Bel-
gravia) Ltd. 4 The learned Judge then went on to
add at page 1084 of the report:
It seems to me that running through the cases there is the
concept that as a general rule two requirements must be
satisfied for a payment to amount to interest, and a fortiori to
amount to `interest of money'. First, there must be a sum of
money by reference to which the payment which is said to be
interest is to be ascertained. A payment cannot be `interest of
money' unless there is the requisite `money' for the payment to
be said to be `interest or. Plainly, there are sums of `money' in
the present case. Second, those sums of money must be sums
that are due to the person entitled to the alleged interest; and it
is this latter requirement that is mainly in issue before me. I do
3 [1947] S.C.R. 394.
4 [1975] 3 All E.R. (Ch. Div.) 1075.
not, of course, say that in every case these two requirements are
exhaustive, or that they are inescapable. Thus I do not see why
payments should not be `interest of money' if A lends money to
B and stipulates that the interest should be paid not to him but
to X: yet for the ordinary case I think that they suffice.
Counsel for the plaintiff on the basis of those
definitions of interest argued that the guarantors,
in undertaking to pay money calculated as interest
for capital sums of money lent the debtor compa
nies, were in fact undertaking to pay interest even
though it was not the guarantors who had received
or benefited from the capital sums on which the
interest is calculated. It is the substance of the
transaction which matters and not the form or
wording of the documents (see La Société
Coopérative Agricole du Canton de Granby v.
M.N.R. 5 ). It would follow, if that argument is
accepted, that the bonds would not be income
bonds as they contain a firm undertaking to pay
interest.
The defendant on the other hand argued that
what was payable by the guarantor was neither
interest nor dividends but something of an entirely
different nature.
There is a fundamental difference in nature
between the obligations of a principal debtor and
those of a guarantor. The defendant quoted from
Hervé Roch in his Traité de Droit civil du Québec,
vol. 13, at pages 591 and 592. The text reads as
follows:
[TRANSLATION] It should also be noted that the surety for an
obligation to perform does not bind himself to perform what the
principal debtor has promised: he guarantees that in the event
of failure to perform damages which the debtor may owe will
be paid; hence it follows that the surety for an obligation of this
type cannot defend an action by the creditor for damages by
pleading that he was not called on to make good the principal
debtor's failure of performance. Finally, the bond is an adjunct
to the principal obligation, and in addition to the rules of
contract it is subject to certain special rules regarding the
surety's relations with the creditor, and the relations of the
sureties with the debtor.
It is to be noted, however, that the learned
author, at least in the first part of the citation, is
referring to a guarantor of "an obligation to per
form" and not "an obligation to pay." In other
words, he is stating that where a third party
guarantees an undertaking on the part of a con
tracting party to execute certain work or to do
5 [1961] S.C.R. 671.
anything, he is really undertaking to save the
obligee harmless from any damages which might
follow from non-performance of the contract by
the main contracting party for whom he is acting
as guarantor. It is really a contract of indemnity.
The following statement pertaining to the nature
of a guarantee is to be found in Halsbury's Laws
of England 6 at pages 411 and 412:
767. Guarantee. A guarantee is an accessory contract, where
by the promisor undertakes to be answerable to the promisee
for the debt, default, or miscarriagé of another person, whose
primary liability to the promisee must exist or be contemplated.
It is often termed, in cases and text books, a "collateral" or
"conditional" contract, in order to distinguish it from one that
is "original" and "absolute".
A guarantee is always a contract of an accessory
nature, ancillary and subsidiary to some other
contract or liability on which it is founded. (See
Mountstephen v. Lakeman 7 ; affirmed sub nom.
Lakeman v. Mountstephen 8 .) But it does not
follow necessarily that no part of any payment
made under such contract could ever be considered
as interest in the hands of the recipient.
Counsel for the defendant argued in addition
that the payment by a guarantor on income bonds
cannot, under section 8(3), above quoted, be
deemed to be a dividend because a guarantor can
be a natural person as well as a corporation and
section 8(3) refers exclusively to an "amount paid
by a corporation," otherwise, the words "taxpay-
er" or "person" would have been used. He also
maintained that, because of the expression "hold-
ers of its income bonds" in section 12(1)(f) previ
ously quoted, that the provisions therein contained
could not contemplate third parties. It does not
deal with the question of whether an amount paid
by a third party is or is not deductible and
nowhere else in the Act is the question dealt with
in respect of income bonds. He argued that,
because of this, the definition of income bonds
only contemplated a debtor and a creditor and
that, since no payment by a third party can be
considered a deemed dividend under section 8(3),
then any payment by a third party cannot be
6 Third Edition, Volume 18.
7 (1871) L.R. 7 Q.B. 196 (Ex. Ch.) at p. 202, per Willes J.
s (1874) L.R. 7 H.L. 17 at pp. 24-25, per Lord Selborne.
considered as interest. I consider the last conclu
sion to be a non sequitur.
There exists jurisprudence to support the propo
sition that what a guarantor pays is not interest. A
leading case on the matter is Holder v. Commis
sioners of Inland Revenue 9 . We find therein the
following statements as to the nature of a payment
made by a guarantor to indemnify a creditor
against non-payment of interest by a principal
debtor. Per Viscount Dunedin at pages 627 and
628:
I think that interest payable on an advance from a bank means
interest on an advance made to the person paying. The guaran
tor does not pay on an advance made to him, but pays under his
guarantee. It is true that he pays a sum which pays all interest
due by the person to whom the advance is made, but his debt is
his debt under the guarantee, not a debt in respect of the
advance made to him.
Per Lord Thankerton at page 631:
Interest is the return given for the use of the advances, and is
due by the person who obtains the advances; the liability of the
guarantor is direct to the creditor, and is an undertaking to
indemnify him against loss. The creditor computes his loss by
the amount of the failure of the principal debtor to pay him
principal and interest. In paying the amount of the indemnity,
whether limited or otherwise, I am of opinion that the guaran
tor cannot be said to be paying interest to the creditor, though
he is making good the loss of interest.
Per Lord Macmillan at page 634:
The short answer, in my opinion, is that the appellants received
no advance from the bank and owed no interest to the bank.
Their relationship to the bank was not that of borrower and
lender, and their liability to the bank was solely that of
guarantors of a third party's indebtedness to the bank. When
they paid the sum of 64,482/. 16s. 8d. to the bank they did so in
discharge of their liability to pay whatever sum, whether of
principal or interest, Blumfield, Ld., owed to the bank. It
cannot, therefore, with legal accuracy be said that the appel
lants made payment to the bank of interest on an advance from
the bank within the meaning of the section.
In the case of McLaws v. M.N.R. 10 Kerr J.
quoted and followed the Holder case, concluding
with the following finding [at p. 6295]:
9 [1932] A.C. (H.L.) 624.
10 70 DTC 6289.
I think that the same reasoning may be applied to the
payments made by the appellant to the bank in this case. He
made them pursuant to his guarantee, which included interest
due to the bank by the company to which it had advanced the
amounts of the loans, but what the appellant paid the bank was
his debt under the guarantee, not a debt in respect of money
borrowed by him. Consequently, the appellant is not entitled to
deduct any part of the payments as "interest" pursuant to
section 11(1)(c), whatever right, if any, to deduction he may
have under other sections.
It is of some interest to note that these cases
dealt with the nature of the payment made by the
guarantor in so far as its deductibility as interest in
the hands of the person disbursing the money is
concerned and not as to the nature of the payment
for taxation purposes qua the payee or recipient of
the monies. The same payment may frequently be
considered as income for taxation purposes in the
hands of the payee and capital in the hands of the
payor and vice versa. Also two sums identical in
nature paid for identical purposes may also be
treated quite differently for taxation purposes,
depending on other circumstances such as the
occupation of the taxpayer.
As to sections regarding income bonds not con
templating third parties because of the use of the
word "corporation" this seems to be, to some
extent, begging the question which in essence
resolves itself into determining whether or not the
bonds qualify as income bonds. If they do not then,
of course, there can be no exemption in any event.
If they do, then it matters not whether there are
third parties, at least where the payment is not
actually made by the third party.
The Holder case dealt with a true guarantee or
contract of suretyship. However, where a third
party undertakes, as in the case at bar, to pay
more than the principal debtor, it is not, strictly
speaking, a guarantee or a true contract of surety-
ship but rather a contract of indemnity, although
it does ipso facto protect the lender against the
default of the borrower.
As to the essence of a guarantee at civil law, see
article 1929 of the Civil Code":
11 Title Fifteenth, Of Suretyship, Chapter First.
Art. 1929. Suretyship is the act by which a person engages to
fulfil the obligation of another in case of its non-fulfilment by
the latter.
The person who contracts this engagement is called surety.
and see the Report on The Québec Civil Code 12 :
CHAPTER XIV—SURETYSHIP
842 Suretyship is a contract by which one person, called a
surety, undertakes towards a creditor to execute the obligation
of the debtor if he fails to execute it.
A person who promises that a debtor will execute his obliga
tion is deemed a surety.
Halsbury's Laws of England" defines a guaran
tee according to common law as follows:
101. Guarantee. A guarantee is an accessory contract by which
the promisor undertakes to be answerable to the promisee for
the debt, default or miscarriage of another person, whose
primary liability to the promisee must exist or be contemplated.
As in the case of any other contract its validity depends upon
the mutual assent of the parties to it, their capacity to contract;
and consideration, actual or implied.
It is also important to note the distinction drawn
in Halsbury's between a contract of indemnity and
guarantee at page 54, paragraph 108 of the same
volume:
108. Guarantee and indemnity. Although a contract of guaran
tee may be described as a contract of indemnity in the widest
sense of the term, yet contracts of guarantee are distinguished
from contracts of indemnity ordinarily so called by the fact that
a guarantee is a collateral contract to answer for the default of
another person, and thus is a contract that is ancillary or
subsidiary to another contract, whereas an indemnity is a
contract by which the promisor undertakes an original and
independent obligation.
The difference between these two types of con
tract was also dealt with by the Court of Appeal in
England in Western Credit, Ltd. v. Alberry 14 . The
Holder case and the McLaws case can therefore be
distinguished from the case at bar on two grounds:
the fact that they dealt with true guarantees as
opposed to what is essentially a contract of addi
tional indemnity but mainly, and above all, on the
grounds that they dealt with the payments made as
compensation for the capital sums lent, from the
standpoint of the payor as opposed to the payee. In
the McLaws case for instance, the decision turned
12 Volume I, Title Seventh, Fourteenth Chapter, Suretyship,
Section I (Civil Code Revision Office, 1978).
"Fourth Edition, Volume 20, Chapter on "Guarantee and
Indemnity" page 49, paragraph 101.
14 [1964] 2 All E.R. 938 (C.A.).
on whether the payment made by the taxpayer
should be charged to income account or capital
account.
I could find nothing in the ordinary definitions
of interest which would make it essential that the
compensation for money lent where it otherwise
meets the criteria of interest, be paid by the bor
rower in order for the payment to qualify as
interest. On the contrary, an ordinary person,
offering to act as a guarantor would simply say to
the proposed lender: "If 'X' (the borrower) does
not pay the interest, I will pay it". He would think
of using no other expression. In the case at bar,
should any of the debtors at any time have paid no
interest because no profits had been realized and
should the third party then have paid pursuant to
his contract of indemnity, then I would have had
no hesitation in finding that such a receipt would
be considered as income in the hands of the
defendant and that, since the amount was calculat
ed on a percentage of a capital sum loaned and
also proportionately to the length of time that the
capital sum remained outstanding, it could only be
defined as interest in the hands of the defendant.
As previously found by me, the contracts of indem
nity or guarantee formed in each case an integral
or essential part of and a condition sine qua non of
the loan. As the bonds were issued pursuant there
to, the latter cannot be considered independently
of the undertaking of the third party. One must
consider the true substance of the transaction as
opposed to its mere form. The fact that the guar
antees in certain cases were contained in separate
documents does not in any way affect the result. I
find that, as part and parcel of the whole scheme
the receipt of interest for the money lent is abso
lutely guaranteed to the lender, the bonds do not
qualify as income bonds.
In the circumstances of the present case, interest
provided for in the collateral agreement is, as
between the parties to the whole transaction, to be
considered as interest payable under the whole
transaction with the guarantor being considered as
included in the transaction. The payment of inter
est even when provided for only in the collateral
agreement, is, in so far as the payee is concerned,
to be considered as interest provided for in the
bond or in the trust agreement, since the execution
of the agreement is a condition sine qua non of the
existence of the whole transaction. I can see no
difference in the case at bar from a situation where
the bond itself would contain the text of the abso
lute guarantee of payment and name the third
party undertaking to pay. Such a bond would not,
in my view, qualify as an income bond as defined
in section 139(1) (t). It is true that where the
guarantee is entirely contained in the collateral
agreement, which is not referred to in any way in
the bonds or in the trust deed, and where the bonds
are subsequently sold to a third party, without the
absolute guarantee being assigned, then, in the
hands of that third party the same bonds would, in
all probability, qualify as income bonds since that
particular holder or payee could no longer be
assured of receiving interest in the event of the
principal debtor not realizing sufficient profits.
Similarly, if the text of the bonds and of the trust
agreement were to conform strictly to the provi
sions of the Act regarding income bonds and if
there were no guarantor but, by separate collateral
agreement the principal debtor were to undertake
directly with the bond holder and not through the
trustee, to pay interest in any event, then surely
the bonds could not be considered as income bonds
as long as that collateral agreement remained
enforceable, notwithstanding the fact that the
bonds themselves are expressed to be payable only
when the debtor has made a profit.
On this issue the finding of the Tax Review
Board will therefore be set aside and the original
assessment confirmed.
I turn next to the issues raised by the defendant
in its counterclaim as to gains realized from the
disposition of certain shares, options and mortgage
bonds which were declared to be taxable as ordi
nary income by both the Minister and the Tax
Review Board.
The transactions involved were the following:
1. 1967—profit realized on sale of mortgage $
bonds re Tri Town Realties 4,000.00
2. 1968—profit realized on sale of shares
and release of purchase option
re CHUM-1050 Limited 98,000.00
3. 1969—profit realized on sales of shares:
London Bottling Co. Ltd. 2,850.00
Tubafour Stud Mills Ltd. 100,000.00
Lloyd Bros. Lumber Co. Ltd. 30,000.00
4. 1970—profit realized on sales of shares:
Canadian Fiberform Ltd. 13,050.00
Sodium Sulphate (Sask) Ltd. 1,500.00
profit realized on sale or release
of option, The Aylmer Dairy Ltd. 7,443.66
The evidence established that RoyNat provided
term financing, that is 3 to 10 years, for small and
medium sized businesses. The loans averaged
approximately $250,000. It was also engaged in
the financing of equipment through leasing or
rent-purchase agreements. As part and parcel of
its various lending transactions in certain cases it
acquired bonus shares and options to purchase
shares. In one case, that is, Canadian Fiberform
Ltd., it claims to have paid fair value for the
shares obtained.
Counsel for the defendant readily admits that it
has been firmly established by jurisprudence that,
where assets other than shares have been acquired
as a bonus when loans are made, those assets are
treated as ordinary income from every standpoint,
since they are considered as gains made in the
course of the taxpayer's business. But he also
argues that in none of the cases were the assets
shares or other forms of investments and that these
should be treated differently because where shares
are concerned, taxpayers are fully taxable on the
profits made on resale only if trading in shares or
if the transaction is found to be an adventure in
the nature of trade. His argument is also founded
on the allegations that in the case at bar, there was
no element of speculation in the enterprise and
also that the distinction between shares and other
assets lies not only in the nature of the assets but
also on the fact that, while RoyNat acquired the
shares in question in relation with its financing
business, the disposition of same had nothing to do
with the financing business.
The facts are really uncontested, the plaintiff
having called no witnesses at trial and both parties
having agreed to rely on certain documentary evi
dence produced as exhibits at trial and the oral
testimony of the Vice-President of Investments of
the defendant given before the Tax Review Board
as well as the exhibits filed at that hearing. I
arrived at the following findings of fact from the
evidence adduced:
1. The subject loans in issue were made in the
regular course of the taxpayer's business as a
money lender but represented only a small part of
its overall activities. Selective equity investments
amounted to approximately 1% of its total
business.
2. The great majority of companies involved were
private companies owned and controlled by not
more than three individuals.
3. RoyNat did not participate in the actual man
agement of the companies in which it made invest
ments nor did it have representatives on their
boards of directors. It also appears that the shares
or options were eventually disposed of at the
request of the borrowers and not at the insistence
of RoyNat.
4. At first the bonuses consisted entirely of shares.
Later, options to buy shares were taken and, final
ly, combinations of both shares and options to
purchase shares were requested as bonuses.
5. Bonus shares or options were obtained in addi
tion to interest where the risk was considered as
above average. If the bonus had not been granted
the interest required on the loans would have been
between one-quarter per cent and one-half per cent
higher. The defendant never financed by means of
equity alone.
6. The bonuses were always requested by the
defendant and not offered by the borrowers, and
were made a condition sine qua non of the
financing.
7. Neither the shares nor the options could have
been obtained by the defendant were it not for the
financing.
8. RoyNat obviously intended to make a profit
from the eventual disposition of shares, generally
after a careful analysis of the financial situation of
the company and did not expect any dividends to
be paid on the shares nor, in fact, were any
dividends received.
9. RoyNat had the required expertise to determine
whether there would be a likelihood of a profit
before requesting the bonus in shares or options. It
also considered the return on the shares as part of
the profits. (Refer to internal memo filed as
Exhibit P1, Tab F.)
10. The evidence as to when the shares or options
were eventually disposed of does not appear to
support the argument advanced by the defendant
to the effect that RoyNat was looking to the
investments over a long term period of 5 to 8
years, after which dividends would be obtained.
The shares or options were disposed of without any
dividends having been paid after the following
periods:
CHUM Radio 7 months
London Bottling Co. 4 years
Tubafour Stud Mills 3 1 / 2 years
Lloyd Brothers Lumber 4 years
Canadian Fiberform 6 months
Sodium Sulphate (Sask)
1st financing 2 years
2nd financing 4 years
Aylmer Dairy 11 months
West Craft 4 1 / 2 years
On the question of when a particular transaction
is an adventure in the nature of trade, counsel for
the defendant quoted from the Supreme Court of
Canada case of Irrigation Industries Limited v.
M.N.R. 15 where Martland J., after citing cases
where it was held that the nature and quantity of
property purchased and sold qualified the transac
tion as an adventure in the nature of trade, distin
guished corporate shares from ordinary property in
the following terms:
Corporate shares are in a different position because they
constitute something the purchase of which is, in itself, an
investment. They are not, in themselves, articles of commerce,
but represent an interest in a corporation which is itself created
for the purpose of doing business. Their acquisition is a well-
recognized method of investing capital in a business enterprise.
15 [1962] S.C.R. 346 at p. 352.
It is perhaps worthy to note here that this case
involved one isolated transaction. Counsel also
referred to the statement of Noël J., as he then
was, in Foreign Power Securities Corporation Ltd.
v. M.N.R. 16 at page 385 where, after quoting the
above passage from the Irrigation Industries case,
supra, stated:
The short period during which these securities were held by
the appellant can be of little assistance to the respondent as
their fast disposal was properly explained by Mr. Wert in that
the directors of the appellant would have been remiss in their
duties had they not taken advantage of the surprisingly high
rise of the market at the time the securities were sold. The fact
that the appellant entered into these transactions for the pur
pose of making a profit as soon as it could and took advantage
of this rise as soon as it occurred, should not either change the
nature of its investments if this is what they were and render
them taxable as trading receipts and this also would appear
from the remarks of Martland J. at p. 355 of the same decision:
The only test which was applied in the present case was
whether the appellant entered into the transaction with the
intention of disposing of the shares at a profit so soon as
there was a reasonable opportunity of so doing. Is that a
sufficient test for determining whether or not this transaction
constitutes an adventure in the nature of trade? I do not
think that, standing alone, it is sufficient.
The decision of Noël J. was upheld on appeal
before the Supreme Court of Canada in M.N.R. v.
Foreign Power Securities Corporation Limited".
Counsel also cited from Thorson P.'s judgment
in the well-known case of M.N.R. v. Taylor 18
regarding some of the criteria to be taken into
consideration when deciding whether a particular
transaction constitutes an adventure in the nature
of trade. He also pointed out, as a reason for
distinguishing it, that the case concerned the pur
chase of lead, that is, a commodity, as opposed to
the purchase of shares.
The defendant also relied on the statement of
the Master of the Rolls Lord Greene in Lomax
(H.M. Inspector of Taxes) v. Peter Dixon & Son,
Ltd. 19 where the latter stated at page 363 of the
report:
16 [1966] Ex.C.R. 358.
17 [1967] S.C.R. 295.
18 [1956-60] Ex.C.R. 3.
19 25 T.C. 353.
The position is more complicated when A lends £100 to B at
a reasonable commercial rate of interest and stipulated for
payment of £120 at the maturity of the loan. In such a case it
may well be that A requires payment of the £20 as compensa
tion for the capital risk; or it may merely be deferred interest.
If it be proved that the former was the case by evidence of what
took place during the negotiations, it is difficult to see on what
principle the £20 ought to be treated as income. In the absence
of such proof, what inference ought to be drawn? Something
may, perhaps, depend on the length of time for which the
money is lent. If the period is short it is perhaps easier to treat
the £20 as deferred interest ....
I refer to these problems, not for the purpose of attempting
to solve them, but in order to show that there can be no general
rule that any sum which a lender receives over and above the
amount which he lends ought to be treated as income. Each
case must, in my opinion, depend on its own facts and evidence
dehors the contract must always be admissible in order to
explain what the contract itself usually disregards, namely, the
quality which ought to be attributed to the sum in question.
I cannot say that I agree with the statement if
unqualified, as it is much too broad: a bonus is
always taxable when it is obtained as part and
parcel of the operation of the taxpayer's regular
business or as part of an adventure in the nature of
trade.
The judgment of Heald J., in this Court, in
Canada Permanent Mortgage Corporation v.
M.N.R. 20 was also relied upon by the defendant.
In that case, however, as opposed to the case at
bar, there was a clear finding of fact on the part of
Heald J. to the effect that the taxpayer was inter
ested in the returns on the stocks rather than gains
on their resale and that the stocks were purchased
and held for their dividend income.
Jackett P., as he then was, in the Exchequer
Court case of Associated Investors of Canada
Limited v. M.N.R. 21 at pages 102 and 103 had this
observation to make as to when an operation is to
be included in the profits of a business:
(It was not argued that a loss could not be taken into account
in computing profit unless it arose from an operation or trans
action calculated or intended to produce a profit. It is clear that
such a contention could not succeed. A profit arising from an
operation or transaction that is an integral part of the current
profit-making activities must be included in the profits from the
business. See Minister of National Revenue v. Independence
20 71 DTC 5409.
21 [1967] 2 Ex.C.R. 96.
Founders Limited, ([1953] S.C.R. 389) and the foreign
exchange cases such as Tip Top Tailors Limited v. Minister of
National Revenue ([1957] S.C.R. 703) ....)
The case did not relate to shares and the obser
vation is obiter dictum, but it remains nevertheless
valid as a general statement of the law. Similarly,
Thurlow J., as he then was, in Stuyvesant-North
Limited v. M.N.R. 22 had this to say at pages
240-241 regarding share options acquired by the
taxpayer as a bonus:
For, even assuming that the rights were bonuses or premiums
and were given and received to compensate for the capital risks
involved in making the two loans and could, on that account, be
regarded as capital if the loans were mere investments, such
bonuses or premiums could not be so regarded if they were
obtained in the course of the operation of the appellant's
business. This distinction is clearly expressed in Californian
Copper Syndicate v. Harris (5 T.C. 159), where the Lord
Justice Clerk said at p. 165:
It is quite a well settled principle in dealing with questions
of assessment of Income Tax, that where the owner of an
ordinary investment chooses to realise it, and obtains a
greater price for it than he originally acquired it at, the
enhanced price is not profit in the sense of Schedule D of the
Income Tax Act of 1842 assessable to Income Tax. But it is
equally well established that enhanced values obtained from
realisation or conversion of securities may be so assessable,
where what is done is not merely a realisation or change of
investment, but an act done in what is truly the carrying on,
or carrying out, of a business ....
In West Coast Parts Co. Ltd. v. M.N.R. 23 my
brother Cattanach J. at page 432 of the report,
after quoting that approval from the Taylor case,
supra, had this comment to make:
There can be no doubt that a money lender who advances
money in the course of an established business on terms where
by he charges interest as such plus a fixed amount determined
by reference to the special risk involved, would count as profits
from his "trade" not only the interest collected as such, but the
additional amounts charged by reason of special risks. If it be
true that such an amount is a profit from a money lender's
trade, it follows, in my view, that, when a person who is not a
money lender enters into such a contract and thus embarks on
an adventure in the nature of the money lender's trade and
earns a similar profit, he acquired a profit from an adventure in
the nature of trade.
22 [1958] Ex.C.R. 230.
23 [1965] 1 Ex.C.R. 422.
In the case at bar it seems obvious that the
profits arose from operations or dealings which
constituted an integral part of the profit-making
activities of the defendant. The bonus shares or
options were, in the course of the operation of its
business of lending money, required by the defend
ant as extra compensation for the additional risks
involved in these cases; it intended to make a profit
from the eventual disposition of the shares and did
not expect dividends nor did it indeed receive any.
The defendant has, in addition, failed to satisfy me
that fair value was paid for the shares or options in
any of the transactions in issue.
Under those circumstances and applying the
principles outlined in the cases on which I have
commented, it seems obvious that the counterclaim
must fail and the finding of the Tax Review Board
and of the Minister must be confirmed on this
issue.
The plaintiff will be entitled to costs throughout.
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.