Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada

Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada
Collection
Supreme Court Judgments
Date
2006-10-20
Neutral citation
2006 SCC 46
Report
[2006] 2 SCR 447
Case number
30695, 30849
Judges
McLachlin, Beverley; Binnie, William Ian Corneil; LeBel, Louis; Deschamps, Marie; Fish, Morris J.; Abella, Rosalie Silberman; Charron, Louise
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
SCC Case Information: 30849, 30695
Decision Content
SUPREME COURT OF CANADA
Citation: Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada, [2006] 2 S.C.R. 447, 2006 SCC 46
Date: 20061020
Docket: 30695, 30849
Between:
Her Majesty The Queen
Appellant
and
Imperial Oil Limited
Respondent
and between:
Her Majesty The Queen
Appellant
and
Inco Limited
Respondent
‑ and ‑
Teck Cominco Limited
Intervener
Coram: McLachlin C.J. and Binnie, LeBel, Deschamps, Fish, Abella and Charron JJ.
Reasons for Judgment:
(paras. 1 to 69)
Dissenting Reasons:
(paras. 70 to 105)
LeBel J. (McLachlin C.J. and Deschamps and Abella JJ. concurring)
Binnie J. (Fish and Charron JJ. concurring)
______________________________
Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada, [2006] 2 S.C.R. 447, 2006 SCC 46
Her Majesty The Queen Appellant
v.
Imperial Oil Limited Respondent
‑ and ‑
Her Majesty The Queen Appellant
v.
Inco Limited Respondent
and
Teck Cominco Limited Intervener
Indexed as: Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada
Neutral citation: 2006 SCC 46.
File Nos.: 30695, 30849.
2006: February 7; 2006: October 20.
Present: McLachlin C.J. and Binnie, LeBel, Deschamps, Fish, Abella and Charron JJ.
on appeal from the federal court of appeal
Taxation — Income tax — Computation of business income — Capital losses — Discount on certain obligations — Foreign exchange losses — Debentures issued by taxpayer companies in U.S. dollars — Appreciation of U.S. dollar against Canadian dollar resulted in foreign exchange losses on redemption of debt obligations — Whether s. 20(1)(f) of Income Tax Act permits deductions from income of foreign exchange losses incurred on redemption of debt obligations — Whether s. 20(1)(f) limited to deduction of original issue discounts — Whether foreign exchange losses constitute capital losses pursuant to s. 39(2) of Income Tax Act — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 20(1) (f), 39(2) .
In 1989, Imperial Oil issued debentures in U.S. dollars and later redeemed a portion of those debentures in 1999. The U.S. dollar had appreciated against the Canadian dollar and Imperial Oil suffered a loss on redemption which represented the original discount and the foreign exchange loss. It took the position that it was entitled to deduct from income the entire loss under s. 20(1) (f)(i) of the Income Tax Act (“ITA ”) or, in the alternative, that it was entitled to a deduction of 75% of the loss under s. 20(1) (f)(ii) and that the non‑deductible 25% under that formula was by default a capital loss under s. 39(2) . The Minister of National Revenue decided that the loss was predominantly a capital loss under s. 39(2) and not deductible under s. 20(1) (f). The Tax Court of Canada upheld the Minister’s assessment with a minor adjustment. The Federal Court of Appeal allowed Imperial Oil’s appeal, in part. It allowed a deduction of 75% of the foreign exchange loss under s. 20(1) (f)(ii), but refused any further deduction.
Similarly, in 1989, Inco issued debentures in U.S. dollars at a discount, later redeeming a portion of them in 2000. Unlike Imperial Oil, Inco had sufficient U.S. funds on hand to redeem or purchase the debentures in the open market. In computing its income for 2000, Inco nevertheless deducted, under s. 20(1) (f) of the ITA , a foreign exchange loss allegedly resulting from the purchase of the 1989 debentures. The Minister disallowed the deduction. The Tax Court of Canada confirmed the Minister’s assessment, finding that the change in the value of the Canadian dollar during the term of the debentures had not resulted in any realized loss or cost to Inco. The Federal Court of Appeal, on the basis of its earlier decision in Imperial Oil, set aside that decision and sent the matter back to the Minister for reassessment.
Held (Binnie, Fish and Charron JJ. dissenting): The appeals should be allowed. The Minister’s assessments, as varied by the Tax Court of Canada in Imperial Oil, should be confirmed.
Per McLachlin C.J. and LeBel, Deschamps and Abella JJ.: Section 20(1) (f) of the ITA does not permit the deduction of foreign exchange losses, which must be claimed as a capital loss under s. 39 . Since the purpose of s. 20(1) (f) is to address a specific class of financing costs arising out of the issuance of debt instruments at a discount, s. 20(1) (f) should not be construed as a broad provision allowing for the deductibility of a wide range of costs attendant upon financing in foreign currency, in the absence of any mention of such costs in the text of the ITA , and despite the fact that such costs are usually regarded as being on capital account. The text, scheme and context of s. 20(1) (f) indicate that the deduction is limited to original issue discounts — shallow discounts in para. (f)(i) and deep discounts in para. (f)(ii). Although the word “discount” does not appear in s. 20(1) (f), the opening words of s. 20(1) (f)(i) set out what is commonly accepted as the definition of a discount. Moreover, there is no express mention in s. 20(1)(f) of a foreign currency exchange. These factors suggest that the primary referent of s. 20(1) (f) is something other than foreign exchange losses, namely, payments in the nature of discounts. Furthermore, the scheme of s. 20 , which provides deductions for virtually all costs of borrowing, does not imply that foreign exchange losses are also deductible under s. 20 . The other costs enumerated in s. 20 are intrinsic costs of borrowing. Foreign exchange losses arise only where the debtor chooses to deal in foreign currency. They belong to a different class than the costs referred to in s. 20 . [1] [62] [64-65] [67]
If s. 20(1)(f) applied to foreign exchange losses, the section would operate quite differently in relation to obligations denominated in foreign currency than it does in relation to obligations denominated in Canadian dollars. In the context of foreign currency obligations, the deduction would reflect the appreciation or depreciation of the principal amount over time, whereas in the context of Canadian dollar obligations, the deduction would reflect a point‑in‑time expense — the discount at the date of issue. In the context of foreign currency obligations, the s. 20(1)(f) deduction would accordingly be available even where there was no original issue discount. Such an approach would have the additional effect of altering the distinction between shallow discounts under s. 20(1)(f)(i) and deep discounts under s. 20(1)(f)(ii), which would be replaced by a distinction of a different nature — one that can be ascertained only at the time of repayment. [66]
If s. 20(1)(f) applied to foreign exchange losses, the section would also conflict with the general treatment of capital gains and losses in the ITA . In particular, such an interpretation would not properly appreciate the role of s. 39 of the ITA . That provision sets out a meaning of capital gains and losses and includes express rules for the treatment of gains and losses resulting from currency fluctuations. Although s. 39 is a residual provision, this section is a statement of Parliament’s intent to treat foreign exchange losses as capital losses. [19] [66] [68]
Finally, the Federal Court of Appeal decision in Gaynor does not support the proposition that all elements of a statutory formula must be converted into their Canadian dollar value at the relevant time. Converting the amounts in the statutory formula merely simplified the method of calculating the amount of the capital gain in that case. Gaynor did not purport to establish a new general principle. [52]
Per Binnie, Fish and Charron JJ. (dissenting): In the nature of things foreign currencies fluctuate in value against the Canadian dollar. These fluctuations are not incidental or collateral to the foreign debt transaction but are as inherent and inescapable as if the debt was denominated in bars of silver. The respondent taxpayers in these cases both issued debentures denominated in U.S. dollars, which they subsequently retired at a time when the U.S. dollar was trading at a higher premium to the Canadian dollar than it had at the date of issuance. The taxpayers’ claim thus fits squarely with s. 20(1) (f) of the ITA . This provision permits a deduction of the amount by which the original issue proceeds of the debt are exceeded by the amount paid in satisfaction of the principal amount of the debt. This deduction is not limited to the “original issue discount” and may include the increase in the cost to the taxpayers of buying U.S. dollars between the date the obligations were issued and the date they were satisfied. The extra cost of buying the U.S. dollars payable to satisfy the requirements of a debenture is part of the cost of the financing arising directly out of the debtor‑creditor relationship. The Crown’s argument limiting s. 20(1) (f) to “original issue discounts” rests on its attempt to bifurcate a single foreign loan transaction into a “loan” contract and a “foreign exchange” loss. Such an argument does not respect the precise nature of the taxpayer’s actual legal relationships and obligations. Furthermore, the limitation of s. 20(1) (f) to “original issue discounts” would be contrary to the Minister’s treatment of other commodity‑type loans where the Minister has routinely allowed a s. 20(1) (f) deduction. There is no principled reason to treat foreign currency loans differently than other commodity‑type loans under s. 20(1) (f). [70] [72] [77‑79] [83-84] [88]
When the relevant language of ss. 20(1) (f) and 248(1) of the ITA is read in light of the statutory purpose, the only way the “maximum total amount . . . payable on account of the obligation” can be ascertained (as required by the definition of “principal amount” in s. 248(1) ) is by using the exchange rate prevailing when the obligation becomes payable. It is at that time the “obligation” arose on the part of the taxpayers to purchase U.S. dollars to retire their debt. It follows that the relevant exchange rate is the rate prevailing at the date of redemption because it is not until that date that it is possible to determine the maximum amount “payable on account of the obligation”. It is thus the redemption, not the issuance, that triggers the tax deduction. Since the principal amount of the obligation must be ascertained at the date of redemption, the debentures in these cases do not meet the criteria of s. 20(1) (f)(i). Consequently, the taxpayers are entitled only to the deduction permitted by s. 20(1) (f)(ii). [77] [86-87]
Cases Cited
By LeBel J.
Distinguished: Gaynor v. The Queen, 91 D.T.C. 5288, aff’g 88 D.T.C. 6394, aff’g 87 D.T.C. 279; referred to: Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, 2001 SCC 62; Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54; Mathew v. Canada, [2005] 2 S.C.R. 643, 2005 SCC 55; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; Tip Top Tailors Ltd. v. Minister of National Revenue, [1957] S.C.R. 703; Eli Lilly and Co. (Canada) Ltd. v. Minister of National Revenue, [1955] S.C.R. 745; Alberta Gas Trunk Line Co. v. Minister of National Revenue, [1972] S.C.R. 498; Imperial Tobacco Co. v. Kelly, [1943] 2 All E.R. 119; Bentley v. Pike (1981), 53 T.C. 590; Pattison (Inspector of Taxes) v. Marine Midland Ltd., [1984] 1 A.C. 362; Capcount Trading v. Evans (1992), 65 T.C. 545; Nowegijick v. The Queen, [1983] 1 S.C.R. 29.
By Binnie J. (dissenting)
Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54; Eli Lilly and Co. (Canada) Ltd. v. Minister of National Revenue, [1955] S.C.R. 745; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; Canada v. Canadian Pacific Ltd., [2002] 3 F.C. 170, 2001 FCA 398; Montreal Coke and Manufacturing Co. v. Minister of National Revenue, [1944] A.C. 126, aff’g [1942] S.C.R. 89 (sub nom. Montreal Light, Heat and Power Consolidated v. Minister of National Revenue); Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32; Tennant v. M.N.R., [1996] 1 S.C.R. 305.
Statutes and Regulations Cited
Currency Act, R.S.C. 1985, c. C-52, ss. 3(1) , 14 .
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 3 , 9 , 18(1) (b), 20(1) , 39 , 79 , 80 , 248 “amount”, “principal amount”.
Authors Cited
Canada. Canada Revenue Agency. Income Tax Rulings Directorate. Advance Income Tax Ruling, No. 1999-0008753 (F), "Débentures échangeables", January 1, 2000.
Canada. Canada Revenue Agency. Income Tax Rulings Directorate. Advance Income Tax Ruling, No. 90063-3 (E), "Exchangeable Debenture", July 30, 1990.
Canada. Canada Revenue Agency. Income Tax Rulings Directorate. Advance Income Tax Ruling, No. 2000-0060103 (E), "Principal Amount of Debt Obligation", January 1, 2001.
Canada. Canada Revenue Agency. Income Tax Rulings Directorate. Technical Interpretation, No. 9703377 (E), "Consumer Based Loan", April 17, 1997.
Côté, Pierre‑André. The Interpretation of Legislation in Canada, 3rd ed. Scarborough, Ont.: Carswell, 2000.
Driedger, Elmer A. Construction of Statutes, 2nd ed. Toronto: Butterworths, 1983.
Krishna, Vern. The Fundamentals of Canadian Income Tax, 8th ed. Toronto: Carswell, 2004.
APPEAL from a judgment of the Federal Court of Appeal (Létourneau, Sharlow and Malone JJ.A.), [2005] 1 C.T.C. 65, 2004 D.T.C. 6702, 327 N.R. 329, [2004] F.C.J. No. 1793 (QL), 2004 FCA 361, allowing Imperial Oil’s appeal, in part, from a judgment of Miller J., [2004] 2 C.T.C. 3030, 2004 D.T.C. 2377, [2004] T.C.J. No. 122 (QL), 2004 TCC 207. Appeal allowed, Binnie, Fish and Charron JJ. dissenting.
APPEAL from a judgment of the Federal Court of Appeal (Décary, Nadon and Sexton JJ.A.), [2005] 1 C.T.C. 369, 2005 D.T.C. 5109, [2005] F.C.J. No. 169 (QL), 2005 FCA 38, allowing Inco’s appeal from a judgment of Bonner J., [2005] 1 C.T.C. 2096, 2004 D.T.C. 3586, [2004] T.C.J. No. 531 (QL), 2004 TCC 468. Appeal allowed, Binnie, Fish and Charron JJ. dissenting.
Wendy Burnham and Rhonda Nahorniak, for the appellant.
Al Meghji and Edward C. Rowe, for the respondent Imperial Oil Limited.
Warren J. A. Mitchell, Q.C., and Michael W. Colborne, for the respondent Inco Limited.
Written submissions only by Wilfrid Lefebvre, Q.C., and Dominic C. Belley, for the intervener.
The judgment of McLachlin C.J. and LeBel, Deschamps and Abella JJ. was delivered by
LeBel J. —
I. Introduction
1 These two appeals turn on the proper interpretation of a provision of the federal Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .) (“ITA ”), namely s. 20(1) (f). In general terms, s. 20(1) permits the deduction of various financing costs in the computation of business income. The question is whether s. 20(1) (f) permits the deduction of foreign exchange losses incurred in the redemption of debt obligations or whether it is limited to the deduction of original issue discounts. With minor changes in the Imperial Oil case, the judgments of the Tax Court upheld the assessments of the Minister of National Revenue (“Minister”) which had disallowed the deduction of the foreign exchange losses. The Federal Court of Appeal allowed the appeals of Imperial Oil and Inco. For the reasons that follow, I would reverse the Court of Appeal’s judgments and reinstate the assessments, in accordance with the approach adopted by Miller J. in the Imperial Oil case. Section 20(1) (f) does not permit the deductions claimed by the respondents, who are only entitled to claim a capital loss under s. 39 of the ITA .
II. Background
A. Imperial Oil
2 In 1989, Imperial Oil issued 30‑year debentures with a face amount of US$300,000,000. In 1999, it redeemed a portion of those debentures with a face value of US$87,130,000. The United States dollar had appreciated against the Canadian dollar and the respondent suffered a loss on redemption of C$27,831,712 representing the original discount and the foreign exchange loss. The respondent took the position that it was entitled to deduct the entire loss under s. 20(1) (f)(i) of the ITA . In the alternative, it took the position that it was entitled to a deduction under s. 20(1) (f)(ii) and that the non‑deductible 25% under that formula was by default a capital loss under s. 39(2) . The Minister decided that the C$27,831,712 loss was predominantly a capital loss under s. 39(2) . The respondent appealed, and three questions were referred to the Tax Court of Canada: what portion was deductible under s. 20(1) (f)(i); what portion was deductible under s. 20(1) (f)(ii); and, what portion was a capital loss under s. 39(2) ?
B. Inco
3 In 1989, Inco issued sinking fund debentures of US$150,000,000 at a discount of 2.6% (or US$3,900,000). It converted the discount to Canadian dollars ($4,652,827) at the exchange rate in effect when the debentures were issued, and deducted 20% of the converted amount as a financing expense under s. 20(1) (e) of the ITA in each of the taxation years 1989 to 1993. The Minister did not challenge these deductions. Inco receives a substantial portion of its revenues in U.S. dollars, which it deposits in U.S. dollar bank accounts. The proceeds of the issuance were deposited in U.S. dollar accounts or used to pay debts denominated in U.S. dollars. Inco had sufficient U.S. funds on hand in the United States to redeem or purchase the debentures in the open market. Between February 21 and May 9, 2000, Inco purchased US$29,120,000 of the 1989 debentures in the open market, paying US$29,012,850 for them. On June 15, 2000, by mandatory and optional payments into the sinking fund, it redeemed more of the 1989 debentures with an aggregate face amount of US$22,500,000. In 1992, Inco issued debentures with a face amount of US$200,000,000. Between March 3 and November 8, 2000, Inco purchased US$21,692,000 of the 1992 debentures in the open market, paying US$21,269,708 for them. In computing its income for 2000, Inco deducted, under s. 20(1) (f) of the ITA , a foreign exchange loss allegedly resulting from the purchase of the 1989 debentures. The Minister disallowed the deduction and Inco appealed to the Tax Court of Canada.
III. Judicial History
A. Imperial Oil Limited
(1) Tax Court of Canada, [2004] 2 C.T.C. 3030, 2004 TCC 207
4 Miller J. mostly agreed with the Minister on the outcome of the appeal filed in the Tax Court of Canada. However, he did not agree with any of the interpretations of s. 20(1) (f) advanced by the taxpayer or the Minister. The result was that he made a minor adjustment to the assessment and that, in the end, Imperial Oil lost their appeal.
5 Miller J. began by noting that the parties agreed that s. 20(1) (f)(i) applied rather than s. 20(1) (f)(ii). The deduction under s. 20(1) (f)(i), he observed, equals the lesser of the principal amount and the amount paid in the year in satisfaction of the principal amount less the amount for which the obligation was issued. Miller J. added that the parties also agreed that the exchange rate at the time of redemption applied to “the amount paid in satisfaction” and that the exchange rate at the time of issuance applied to “the issue amount”, but disagreed as to what rate applied to the “principal amount”. He concluded that no ambiguity arose if the calculation was done entirely in U.S. dollars and only the resulting loss was converted into Canadian dollars using the rate at the time of redemption. In his opinion, s. 20(1) (f)(i) was not intended to apply to foreign exchange gains or losses.
6 Miller J. rejected an interpretation of Gaynor v. The Queen, 91 D.T.C. 5288 (F.C.A.), according to which every transaction resulting in an asset, liability, revenue item or expense must be converted into Canadian dollars at the exchange rate in effect on the date of the transaction. He concluded that Gaynor applies only to computations of capital gains and that nothing in Gaynor requires that it be applied to income computations or dictates that the word “amount” refers to “Canadian amount” wherever it appears in the ITA . Miller J. distinguished capital gains, which result from the change in the value of an asset over time, that is, between the times of acquisition and disposition, from income expenses, which require a snapshot at the time of payment without the measurement of a change in value over time. He decided that the formula under s. 20(1) (f)(i) does not address increases or decreases in value but applies at a single point in time and that it was therefore sufficient to convert only the resulting loss into Canadian dollars. He added that, if he was wrong in this respect, the object of the section required that each amount of the formula be converted at the 1999 exchange rate because the “one time snapshot rate” has to be the rate at the time of redemption (para. 46).
7 Miller J. concluded that Parliament had not intended foreign exchange losses to be deductible under s. 20(1) (f), as they pertained to the capital element of borrowing. He stated that s. 20(1) (f) deals with obligations issued at less than face value and allows the discount to be deducted at the time of payment. In his view, foreign exchange losses incurred in the course of borrowing are not akin to the other costs of borrowing listed as deductible expenses in s. 20(1) . He noted that foreign exchange losses are not specifically identified as a capital item to be treated as a current expense and that the other costs for which deductions are available are known at the time of the contract and derive from the contract of origin. Miller J. concluded that the deduction in s. 20(1) (f) encompasses only original issue discounts and the part of the foreign exchange loss that pertains specifically to the deductible discounts. On that basis, he held that $1,548,325 was deductible under s. 20(1) (f)(i), that nothing was deductible under s. 20(1) (f)(ii), and that there was a capital loss of $26,283,387.
(2) Federal Court of Appeal, [2005] 1 C.T.C. 65, 2004 FCA 361
8 Imperial Oil appealed and the Minister cross-appealed. The Court of Appeal allowed Imperial Oil’s appeal in part. It allowed a deduction of 75% of the foreign exchange loss under s. 20(1) (f)(ii), but refused any further deduction.
9 Sharlow J.A., for the court, concluded that the principal amount of a debt denominated in foreign currency fluctuates with the exchange rate for the purposes of s. 20(1) (f) and that, in the instant case, the amount increased between the dates of issuance and redemption. She concluded that Gaynor was binding and that, according to it, each element of a computation under s. 20(1) (f) must be converted into Canadian dollars at the exchange rate prevailing at the time of the transaction in question. She calculated the principal amount at the time of redemption using the exchange rate on the redemption date, and the issue amount using the exchange rate on the date of issue, and concluded that the principal amount had increased from $102,517,158 to $129,119,689. Sharlow J.A. concluded that a principal amount can increase during the term of a loan if the increase is mandated by a contractual term governing the debt, and that a foreign currency loan implicitly involves such a contractual term. Because a foreign currency loan is for units of foreign currency on terms that require the same number of units of the foreign currency to be returned at the end of the term, the effect is that the Canadian dollar equivalent of the repayment may be more or less than the Canadian dollar equivalent of the borrowed amount. She found that s. 248(26) of the ITA does not compel a conclusion that the principal amount was necessarily the same at the times of issuance and redemption, because all it does is clarify s. 80 , and even if it were applied to s. 20(1) (f), it would merely confirm that the original principal amount was $102,517,158.
10 Sharlow J.A. stated that the deduction provided for in s. 20(1) (f) is available where the threshold test established in the opening words of the provision is met and that this provision most commonly applies when debt is issued at a discount, although it may also apply in other circumstances. Because the full deduction under s. 20(1) (f)(i) is available only where the obligation was issued for not less than 97% of the principal amount, and because this condition had not been met in the case at bar, the respondent was entitled only to the 75% deduction under s. 20(1) (f)(ii). Sharlow J.A. rejected an argument that the non‑deductible 25% was excluded from the computation of income and fell by default into s. 39(2) as a deemed capital loss. She concluded that s. 248(28) prevents double counting and that the total redemption cost falls within s. 20(1) (f)(ii). She observed that the deduction is designed to be equivalent to the tax relief for a capital loss and that to allow a further deduction under s. 39(2) would be to allow more relief than Parliament had intended. In light of these conclusions, Sharlow J.A. was of the view that there was no need to address the Minister’s cross-appeal.
B. Inco Limited
(1) Tax Court of Canada, [2005] 1 C.T.C. 2096, 2004 TCC 468
11 Bonner J. heard the appeal in Inco after the decision of his colleague Miller J. in Imperial Oil. He stated that he did not agree with parts of Miller J.’s reasoning and wrote his own reasons for dismissing the appeal and confirming the assessment.
12 Bonner J. held that s. 20(1) (f) of the ITA did not permit the deduction of the foreign exchange losses. He noted that Inco had borrowed U.S. dollars in 1989 and 1992, had either deposited the funds in U.S. dollar accounts or used them to repay U.S. dollar debt, and had then drawn on U.S. dollar accounts to retire the debentures. He found that the change in the value of the Canadian dollar during the term of the debentures had not resulted in any realized loss or cost to Inco and that Inco was seeking to deduct what was, in his opinion, a phantom loss. In his view, it was impossible to imagine that s. 20(1) (f) was intended to permit a deduction in the absence of a realized loss or cost. The foreign exchange fluctuations neither added to nor subtracted from the cost of borrowing. He rejected an argument that, for the purposes of s. 20(1) (f), the “principal amount” of a borrowing fluctuates with exchange rates over the life of the instrument. In his opinion, the “principal amount” referred to in s. 20(1) (f) is the face amount of the instrument when it is issued, which does not vary, and there is no basis in logic for a view that the expression of that principal amount in a foreign currency gives the Canadian dollar equivalent of the principal amount a variable quality. He stated that treating the principal amount as one that fluctuates with exchange rates would include amounts in the deduction that were never in Parliament’s contemplation. Given his conclusion, he declined to consider whether s. 20(1) (f) would apply to purchases of obligations on the open market for cancellation by the debtor.
(2) Federal Court of Appeal, [2005] 1 C.T.C. 369, 2005 FCA 38
13 Inco’s appeal to the Federal Court of Appeal was successful. Nadon J.A. held that the Court had decided the relevant issues in its previous decision in the Imperial Oil case and that the two cases could not be distinguished. For these reasons, he set aside the Tax Court’s decision and sent the matter back to the Minister for reassessment.
IV. Analysis
A. Issues
14 The parties disagree on the tax treatment of foreign exchange losses incurred upon redemption or, at least in part in the Inco case, upon repurchase and cancellation of debentures issued in U.S. dollars. The outcome of the appeals turns on the interpretation of s. 20(1) (f) of the ITA , which permits the following deduction when computing business income:
20. (1) . . .
(f) an amount paid in the year in satisfaction of the principal amount of any bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation issued by the taxpayer after June 18, 1971 on which interest was stipulated to be payable, to the extent that the amount so paid does not exceed,
(i) in any case where the obligation was issued for an amount not less than 97% of its principal amount, and the yield from the obligation, expressed in terms of an annual rate on the amount for which the obligation was issued (which annual rate shall, if the terms of the obligation or any agreement relating thereto conferred on its holder a right to demand payment of the principal amount of the obligation or the amount outstanding as or on account of its principal amount, as the case may be, before the maturity of the obligation, be calculated on the basis of the yield that produces the highest annual rate obtainable either on the maturity of the obligation or conditional on the exercise of any such right) does not exceed 4/3 of the interest stipulated to be payable on the obligation, expressed in terms of an annual rate on
(A) the principal amount of the obligation, if no amount is payable on account of the principal amount before the maturity of the obligation, or
(B) the amount outstanding from time to time as or on account of the principal amount of the obligation, in any other case,
the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding year in satisfaction of its principal amount exceeds the amount for which the obligation was issued, and
(ii) in any other case, 3/4 of the lesser of the amount so paid and the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding taxation year in satisfaction of its principal amount exceeds the amount for which the obligation was issued;
15 On a proper interpretation, is the deduction in this provision limited to original issue discounts? Should it be viewed as encompassing a broader range of financing costs, including foreign exchange losses? Are such losses deductible only as capital losses under s. 39 of the ITA ? In these two appeals, although the parties purport to base their arguments on the same principles of interpretation of tax statutes, their answers to these questions and their propositions regarding the scope of s. 20(1) (f) are in stark conflict.
16 The scope of the present litigation has been narrowed and clarified since the Minister issued his assessments. Imperial Oil now relies solely on s. 20(1) (f)(ii) and asks for only 75% of its currency exchange loss, as permitted by that provision. It no longer claims a full deduction under s. 20(1) (f)(i) or a capital loss under s. 39 for the remaining 25%. In Inco, the Minister has abandoned the argument that the taxpayer’s currency losses are purely notional or phantom losses. In this appeal, the Minister’s factum raises an issue which is specific to Inco, namely whether currency losses incurred as a result of a repurchase of debt instruments on the open market are deductible only under s. 39(3). There are no real evidentiary difficulties. The two cases proceeded on the basis of joint statements of facts. In addition, in Inco, the Minister presented expert evidence about the meanings attributed by the financial industry to some of the terms used in s. 20(1) (f). In essence, the two appeals raise similar issues. Before I turn to those issues, I will outline the statutory framework that governs the present litigation.
B. Statutory Framework
17 Despite its undeniable — and growing — complexity, the current federal ITA displays some fundamental structural characteristics. One of these characteristics, which is provided for in s. 3 , is the distinction between income and capital. Capital gains are only partially brought into income for taxation purposes. The rules governing the computation of income, gains and losses are found in ss. 9 to 37 . They include a general rule stated in s. 18(1) (b), which prohibits the deduction of capital amounts unless another provision of the ITA expressly authorizes such a deduction:
18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of . . .
(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part;
18 A series of exceptions to this rule are set out in s. 20, which provides for a broad range of deductions in respect of a variety of financing costs, such as interest (s. 20(1) (c)), financing expenses, including commissions to securities dealers (s. 20(1) (e)), and annual fees on debt (s. 20(1) (e.1)). Section 20(1) (f) is a part of this list.
19 Section 39 then sets out the meaning of capital gains and losses. It includes express rules in s. 39(2) for the treatment of gains and losses resulting from currency fluctuations:
39. . . .
(2) Notwithstanding subsection (1), where, by virtue of any fluctuation after 1971 in the value of the currency or currencies of one or more countries other than Canada relative to Canadian currency, a taxpayer has made a gain or sustained a loss in a taxation year, the following rules apply:
(a) the amount, if any, by which
(i) the total of all such gains made by the taxpayer in the year (to the extent of the amounts thereof that would not, if section 3 were read in the manner described in paragraph (1)(a) of this section, be included in computing the taxpayer’s income for the year or any other taxation year)
exceeds
(ii) the total of all such losses sustained by the taxpayer in the year (to the extent of the amounts thereof that would not, if section 3 were read in the manner described in paragraph (1)(a) of this section, be deductible in computing the taxpayer’s income for the year or any other taxation year), and
(iii) if the taxpayer is an individual, $200,
shall be deemed to be a capital gain of the taxpayer for the year from the disposition of currency of a country other than Canada, the amount of which capital gain is the amount determined under this paragraph; and
(b) the amount, if any, by which
(i) the total determined under subparagraph (a)(ii),
exceeds
(ii) the total determined under subparagraph (a)(i), and
(iii) if the taxpayer is an individual, $200,
shall be deemed to be a capital loss of the taxpayer for the year from the disposition of currency of a country other than Canada, the amount of which capital loss is the amount determined under this paragraph.
20 In addition, s. 39(3) provides specific rules in respect of gains and losses arising out of purchases of bonds on the open market:
39. . . .
(3) Where a taxpayer has issued any bond, debenture or similar obligation and has at any subsequent time in a taxation year and after 1971 purchased the obligation in the open market, in the manner in which any such obligation would normally be purchased in the open market by any member of the public,
(a) the amount, if any, by which the amount for which the obligation was issued by the taxpayer exceeds the purchase price paid or agreed to be paid by the taxpayer for the obligation shall be deemed to be a capital gain of the taxpayer for the taxation year from the disposition of a capital property, and
(b) the amount, if any, by which the purchase price paid or agreed to be paid by the taxpayer for the obligation exceeds the greater of the principal amount of the obligation and the amount for which it was issued by the taxpayer shall be deemed to be a capital loss of the taxpayer for the taxation year from the disposition of a capital property,
to the extent that the amount determined under paragraph (a) or (b) would not, if section 3 were read in the manner described in paragraph (1)(a) and this Act were read without reference to subsections 80(12) and (13), be included or be deductible, as the case may be, in computing the taxpayer’s income for the year or any other taxation year.
C. Positions of the Parties
21 In the Minister’s opinion, s. 20(1) (f) is clear in its wording and purpose. It establishes a specific deduction for discounts on the issuance of debt instruments. The provision was never intended to address the tax consequences of foreign exchange losses related to the issuance and redemption of foreign currency bonds or debentures, or, in the Inco case, to the purchase of such bonds or debentures on the open market. Section 39(2) applies, and it treats such losses as capital losses, which can only be set off against capital gains.
22 The taxpayers, too, rely on the clarity of the wording of s. 20(1) (f). In their opinion, this provision, properly understood, simply means that foreign exchange losses in respect of debt instruments are deemed to be deductible from profits for income tax purposes. Section 39(2) merely plays the role of a residual basket clause which applies only when other provisions do not.
23 Whichever way we turn, therefore, this is another classic case of interpretation of tax statutes. What are these provisions? How do they interrelate? Given the nature of this problem, a brief review of the principles of interpretation applicable to tax statutes is appropriate.
D. Principles of Interpretation Applicable to Tax Statutes
24 This Court has produced a considerable body of case law on the interpretation of tax statutes. I neither intend nor need to fully review it. I will focus on a few key principles which appear to flow from it, and on their development.
25 The jurisprudence of this Court is grounded in the modern approach to statutory interpretation. Since Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, the Court has held that the strict approach to the interpretation of tax statutes is no longer appropriate and that the modern approach should also apply to such statutes:
[T]he words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act . . . .
(E. A. Driedger, Construction of Statutes (2nd ed. 1983), at p. 87; Stubart, at p. 578, per Estey J.; Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, 2001 SCC 62, at para. 36, per Iacobucci J.)
26 Despite this endorsement of the modern approach, the particular nature of tax statutes and the peculiarities of their often complex structures explain a continuing emphasis on the need to carefully consider the actual words of the ITA , so that taxpayers can safely rely on them when conducting business and arranging their tax affairs. Broad considerations of statutory purpose should not be allowed to displace the specific language used by Parliament (Ludco, at paras. 38-39).
27 The Court recently reasserted the key principles governing the interpretation of tax statutes — although in the context of the “general anti-avoidance rule”, or “GAAR” — in its judgments in Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54, and Mathew v. Canada, [2005] 2 S.C.R. 643, 2005 SCC 55. On the one hand, the Court acknowledged the continuing relevance of a textual interpretation of such statutes. On the other hand, it emphasized the importance of reading their provisions in context, that is, within the overall scheme of the legislation, as required by the modern approach.
28 In their joint reasons in Canada Trustco, the Chief Justice and Major J. stated at the outset that the modern approach applies to the interpretation of tax statutes. Words are to be read in context, in light of the statute as a whole, that is, always keeping in mind the words of its other provisions:
It has been long established as a matter of statutory interpretation that “the words of an Act are to be read in their entir