Plains Midstream Canada ULC v. The Queen

Plains Midstream Canada ULC v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2017-10-06
Neutral citation
2017 TCC 207
File numbers
2012-4907(IT)G, 2013-1522(IT)G
Judges and Taxing Officers
Robert James Hogan
Subjects
Income Tax Act
Decision Content
Docket: 2012-4907(IT)G
2013-1522(IT)G
BETWEEN:
PLAINS MIDSTREAM CANADA ULC,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on June 20, 21 and 22, 2017, at Calgary, Alberta
Before: The Honourable Justice Robert J. Hogan
Appearances:
Counsel for the Appellant:
Gerald Grenon
Al Meghji
Edward Rowe
Counsel for the Respondent:
Carla Lamash
Mary Softley
JUDGMENT
The Appellant’s appeal in respect of its 1995 and 1996 taxation years is dismissed in accordance with the attached Reasons for Judgment.
The parties will have until October 20, 2017 to arrive at an agreement on costs, failing which they must file their written submissions on costs no later than October 25, 2017. Such submissions are not to exceed five pages.
Signed at Ottawa, Canada, this 6th day of October 2017.
“Robert J. Hogan”
Hogan J.
Citation: 2017 TCC 207
Date: 20171006
Docket: 2012-4907(IT)G
2013-1522(IT)G
BETWEEN:
PLAINS MIDSTREAM CANADA ULC,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
I. OVERVIEW [1] After an ill-fated drilling program in the Arctic, Dome Petroleum Limited (“Dome Petroleum”) found itself in financial difficulty. By the mid-1980s it was clear that the reserves it had discovered were not commercially viable. By 1987 it had become obvious to all that Dome Petroleum and its subsidiaries required debt relief, otherwise they could not survive as going concerns.
[2] Amoco Canada Petroleum Company Ltd. (“Amoco”), the predecessor to Plains Midstream Canada ULC (the “Appellant”), which had resource properties in similar locations to those held by Dome Petroleum, felt that this was an opportune time to acquire Dome Petroleum provided Dome Petroleum could settle its existing debts on favourable terms.
[3] Amoco identified one specific debt that was particularly problematic. Dome Petroleum and Dome Canada Limited (“Dome Canada”), a public company in which Dome Petroleum had a significant interest, were parties to an agreement with the Arctic Petroleum Corporation of Japan (“APCJ”) that provided for exploration and development in the Beaufort Sea (the “Formal Contract”). A key part of the Formal Contract was a $400 million exploration loan that was advanced to Dome Petroleum and Dome Canada in 1981 and was repayable in 2030. Both Dome companies were jointly and severally liable for the entire $400 million exploration loan and for the performance of all obligations contracted under the Formal Contract.
[4] After reaching an agreement with APCJ, Dome Petroleum and Dome Canada entered into a joint venture agreement whereby they stipulated, as between themselves, that Dome Petroleum was liable for an amount of $175 million of the exploration loan, while Dome Canada was liable for an amount of $225 million. Through a series of transactions described in the Partial Agreed Statement of Facts (“PASOF”), reproduced in its entirety in Appendix A to these reasons, Dome Canada became an entity wholly independent from Dome Petroleum save for its joint and several obligations under the Formal Contract. Following the transactions Dome Canada was renamed Encor Energy Corporation (“Encor”).
[5] Amoco viewed certain features of the Formal Contract as significant obstacles to a successful takeover of Dome Petroleum. After completion of the transactions, Dome Petroleum and Encor would be independent entities. However, unless this situation was addressed with APCJ, they would remain joint and several obligors under the Formal Agreement. In that case, if either party became insolvent, the exploration loan would become fully repayable. APCJ could look to either party for payment. This risk of default also extended to Dome Petroleum’s other credit facilities. The evidence shows that Amoco was unwilling to acquire Dome Petroleum without the adoption of a multi-step plan (“Plan”) to initially mitigate and eventually eliminate the risk of cross-defaults imposed by the terms of the Formal Contract and under Dome Petroleum’s other credit agreements.
[6] The Plan was executed in stages over a period of time stretching from 1988 to 1992. The first steps of the Plan involved Amoco agreeing to assume Encor’s obligations under the Formal Contract, including, as between Encor and Dome Petroleum, Encor’s obligation to repay $225 million out of the $400 million payable to APCJ under the exploration loan in 2030 at the latest. Encor paid Amoco $17.5 million to assume Encor’s obligations under the Formal Contract and provided Amoco with additional consideration. As a condition of that transaction, Encor was to agree to vote in favour of Dome Petroleum’s Plan of Arrangement. Encor’s consent to certain key transactions (defined below) was essential to the completion by the Appellant of the subscription for, or acquisition of, the shares of Dome Petroleum. For example, in addition to agreeing to vote in favour of the Plan of Arrangement, Encor agreed to cooperate with Amoco in the renegotiation of the terms of the Formal Contract with APCJ, which included cooperation in connection with the long negotiations that ultimately led to the release of Encor as a joint and several debtor under the Formal Contract.[1] It was only in 1992 that the risk of cross-default was eliminated as a result of APCJ releasing Encor as a joint and several obligor under the Formal Contract.
[7] The Settlement Agreement, the Encor Indemnity and Subrogation Agreement, the Accommodation Agreement and the Release Agreement together with the obligations imposed on the parties by the Formal Contract are collectively hereinafter referred to as the (“Key Transactions” or “Key Agreements”)[2]. All of the other defined terms in these reasons for judgment have the meaning ascribed to them in the PASOF unless otherwise indicated.
[8] Initially, for tax purposes the Appellant attempted to deduct as interest on a straight-line basis the difference between the amount owed by it under the exploration loan ($225 million) and what it viewed as the consideration received by it from Encor ($17.5 million) calculated over 43 years.[3]
[9] In 1995 and 1996, the taxation years at issue, the Appellant was in a loss position. As a result, the only way that the Appellant could compel the Minister to address the validity of its interest deductions was to request loss determinations.
[10] The Minister, in issuing loss determinations for each of those years, denied the Appellant a deduction for the interest that it had claimed.
[11] Although the Appellant had initially claimed an interest deduction on a straight-line basis, shortly before trial, the Appellant reduced its interest deduction claim to $1,043,700. This amount was determined by applying a simple interest rate of 5.964% to the $17.5 million that Amoco received from Encor.
[12] The central question to resolve in this appeal is whether the Appellant is entitled to deduct the amount it now claims under the combined operation of subsection 16(1) and paragraph 20(1)(c) of the Income Tax Act[4] (the “ITA”).
[13] For the reasons that follow, I am of the opinion that the amounts claimed by the Appellant as interest deductions in 1995 and 1996 in connection with the Key Transactions are not deductible under the provisions that it has relied upon.
II. POSITIONS OF THE PARTIES A. Appellant’s position [14] The Appellant argues that it is entitled to deduct the difference between its $17.5 million receipt and its $225 million liability under the exploration loan (the “Difference”) because that amount reflects the time value of money, and paragraph 16(1)(a) of the ITA allows the Key Transactions to be recast by reference to their economic substance. As regards economic substance, I infer that the Appellant is referring to the purpose and economic impact or consequences of the Key Transactions as contrasted with their form and legal characterization.
[15] The Appellant acknowledges that it can deduct only the amount that can reasonably be regarded as simple interest paid in the years in dispute. Under paragraph 20(1)(d) of the ITA, compound interest can only be deducted if and when paid in 2030.
[16] The Appellant argued that the net present value of $225 million was determined by the parties to the Settlement Agreement to be equivalent to the $17.5 million it received from Encor. The Appellant alleged that the latter amount was recorded on its financial statement as the initial liability assumed by it under the Formal Contract which treatment was based on the economic substance of the Key Transactions.
[17] The Appellant argues that the case law confirms that it can apply subsection 16(1) of the ITA strictly by reference to the impact of the transactions from the Appellant’s perspective. In other words, the transactions can result in an amount that can be deemed to be interest to the Appellant but can also be a repayment of principal to APCJ. In essence, subsection 16(1) of the ITA does not require symmetry for the payer and payee. According to the Appellant, once an amount is deemed to be interest through the operation of subsection 16(1) of the ITA, the amount is then deductible under subsection 20(1)(c) of the ITA if the conditions of that provision are satisfied.
[18] The Appellant in its pleadings presented an alternative argument. Initially it claimed that, on the basis of the legal concept of interest, the amount it deducted as interest was deductible solely under paragraph 20(1)(c) of the ITA. However, at the outset of the trial, the Appellant conceded that, to succeed in its appeal, it needed to fit that amount within subsection 16(1) of the ITA before subsection 20(1)(c) of the ITA could be applied.
B. Respondent’s position [19] Unsurprisingly, the Respondent advanced a contrary view. The Respondent argues that the Appellant’s interpretation of subsection 16(1) of the ITA is too broad; this provision cannot be used to recast transactions solely by reference to what might be viewed as their economic substance considered in the abstract. According to the Respondent, the Appellant’s interpretation of subsection 16(1) of the ITA does not align with the wording, context or purpose of the provision, as outlined below. All of the relevant facts and circumstances surrounding the agreements that give rise to the alleged blended payments must be considered.
[20] The Respondent argues that subsection 16(1) of the ITA dictates symmetrical tax treatment for both the payer and payee. If this provision applies, it deems an amount to be interest for both parties to the transaction. The wording of the provision and the scheme of the ITA lead to this conclusion. The Respondent submits that all of the relevant facts and circumstances demonstrate that there are no blended payments to be made by the Appellant to APCJ. Furthermore, the Appellant is not bound to make blended payments to Encor.
[21] Lastly, even if subsection 16(1) of the ITA applies, the Respondent submits that the amount deemed to be interest under subsection 16(1) of the ITA is not deductible under paragraph 20(1)(c) of the ITA because the conditions outlined in that provision are not satisfied.
III. CONTEXTUAL BACKGROUND AND KEY FACTUAL FINDINGS [22] In the late 1970s Dome Petroleum, reached out to strategic parties to fund its planned oil exploration and development activities in the Beaufort Sea and share the risks and rewards of those activities. During the same period, the Japanese government was willing to invest in oil exploration and development activities in order to secure a long-term supply of petroleum for Japan. It agreed to advance $400 million, subject to performance of the obligations and duties contracted by Dome Canada and Dome Petroleum under the Formal Agreement. The exploration loan was only one of the features of the Formal Contract.
[23] The exploration loan was to be spent on a five-year exploration program in the Beaufort Sea that began in 1980 and would cost a total of $1 billion to $1.5 billion. The Formal Contract imposed significant obligations on Dome Petroleum and Dome Canada with respect to their drilling, development and oil production activities in that area. The exploration loan was to be repaid at the latest on December 31, 2030, subject to the triggering of early repayment conditions. Interest was payable contingent on the production of oil, of which there has been none to date.
[24] The evidence shows that Dome Petroleum had to establish a unique corporate structure to carry out its oil exploration and development activities in the Beaufort Sea because of regulatory constraints imposed under the ill-conceived National Energy Program. To satisfy foreign ownership restrictions, Dome Canada became a public Canadian corporation. Dome Petroleum’s interest could not exceed 47%. Drilling and development activities would be carried out by both entities to ensure compliance with the law. APCJ was not indisposed toward this arrangement because it had required both Dome Petroleum and Dome Canada to be joint and several obligors under the Formal Contract. I surmise that Dome Petroleum viewed the joint and several credit risk to be acceptable because it enjoyed effective control over Dome Canada’s operations.
[25] As noted above, this credit risk was unacceptable to Amoco because Dome Petroleum planned to sell its interest in Encor to satisfy the demand of its creditors affected by the Plan of Arrangement. Dome Canada would become an independent entity pursuing its own business plan without the influence of Dome Petroleum. The risk of cross-default was equally unacceptable to Encor for the same reasons.[5]
[26] Encor was a creditor of Dome Petroleum. Its consent to the Plan of Arrangement was required. Dome Petroleum was in default under the Formal Contract; it required APCJ to relieve it of its prior defaults. More importantly, the Appellant required APCJ’s consent under the Plan of Arrangement. It required Encor’s cooperation in order to present to APCJ a transaction acceptable to it in order to gain its approval.
[27] It was against this backdrop that Dome Petroleum agreed to assume Encor’s obligations under the Formal Contract and hold it harmless as regards any damage resulting from the breach of any of its performance obligations thereunder. This was done through the execution of the Settlement Agreement and the Encor Indemnity and Subrogation Agreement.
[28] Amoco, Dome Petroleum and Encor reached an agreement with APCJ to be relieved of all defaults under the Formal Contract prior to the date of execution of the Plan of Arrangement. This is reflected in the Accommodation Agreement. Upon the execution of that agreement, Amoco became jointly and severally liable for the performance of all obligations and duties imposed under the Formal Contract.
[29] While the combination of the above agreements mitigated the risk of cross-default for Amoco, Encor and Dome Petroleum, it did not eliminate it altogether. If any of the parties became insolvent, the reimbursement of the exploration loan would be accelerated. This could extend to each of the parties’ other credit facilities, thus increasing the cost of financing. The risk of cross-default was only entirely eliminated in 1992 when APCJ was persuaded to release Encor. At that time, the Settlement Agreement and the Encor Indemnity and Subrogation Agreement were terminated because they had served their purpose.
[30] At trial, the Appellant presented what can best be described colloquially as a Hail Mary argument. It alleged that the amounts in issue were deductible as income expenses under section 9 of the ITA. My questions to counsel during oral argument appear to have caused the Appellant to experience a change of heart. Approximately two weeks after the end of the trial, the Appellant’s counsel advised the Court that it had withdrawn this argument from my consideration. While this is the case, I believe a few observations are nonetheless warranted with respect to this theory.
[31] The overwhelming evidence establishes that the Settlement Agreement, the Encor Indemnity and Subrogation Agreement and the Release Agreement were entered into on account of capital. The parties, in the PASOF, agree that the ultimate objective of Amoco in entering into these agreements was to complete the Plan of Arrangement. In other words, the purpose of those transactions was to allow Amoco to complete the acquisition of all of the issued and outstanding shares of Dome Petroleum, which are undisputedly capital assets in the hands of Amoco.[6] Therefore, in this context, the expenses incurred by Amoco with respect to the implementation and execution of those agreements were not running expenses. This is particularly true with respect to the Appellant’s undertaking to Encor to repay $225 million owed to APCJ under the exploration loan instead of Encor.[7]
[32] The read-ins from the discovery transcript confirm the Respondent’s allegation that the Appellant engaged in a time-consuming game of cat and mouse with respect to questions posed on the accounting treatment adopted by it to reflect the impact of the Key Transactions on its financial statements. The Appellant engaged in a clear strategy of obfuscation by refusing to answer most questions on the grounds of irrelevance. When answers were reluctantly given, they were models of obscurity.
[33] The Appellant argued that the economic impact or consequences of the Key Transactions, considered together, were akin to those produced under a so-called “defeasance transaction”. In financial circles, it is common knowledge that there are two types of defeasance transactions: legal defeasance transactions and “in substance” defeasance transactions. Legal defeasance refers to transaction steps that can be carried out to free the debtor of its obligation to repay a debt. The terms and conditions of the transaction steps to be taken to achieve that result are spelled out in the trust indenture by which the debt is governed. Typically the mechanics of the transaction call for the debtor to place high-quality marketable government securities irrevocably in a special-purpose trust. The trust receives the securities in consideration of its assumption of the debt. If the terms and conditions of the transaction are carried out in compliance with the indenture, the debtor is relieved of its debt.[8]
[34] A defeasance transaction is attractive to a debtor when interest rates have increased substantially.[9] The debtor can purchase marketable securities that generate more interest than that paid on the debt. Because the debt is settled for a lesser amount than its face value, a gain can be recorded on the debtor’s balance sheet. Often, a debtor will enter into this type of transaction to improve its debt-to-equity ratio.
[35] An “in substance” defeasance refers to a transaction that is carried out in a similar manner to a legal defeasance. The key distinction is that the debtor is not released from its obligation to repay the debt because the steps of the transaction and the legal effects thereof are not provided for under the indenture. Generally speaking, under the accounting principles applicable to the periods at issue in this matter, an “in substance” defeasance could be accounted for in a similar manner to a legal defeasance because the ultimate economic consequence to the debtor was viewed to be the same. The placing of marketable securities irrevocably in a special purpose trust provides a high degree of certainty that the original debtor will not be called upon to pay the debt. The trust has no other activities than the performance of its debt service obligations. The cash flow from the marketable securities is earmarked specifically to service the debt assumed by the trust.[10]
[36] Considering the above, I speculate that Encor was seeking to record an accounting gain in connection with the transactions, although, as can be seen from what is stated below, the economic consequence, impact or substance of the transactions was quite different than that of a legal or “in substance” defeasance. I further speculate that Amoco may have recorded the transactions for accounting purposes as it claims to have done to facilitate Encor’s desired tax and accounting outcome.
[37] The problem is that the Appellant produced no reliable evidence to establish how the Key Transactions were accounted for on its financial statements and to demonstrate that its alleged accounting treatment was in accordance with generally accepted accounting principles (“GAAP”). The chief financial officer or controller of the Appellant was not called to explain how the transactions were recorded for financial statement purposes. The scant documentary evidence produced by the Appellant was unreliable. No expert evidence was led by the Appellant to justify the accounting treatment that it alleged that it had adopted. In light of all of this, I draw a negative inference as to the correctness of the accounting treatment that the Appellant alleged it had adopted to account for its assumption of Encor’s duties and obligations under the Formal Contract.[11]
[38] While the $17.5 million played a role in Amoco’s decision to enter into the Settlement Agreement and the Encor Indemnity and Subrogation Agreement, the evidence shows that Amoco received additional consideration from Encor. Encor was a creditor of Dome Petroleum that was affected by the Plan of Arrangement. By entering into the Settlement Agreement and the Encor Indemnity and Subrogation Agreement, Amoco gained Encor’s approval of the Plan of Arrangement. Encor also agreed to cooperate in the negotiations that led to the execution of the Accommodation Agreement on terms and conditions satisfactory to the Appellant. The Appellant offered no explanation as to how the value of this approval affected the alleged accounting treatment of the Key Transactions.
[39] The Appellant also received, indirectly, additional consideration. The shares of Encor were sold by Dome Petroleum to raise funds to pay Dome Petroleum’s creditors. They were sold on December 8, 1987 for approximately $398 million. Amoco and Encor entered into the Settlement Agreement on November 28, 1987. I surmise that the purchasers of the Encor shares were well aware of the impact of the Settlement Agreement and the Encor Indemnity and Subrogation Agreement when they closed that transaction.
[40] In a memorandum dated September 3, 1987,[12] N.J. Rubash, Executive Vice-president (Int’l.) Amoco Production Company who was charged with oversight of the negotiation and implementation of the Key Transactions wrote:
. . . Amoco’s plan for acquiring Dome assumed that the Encor shares will be sold to raise cash and pay off some of the debt which will arise as part of the acquisition. It was anticipated that, before they were sold , the value of Encor’s share[s] would be increased by a couple of dollars per share by a negotiation which would do away with Encor’s joint and [several] obligations regarding Dome’s C$175 million share portion of the Arctic Loan. Further enhancement in the share price should arrive if Encor was freed of its obligation to repay its own C$225 million share of principal under the Arctic Loan Agreement . . .
[41] While the Encor shares were sold prior to the completion of the Plan of Arrangement, I believe it is reasonable to infer that the above agreements had a favourable impact on the price negotiated by Dome Petroleum for the Encor shares. I surmise that Amoco was comfortable with this transaction. The result was that Amoco likely had to take on less debt to fund its purchase of Dome Petroleum. The Appellant’s assessment of the economic substance of the Key Transactions as being a so-called defeasance transaction does not account for all of the above. The impact, consequences and economic substance of the Key Transactions are far removed from the characteristics, impact and consequences of a defeasance transaction.
[42] In addition, as noted earlier, the risks of cross-default also loomed large in Amoco’s consideration of why to enter into and how to structure the Key Transactions. The execution and coming into force of the Settlement Agreement, the Encor Indemnity and Subrogation Agreement and the Accommodation Agreement were carefully choreographed under the Plan of Arrangement to occur immediately prior to, but to be conditional upon, the successful completion of the Plan of Arrangement. The execution of the Settlement Agreement and the Encor Indemnity and Subrogation Agreement facilitated the execution of the Accommodation Agreement by relieving the parties of all past defaults under the Formal Agreement and led to the adoption of more favourable terms. All of this protected the value of Amoco’s investment in Dome Petroleum and paved the way for the execution of the Release Agreement eliminating the risk of cross-defaults.
[43] I surmise from the evidence that the elimination of the risk of cross-defaults was of paramount importance because it would make the financing of the Appellant’s and Dome Petroleum’s activities less expensive. Undoubtedly, this constituted real value or consideration for the Appellant.
[44] The terms of the Formal Contract stipulated that the $400 million exploration loan was to be repaid on December 31, 2030, subject to the applicability of any early repayment conditions, which were contingent on the production of oil. It is clear that to date there has been no commercial production of oil in the Beaufort Sea. As a result, the conditions of the exploration loan contingent on production (early repayment and remuneration) never came to fruition.
[45] Beyond the repayment of the exploration loan, the Formal Contract also set out obligations with regard to the continued exploration for oil in the Beaufort Sea. By agreeing to assume Encor’s obligations under the Formal Contract, the Appellant became liable for the performance of all of the duties and obligations under the Formal Contract. In summary, it agreed to do much more than repay $225 million in 2030. The evidence also shows that it received from Encor more things of value than $17.5 million for its agreement to assume all of Encor’s liabilities and duties under the Formal Contract.
[46] The evidence clearly establishes that APCJ had advanced $400 million, and that its joint and several debtors were obliged to repay this amount in 2030. The entire $400 million constituted capital, or the principal owed to APCJ, in accordance with the definition of “principal amount” under the ITA. The Appellant does not dispute this factual finding. As noted earlier, the Appellant’s position is that the application of subsection 16(1) of the ITA allows for an amount to be treated as interest for the debtor and principal or capital for the creditor.
IV. ISSUES [47] Is the amount claimed by the Appellant in connection with the Key Transactions deemed to be interest under subsection 16(1) of the ITA? If the answer is yes, is the amount then deductible as interest under paragraph 20(1)(c) of the ITA?
[48] This matter involves addressing the issue of whether it is possible to have an asymmetrical application of subsection 16(1)(a) of the ITA which would allow an amount to be classified as deemed interest for the debtor and capital for the creditor.
V. ANALYSIS A. Application of Section 16 of the ITA [49] At trial, the parties advanced conflicting positions on how to properly apply subsection 16(1) of the ITA. For ease of reference I have reproduced the relevant parts of subsection 16(1) of the ITA, which states:
16 (1) Where, under a contract or other arrangement, an amount can reasonably be regarded as being in part interest or other amount of an income nature and in part an amount of a capital nature, the following rules apply:
(a) the part of the amount that can reasonably be regarded as interest shall, irrespective of when the contract or arrangement was made or the form or legal effect thereof, be deemed to be interest on a debt obligation held by the person to whom the amount is paid or payable.
[50] I will now outline my view on the proper scope of the application of subsection 16(1) of the ITA. Before I do so, a brief overview of the principles of statutory construction that I will apply to determine the proper meaning of paragraph 16(1)(a) of the ITA is useful.
[51] The modern approach to statutory construction, which involves a textual, contextual and purposive analysis or, more precisely, which looks at the grammatical and ordinary sense of a provision with reference to its entire context, its purpose and the intention of Parliament, was described in the Supreme Court of Canada decision Canada Trustco Mortgage Co. v. Canada. The unanimous court provided an overview of the history of the approaches to statutory interpretation and added that the ITA must be interpreted in such a way as to achieve consistency, predictability and fairness. [13]
[52] In Canada Trustco, the Supreme Court also stated that, where a provision contains words with unequivocal meaning, the ordinary meaning of those words plays a dominant role and that, where on the other hand the words may support more than one reasonable meaning, the ordinary meaning of the words plays a lesser role and the focus shifts towards the ITA’s harmonious whole. [14]
(1) Text of Subsection 16(1) of the ITA [53] The wording of subsection 16(1) of the ITA sheds light on the intent of that provision.
[54] The preamble to subsection 16(1) of the ITA begins with the phrase “where, under a contract or other arrangement”. This phrase requires the Court to identify and examine the “contract or other arrangement” that provides for what can reasonably be considered to be blended payments of capital and interest.
[55] The phrase “can reasonably be regarded” requires the Court to take into account all of the relevant circumstances, including, in the instance case, the terms and conditions of the Key Agreements.
[56] The phrase “irrespective of when the contract or arrangement was made or the form or legal effect thereof” requires the Court to take into account the economic impact or consequences of all of the above. This latter factor is what the Appellant relies upon in arguing that the economic substance of the arrangement is that the Appellant received $17.5 million in consideration of its agreeing to pay $225 million to APCJ in 2030. The Difference represents compensation for the use of the $17.5 million over the period, or in other words, compensation for the time value of money, which is the key reason why interest is paid.
[57] While I agree with the Appellant that the economic substance of the Key Transactions must be considered, all of the other relevant factors and circumstances must also be taken into account. The proper weight to be accorded to the various factors is to be determined on a case-by-case basis. In summary, the economic substance of the Key Transactions cannot be considered in the abstract.
[58] More importantly, for the reasons that follow, I am of the view that both the creditor’s and debtor’s perspectives must be considered, contrary to the position advanced by the Appellant. The language used in subsection 16(1) of the ITA stating that the payment is “deemed to be interest on a debt obligation held by the person to whom the amount is paid or payable” reflects Parliament’s intention that both parties receive symmetrical treatment. In other words, the amount is deemed to be interest for both parties.
[59] Finally the phrase “can reasonably be regarded” signifies that the characterization of the payment as interest and principal must simply be reasonable having regard to all of the relevant circumstances that must be taken into account in coming to that determination.
[60] A textual interpretation of subsection 16(1) of the ITA, which provides for symmetrical treatment, does not favour the Appellant’s position, as no part of the amount that is due by the Appellant can reasonably be regarded as interest that is payable to APCJ under the terms and conditions of the exploration loan. Nor, for that matter, was the Appellant required to make blended payments to Encor under the Settlement Agreement or the Encor Indemnity and Subrogation Agreement.
(2) Contextual Analysis [61] A contextual analysis of subsection 16(1) of the ITA includes looking at the history of the subsection, its stated purpose and its interactions with other provisions of the ITA. The notion of a harmonious whole includes an analysis of the underlying mechanics of the ITA, as the interpretation of a deeming rule must be logically consistent with the rest of the ITA. I will now embark on that analysis
(i) Context of Subsection 16(1) Within the ITA [62] Subsection 16(1) is found in Part I of the ITA. When paragraph 16(1)(a) of the ITA applies, a portion of the blended payment that can reasonably be regarded as interest is taxable to the creditor under paragraph 12(1)(c) of the ITA and is deductible by the debtor under paragraph 20(1)(c) of the ITA provided that the other conditions stated in paragraph 20(1)(c) of the ITA are satisfied.[15]
[63] Subsection 214(2) of the ITA provides that, where a payment would have resulted in an inclusion of an amount in income deemed interest under Part I of the ITA if Part I applied to a non-resident creditor, the amount is deemed to have been paid or credited as interest to the non-resident person. The above reinforces the view that Parliament intended symmetrical treatment of the amount as interest.
[64] Other provisions found in Part I of the ITA support this view. For example, subsection 12(9) of the ITA specifically provides for asymmetrical treatment by deeming amounts determined in respect of certain “prescribed debt obligation[s]” to be interest deemed to accrue in the year for the holder of the debt obligation. Subsection 12(9) of the ITA applies to the holder of the debt obligation; it does not affect the characterization of the payment for the debtor.
[65] That provision covers debt obligations issued at a discount and interest coupons and debt obligations purchased at a discount. This may occur, for example, in a transaction where interest coupons are stripped from and sold separately from the bond by a financial intermediary. If, as suggested by the Appellant, subsection 16(1) of the ITA was intended to apply differently when considered from the perspective of the creditor and debtor, subsection 12(9) of the ITA would, to a large extent, be unnecessary. I also observe that the outcome may not be the same under both provisions. Subsection 16(1) of the ITA deems a reasonable amount to be interest. Subsection 12(9) of the ITA mandates the inclusion of interest determined in a prescribed manner.
[66] The broad interpretation proposed by the Appellant would also cause conflict with other provisions of the ITA. For example, lease payments under a so-called capital lease could be construed as payments of interest and principal under the Appellant’s theory on the basis that, from an economic substance standpoint, the transaction could be construed as a sale of equipment for a balance of sale. In such a case the lease payments could be regarded as blended payments of interest and principal.
[67] Compare this result to the elective tax treatment provided for under section 16.1 of the ITA, a more specific provision that allows rental payments to be recharacterized as blended payments of principal and interest only for the lessee. When an election is made under that provision, the rental payments are no longer deductible for the lessee. Instead the lessee is entitled to claim capital cost allowance with respect to the leased property, which is deemed to have been acquired at cost equal to its fair market value at the commencement of the lease. The rental payments are deemed to be blended payments of principal and of interest calculated at a prescribed rate. From a lessee’s perspective, the ability to make or not make the election would become somewhat meaningless if subsection 16(1)(a) of the ITA applied automatically to recharacterize the rental payments made by the lessee as blended payments of interest and capital. Would a lessee be able to use a “reasonable rate” to calculate the interest payment or would he be bound to use a prescribed rate if the parties agreed to make the election? If the lessee could use a “reasonable rate”, this could be reason enough not to make the election. As a last point, I observe that subsection 16(1) of ITA does not state how the debtor’s cost of property acquired in consideration of the assumption of a liability by the purchaser should be determined. Should the cost be limited to the net present value of the property acquired assuming the liability is interest-free or provides for contingent interest?
[68] Finally, as noted earlier, it is unthinkable that Parliament would have intended the asymmetrical treatment proposed by the Appellant as this would open the door to transactions in which one party receives a tax benefit and the other party receives a non-taxable payment, resulting in a one-sided tax expenditure. Explicit language would have been expected in this regard, as is the case with subsection 12(9) of the ITA and section 16.1 of the ITA.
(ii) Historical Context of Subsection 16(1) of the ITA [69] Part of the exercise of statutory interpretation involves looking at the history of the statute in question in order to see if anything can be gleaned from it with the respect to the intention of Parliament.
[70] Section 7 originally existed as section 3(2) of the Income War Tax Act (first added in 1942), which read as follows:
3(2) Where under any existing or future contract or arrangement for the payment of money, the Minister is of opinion that
(a) payments of principal money and interest are blended, or
(b) payment is made pursuant to a plan which involves an allowance of interest
whether or not there is any provision for payment of interest at a nominal rate or at all, the Minister shall have the power to determine what part of any such payment is interest and the part so determined to be interest shall be deemed to be income for the purposes of this Act.
[71] The above shows that the provision was intended as an anti-avoidance provision, targeting situations where taxpayers reclassified interest payments as capital payments in order to avoid tax. Specifically, it is stated in the 1942 budget speech (at page 15):
Legislation will be introduced to prevent tax avoidance in certain directions. For example, it is proposed that income received from oil or gas wells organized on the so-called royalty basis shall be deemed to be income received by the person or persons actually operating the oil or gas wells on behalf of the royalty holders and taxed at that point. Also, when property is sold on an instalment basis the capital payments shall be deemed to include interest at a reasonable rate in cases where there is no interest provided for or where the interest provided for is unduly low.
[72] The purpose of the provision was expanded on during the 1942 parliamentary debates concerning the provision:[16]
Mr. GIBSON: The object of this section is to close the door to tax avoidance, which is possible when arrangements are entered into whereby payments of capital are made without interest being paid at all. Cases of the kind have come to light, and it is to provide that a fair rate of interest will be deemed to be included in those payments, so that a man may not buy a property and over a period of ten, fifteen or twenty years pay so much in the way of capital payments, without interest.
Mr. HAN