Imperial Oil Ltd. v. Canada

Imperial Oil Ltd. v. Canada Court (s) Database Federal Court of Appeal Decisions Date 2004-10-26 Neutral citation 2004 FCA 361 File numbers A-142-04 Notes Digest Decision Content Date: 20041026 Docket: A-142-04 Citation: 2004 FCA 361 CORAM: LÉTOURNEAU J.A. SHARLOW J.A. MALONE J.A. BETWEEN: IMPERIAL OIL LIMITED Appellant and HER MAJESTY THE QUEEN Respondent and INCO LIMITED Intervener Heard at Ottawa, Ontario on September 7, 2004. Judgment delivered at Ottawa, Ontario on October 26, 2004. REASONS FOR JUDGMENT BY: SHARLOW J.A. CONCURRED IN BY: LÉTOURNEAU J.A. MALONE J.A. Date: 20041026 Docket: A-142-04 Citation: 2004 FCA 361 CORAM: LÉTOURNEAU J.A. SHARLOW J.A. MALONE J.A. BETWEEN: IMPERIAL OIL LIMITED Appellant and HER MAJESTY THE QUEEN Respondent and INCO LIMITED Intervener REASONS FOR JUDGMENT SHARLOW J.A. [1] The principal issue in this case is whether, in computing income for purposes of the Income Tax Act, R.S.C. 1985, C. 1 (5th supp.), a foreign currency loss incurred upon the repayment of a debt denominated in a foreign currency may be deducted under paragraph 20(1)(f) of the Income Tax Act. [2] The issues are discussed under the following headings: Paragraph Statutory framework............................................................................................... 3 Facts.................................................................................................................... 19 Procedural history................................................................................................. 23 The Gaynor principle............................................................................................. 32 Paragraph 20(1)(f)................................................................................................. 41 Subsection 39(2)................................................................................................... 67 Conclusion............................................................................................................ 70 Statutory framework [3] Section 3 of the Income Tax Act sets out a lengthy formula for the computation of income. It is not necessary for the purposes of this case to reproduce section 3. It is enough to say that it is by virtue of section 3 that capital gains and capital losses are determined independently of income from sources such as employment, business and property. [4] As this case involves a dispute about the computation of income from a business, section 9 of the Income Tax Act is relevant. It reads as follows: 9. (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property for the year. 9. (1) Sous réserve des autres dispositions de la présente partie, le revenu qu'un contribuable tire d'une entreprise ou d'un bien pour une année d'imposition est le bénéfice qu'il en tire pour cette année. [5] Section 9 is subject to section 18, which prohibits the deduction of certain amounts in computing income from a business or property. Paragraph 18(1)(b) reads as follows: 18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of ... 18. (1) Dans le calcul du revenu du contribuable tiré d'une entreprise ou d'un bien, les éléments suivants ne sont pas déductibles: ... (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 ... b) une dépense en capital, une perte en capital ou un remplacement de capital, un paiement à titre de capital ou une provision pour amortissement, désuétude ou épuisement, sauf ce qui est expressément permis par la présente partie ... [6] One of the many exceptions to paragraph 18(1)(b) is found in paragraph 20(1)(f), the interpretation of which is at the heart of the dispute in this case. It reads as follows: 20. (1) Notwithstanding paragraphs 18(1)(a), 18(1)(b) and 18(1)(h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto ... 20. (1) Malgré les alinéas 18(1)a), b) et h), sont déductibles dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qu'il est raisonnable de considérer comme s'y rapportant: ... (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, f) une somme payée au cours de l'année en acquittement du principal de quelque obligation, effet, billet, créance hypothécaire ou titre semblable émis par le contribuable après le 18 juin 1971 et sur lequel un intérêt a été déclaré payable, dans la mesure où la somme ainsi payée ne dépasse pas: (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 (i) chaque fois que le titre a été émis pour une somme non inférieure aux 97 % de son principal et que le rendement du titre, exprimé en pourcentage annuel de la somme pour laquelle il a été émis (pourcentage annuel qui doit, si les conditions d'émission du titre ou les dispositions d'une convention y afférente donnaient à leur détenteur le droit d'exiger le paiement du principal du titre ou de la somme restant à rembourser sur ce principal avant l'échéance de ce titre, être calculé sur la base du rendement qui permet d'obtenir le pourcentage annuel le plus élevé possible soit à l'échéance du titre, soit sous réserve de l'exercice de tout droit de ce genre) ne dépasse pas les 4/3 de l'intérêt déclaré payable sur le titre, exprimé en pourcentage annuel: (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 (A) du principal du titre, si aucune somme n'est payable sur le principal avant l'échéance du titre, (B) the amount outstanding from time to time as or on account of the principal amount of the obligation, in any other case, (B) de la somme restant à rembourser sur le principal du titre, dans les autres cas, 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 l'excédent du moins élevé du principal du titre et du total des sommes payées au cours de l'année ou d'une année antérieure en acquittement du principal de ce titre sur la somme pour laquelle le titre a été émis, (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; (ii) dans les autres cas, les 3/4 du moins élevé de la somme ainsi payée et de l'excédent du moins élevé du principal du titre et du total des sommes payées au cours de l'année ou d'une année d'imposition antérieure en acquittement du principal du titre sur la somme pour laquelle le titre a été émis; [7] The term "principal amount", which appears several times in paragraph 20(1)(f), is defined in subsection 248(1). By virtue of that definition, any amount payable to discharge a debt is part of its "principal amount", except interest or a premium payable if the debtor elects to repay the debt before the end of its term. The definition reads as follows: 248. (1) In this Act, ... 248. (1) Les définitions qui suivent s'appliquent à la présente loi. ... "principal amount", in relation to any obligation, means the amount that, under the terms of the obligation or any agreement relating thereto, is the maximum amount or maximum total amount, as the case may be, payable on account of the obligation by the issuer thereof, otherwise than as or on account of interest or as or on account of any premium payable by the issuer conditional on the exercise by the issuer of a right to redeem the obligation before the maturity thereof; « _principal_ » S'agissant du principal d'une obligation donnée, la somme maximale ou la somme globale maximale, selon le cas, payable, d'après les conditions de l'obligation ou de toute convention y afférente, au titre de l'obligation, par celui qui l'a émise, autrement qu'au titre des intérêts ou d'une prime que verserait l'émetteur s'il exerçait son droit de racheter l'obligation avant l'échéance de celle-ci. [8] Paragraph 20(1)(f) is one of a number of provisions in the Income Tax Act that permit the deduction of financing costs incurred for the purpose of earning income from a business or property. Other such provisions are found in paragraphs 20(1)(c) and (d) (interest) and paragraphs 20(1)(e), (e.1) and (e.2) (commissions and fees). [9] Historically, financing costs have been treated as outlays of or on account of capital, unless they are made in respect of certain financial businesses, such as banking and money lending, in which money is essentially a trading asset. Thus, for most businesses, the deduction of financing costs is prohibited by paragraph 18(1)(b) except as permitted by paragraph 20(1)(c), (d), (e), (e.1), (e.2) or (f). [10] The opening words of paragraph 20(1)(f) establish a threshold test, which is met if an amount is "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". Paragraph 20(1)(f) most commonly applies when debt is issued at a discount (for example, if a $100 bond is issued for $98, the bond is said to be issued at a 2% discount), but it may apply in other circumstances also. [11] If the threshold test is met and the contractual terms applicable to the debt meet certain conditions relating to the original issue discount and the yield on the debt, subparagraph 20(1)(f)(i) permits a deduction of the amount by which the original issue proceeds of the debt are exceeded by the lesser of the principal amount of the debt and the amount paid in satisfaction of the principal amount of the debt. [12] If the threshold test is met but the conditions in subparagraph 20(1)(f)(i) are not met, then a deduction is permitted under subparagraph 20(1)(f)(ii), but the deduction is limited to a stipulated percentage of the amount that would otherwise have been deducted under subparagraph 20(1)(f)(i). [13] The subparagraph 20(1)(f)(ii) percentage is now 50%. In 1999, the year that is relevant to this case, it was 75%. The percentage for a particular taxation year is generally the same as the capital gains inclusion rate for that year (see the capital gains discussion below). [14] Capital gains and losses are computed under sections 38 through 55 of the Income Tax Act, and independently of the computation of income from any source. For the purposes of this case, the most important capital gains provision is subsection 39(2), which reads as follows: 39 (2) Notwithstanding subsection 39(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 39 (2) Malgré le paragraphe (1), lorsque, par suite de toute fluctuation, postérieure à 1971, de la valeur de la monnaie ou des monnaies d'un ou de plusieurs pays étrangers par rapport à la monnaie canadienne, un contribuable a réalisé un gain ou subi une perte au cours d'une année d'imposition, les règles suivantes s'appliquent: a) est réputé être un gain en capital du contribuable pour l'année, tiré de la disposition de la monnaie d'un pays étranger, gain en capital qui est le montant déterminé en vertu du présent alinéa, l'excédent éventuel: (i) du total de ces gains réalisés par le contribuable au cours de l'année (jusqu'à concurrence des montants de ceux-ci qui, si l'article 3 était lu de la manière indiquée à l'alinéa (1)a) du présent article, ne seraient pas inclus dans le calcul de son revenu pour l'année ou pour toute autre année d'imposition), sur: (ii) le total des pertes subies par le contribuable au cours de l'année (jusqu'à concurrence des montants de celles-ci qui, si l'article 3 était lu de la manière indiquée à l'alinéa (1)a) du présent article, ne seraient pas déductibles dans le calcul de son revenu pour l'année ou pour toute autre année d'imposition), (iii) si le contribuable est un particulier, 200 $; (b) the amount, if any, by which (i) the total determined under subparagraph 39(2)(a)(ii), exceeds (ii) the total determined under subparagraph 39(2)(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. b) est réputé être une perte en capital du contribuable pour l'année, résultant de la disposition de la monnaie d'un pays étranger, perte en capital qui est le montant déterminé en vertu du présent alinéa, l'excédent éventuel: (i) du total déterminé en vertu du sous-alinéa a)(ii), sur: (ii) le total déterminé en vertu du sous-alinéa a)(i), (iii) si le contribuable est un particulier, 200 $. [15] To paraphrase 39(2), a gain or loss on capital account that is caused by a change in the value of a foreign currency relative to Canadian currency is deemed to be a capital gain or loss from the disposition of foreign currency. Subsection 39(2) may apply if, for example, a foreign exchange gain or loss arises upon the payment of a debt or the redemption of a security denominated in a foreign currency, which is the kind of transaction in issue in this case. [16] The scope of subsection 39(2) is limited by a phrase within the parentheses in subparagraph 39(2)(a)(i), relating to foreign exchange gains. The phrase is "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". A similar phrase is found in parentheses in subparagraph 39(2)(a)(ii), relating to foreign exchange losses (and also in paragraphs 39(1)(a) and (b), not reproduced, which are applicable to all other capital gains and losses). These parenthetical words ensure that, for income tax purposes, no amount is treated as a capital gain or capital loss if it is part of the computation of income or loss from a source, such as a business or property. [17] There are two important differences between the tax treatment of income and losses from a source and the tax treatment of capital gains and capital losses. One difference is the effective rate of tax. The Income Tax Act requires all capital gains and losses to be reduced by a percentage, sometimes referred to as the "capital gains inclusion rate". Currently that rate is 50%, but in 1999 it was 75%. Thus, in 1999, 75% of capital gains were included in income, and 75% of capital losses were deductible. [18] The second difference is that a loss on income account may be applied against any income, but the deductible portion of a capital loss can be applied only against the taxable portion of capital gains. Thus, a taxpayer who has capital losses but no capital gains in a particular taxation year may obtain no tax relief for the capital losses in that year. Facts [19] On October 16, 1989, Imperial Oil issued 30-year debentures with a face amount of US$300,000,000 and used the proceeds in its business. It is undisputed that the issuance of the debentures was a capital transaction. Thus, any costs incurred by Imperial Oil with respect to that financing transaction are not deductible in computing Imperial Oil's business income except as permitted by paragraph 20(1)(c), (d), (e), (e.1), (e.2) or (f). [20] The debentures were issued at a discount of 1.199% and bore interest at 8.75% per year, so that the annual yield on the debentures, as determined at the time of issuance, was 8.86%. The debentures were redeemable at the option of Imperial Oil on October 15 of each year from 1999 to the end of the term, subject to the payment of a premium upon any repayments in 1999 to 2008, inclusive. Imperial Oil has claimed deductions under paragraph 20(1)(c) for interest payable on the debentures, and those deductions have been allowed. [21] On October 15, 1999, Imperial Oil redeemed some of the debentures that had been issued on October 16, 1989. The face amount of the redeemed debentures was US$87,130,000. Imperial Oil paid that amount, plus the redemption premium, to redeem the debentures. (There is no controversy about the tax treatment of the redemption premium.) [22] The rate for the conversion of U.S. dollars to Canadian dollars was 1.17660 on October 16, 1989, and 1.48192 on October 15, 1999. Because of that increase in the conversion rate, the Canadian dollar equivalent of the U.S. dollars paid in 1999 to redeem the debentures was more than the Canadian dollar equivalent of the U.S. dollar amount that Imperial Oil received in 1989 for those debentures. The difference, which I will call the "total redemption cost", was $27,831,712. This is illustrated in the following table: U.S. Dollars Canadian dollars Canadian dollars Face amount of debentures redeemed in 1999 $ 87,130,000 $102,517,158 1 $129,119,689 2 Less: actual proceeds of issuance in 1999 (86,085,311) (101,287,977) 1 (101,287,977) 1 Original issue discount $ 1,044,689 $ 1,229,181 1 Total redemption cost $ 27,831,712 Note 1. Canadian dollars at the conversion rate on October 16, 1989 (1.17660). Note 2. Canadian dollars at the conversion rate on October 15, 1999 (1.48192). Procedural history [23] When filing its income tax return for 1999, Imperial Oil claimed a deduction under subparagraph 20(1)(f)(i) for the original issue discount, and also reported a deemed capital loss under subsection 39(2). However, because Imperial Oil had no capital gains in 1999, no part of the deemed capital loss was deductible in that year. [24] In a notice of appeal filed in the Tax Court of Canada, Imperial Oil took the position that it was entitled to a deduction under subparagraph 20(1)(f)(i) for the total redemption cost of $27,831,712, and that subsection 39(2) had no application. The Crown did not accept that position. In October of 2003, Imperial Oil and the Crown agreed to refer three questions to the Tax Court of Canada pursuant to subsection 173(1) of the Income Tax Act, which reads as follows: 173. (1) Where the Minister and a taxpayer agree in writing that a question of law, fact or mixed law and fact arising under this Act, in respect of any assessment, proposed assessment, determination or proposed determination, should be determined by the Tax Court of Canada, that question shall be determined by that Court. 173. (1) Lorsque le ministre et un contribuable conviennent, par écrit, de faire trancher par la Cour canadienne de l'impôt une question de droit, de fait ou de droit et de fait, portant sur une cotisation ou une détermination, réelles ou projetées, découlant de l'application de la présente loi, cette cour se prononce sur cette question. [25] The three questions submitted to the Tax Court are: (a) What portion, if any, of the said $27,831,712 is deductible under subparagraph 20(1)(f)(i) of the Act? (b) What portion, if any, of the said $27,831,712 is deductible under subparagraph 20(1)(f)(ii) of the Act? (c) What portion, if any of the said $27,831,712 is a capital loss under subsection 39(2) of the Act? [26] The reference was heard on November 25, 2003, and resulted in a judgment dated March 10, 2004, in which the questions were answered as follows: (a) The amount of $1,548,325 is deductible under subparagraph 20(1)(f)(i). (b) Nothing is deductible under subparagraph 20(1)(f)(ii). (c) The amount of $26,283,387 is the capital loss under subsection 39(2) of the Act. [27] Although these answers favoured the Crown, the Judge did not award costs to the Crown because his conclusion was based on an analysis that was not supported by the Crown. [28] Neither party agrees with the answers given by the Judge. Imperial Oil has appealed to this Court pursuant to subsection 173(4.1) of the Income Tax Act, and the Crown has cross-appealed. The Crown, in addition to arguing that the questions were answered incorrectly, also challenges the Judge's order on costs. [29] Imperial Oil's main ground of appeal, as asserted in its notice of appeal and in its memorandum of fact and law, is that the total redemption cost ($27,831,712) is deductible in 1999 under subparagraph 20(1)(f)(i). Its alternative argument is that 75% of the total redemption cost ($27,831,712 x 75% = $20,873,784) is deductible under subparagraph 20(1)(f)(ii) and the remaining 25% is a deemed capital loss under subsection 39(2). [30] The Crown argues that subparagraph 20(1)(f)(i) permits a deduction of $1,229,181 (the original issue discount in 1989 Canadian dollars), and that the difference between the total redemption cost and the paragraph 20(1)(f)(i) deduction ($27,831,712 - $1,229,181 = $26,602,531) is a deemed capital loss under subsection 39(2). [31] By order dated August 16, 2004, Inco Ltd. was permitted to intervene in Imperial Oil's appeal to argue for Imperial Oil's alternative position. Inco is the appellant in a case similar to this one which was pending in the Tax Court when this appeal was heard. At the hearing of this appeal, Imperial Oil abandoned its main argument and relied solely on its alternative position. After this appeal was heard but before judgment, Inco's appeal was dismissed by the Tax Court (2004 TCC 468). Counsel provided this Court with a copy of that decision, and it has been considered. The Gaynor principle [32] The decision under appeal depends to a large extent on the conclusion of the Judge not to follow Gaynor v. Minister of National Revenue, [1991] 1 C.T.C. 470, 91 D.T.C. 5288 (F.C.A.), affirming [1988] 2 C.T.C. 163, 88 D.T.C. 6394 (F.C.T.D., per Pinard J.), affirming [1987] 1 C.T.C. 2359, 87 D.T.C. 279 (T.C.C., per Sarchuk T.C.J., as he then was). All parties argued that the Judge erred in his analysis of Gaynor. It is convenient to deal with that point first. [33] Gaynor involved a dispute about the correct method of computing a capital gain on the disposition of securities that were sold for U.S. dollars and had been bought with U.S. dollars. Ms. Gaynor had argued that she should first determine the difference in U.S. dollars between the proceeds of sale and her cost of the securities, and then convert that amount to Canadian dollars at the rate of exchange at the date of sale. That argument was rejected for the reasons explained as follows by Justice Pratte, writing for this Court (emphasis added): Paragraph 40(1)(a) of the Income Tax Act makes it clear that the capital gain realized by the appellant in each case was the "amount" by which the proceeds of the disposition of her securities exceeded the adjusted cost base of those securities. When that provision speaks of the "amount" of the capital gain, it obviously refers to an amount expressed in Canadian currency. As that amount is the result of a comparison between two other amounts, namely the amount representing the cost of the securities and the amount representing the value of the proceeds of disposition, it necessarily follows that both the cost of the securities and the value of the proceeds of disposition must be valued in Canadian currency which is the only monetary standard of value known to Canadian law. Once this is realized, it becomes clear that the cost of the securities to the appellant must be expressed in Canadian currency at the exchange rate prevailing at the time of their acquisition while the valuation of the proceeds of disposition of the same securities must be made in Canadian currency at the rate of exchange prevailing at the time of the disposition. [34] In the case now under appeal, the Judge considered Gaynor but concluded, on the basis of Bentley v. Pike (1981), 53 T.C. 590 (Ch. D.), Pattison v. Marine Midland Ltd., [1984] 1 A.C. 362 (H.L.) and Capcount Trading v. Evans (1992), 65 T.C. 545 (C.A.), that the principles to be applied in computing business income arising from a foreign currency transaction may not be the same as the principles to be applied in computing a capital gain arising from a foreign currency transaction. As the dispute in this case involves the computation of business income, the Judge reasoned that he should not be guided by Gaynor because it deals with the computation of a capital gain, not the computation of business income. [35] Once the Judge excluded Gaynor from his analysis, he adopted in essence the methodology that was rejected in Gaynor. He held that the amount of the paragraph 20(1)(f) deduction in this case should be determined solely by reference to the conversion rate on the date of the payment that triggered the application of paragraph 20(1)(f), in this case October 15, 1999, the date the debentures were redeemed. He applied that rate to the original issue discount, in U.S. dollars, illustrating his computation in two ways that are mathematically equivalent: First method Second method (U.S. dollars) Redemption payment $87,130,000 Less: issue proceeds 86,085,311 Difference $ 1,044,689 Redemption payment (in Canadian dollars at the 1999 rate) $129,119,689 20(1)(f) deduction: difference in Canadian dollars at the 1999 rate (1.48192)* $ 1,548,525 Less: issue proceeds (in Canadian dollars converted at the 1999 rate) 127,571,544 20(1)(f) deduction* $ 1,548,325 Total redemption cost $27,831,712 Less: 20(1)(f) deduction* 1,548,325 39(2) capital loss $26,283,387 Total redemption cost $27,831,712 Less: 20(1)(f) deduction* 1,548,325 39(2) capital loss $26,283,387 * These are the amounts calculated by the Judge, which appears to be incorrect. This amount should be $1,548,145 ($1,044,689 x 1.48192). However, nothing turns on the precise calculation. [36] I do not agree that the principle in Gaynor applies only to the computation of capital gains and losses. Nor do any of the English cases referred to above establish or compel that conclusion. [37] Bentley and Capcount are similar to Gaynor in that both involved a dispute about a capital gain on property where the acquisition and disposition were foreign currency transactions. Both Bentley and Capcount were decided consistently with Gaynor. [38] Pattison dealt with quite a different question, which was the determination, under ordinary commercial or accounting principles, of the profits of an English bank that entered into certain banking transactions in a foreign currency. Whatever Pattison may say about the correct method of accounting for foreign currency transactions that are an integral part of a banking business, it says nothing about the issue that arose in this case, which is the correct application of a statutory formula where at least one element of the statutory formula is a receipt or payment of foreign currency. In this case, Gaynor is applicable and should have been treated as binding. [39] As I read Gaynor, it stands for the proposition that, if a foreign currency transaction is an element of any computation required by a statutory formula, the amount of the foreign currency must be converted to Canadian dollars at the conversion rate prevailing at the time of the transaction. Thus, to apply paragraph 20(1)(f) to a debt denominated in a foreign currency, each element of the computation of the paragraph 20(1)(f) deduction must be converted to Canadian dollars at the conversion rate in effect on the relevant date. [40] In this case, the parties agree that paragraph 20(1)(f) must be interpreted and applied consistently with the Gaynor principle, but they disagree on whether the conversion of certain elements of the computation should be done as of October 16, 1989 when the debentures were issued, or October 15, 1999 when the debentures were redeemed. The following discussion deals with that debate. Paragraph 20(1)(f) [41] The first question asked by paragraph 20(1)(f) is whether a payment has been made that meets the threshold test in the opening words of paragraph 20(1)(f). It is common ground that the threshold test is met in this case because, on October 15, 1999 (which is within the taxation year under appeal), Imperial Oil paid an amount in satisfaction of the principal amount of the debentures, the debentures were issued after June 18, 1971, and interest was stipulated to be payable on the debentures. [42] Once it is determined that the threshold test for the application of paragraph 20(1)(f) is met, it is necessary to consider whether a deduction is permitted under subparagraph 20(1)(f)(i) or under subparagraph 20(1)(f)(ii). Each of those provisions includes a statutory formula for determining the amount of the permissible deduction. The two formulas have a number of common elements. One is the "principal amount" of the debt obligation in question, and the other is the amount for which the debt obligation was issued. [43] The determination of the "principal amount" of a debt depends upon the definition of "principal amount" in subsection 248(1) (quoted above). Applying that definition, the question in this case becomes this: what was the maximum amount payable on account of the debentures immediately before they were redeemed on October 15, 1999 (disregarding interest and the redemption premium)? That question must be answered as of the date of the redemption, so that for the purposes of applying Gaynor, the relevant date is October 15, 1999. The answer is that the "principal amount" of the debentures immediately before their redemption on October 15, 1999, was $129,119,689, the Canadian dollar equivalent, on October 15, 1999, of the U.S. dollar face amount of the debentures redeemed on that date (U.S.$87,130,000 x 1.48192). [44] What was the amount for which the debentures were issued? The parties agree that this is a question about the facts as they existed on the date the debentures were issued, October 16, 1989, which is therefore the relevant date for the purposes of applying Gaynor. The parties also agree that the debentures were issued for an amount equal to the difference between their "principal amount" on October 16, 1989, when the debentures were issued, and the original issue discount. The Canadian dollar conversion rate on October 16, 1989 was 1.17660, so that the "principal amount" of the debentures, as of October 16, 1989, was $102,517,158 (U.S. $87,130,000 x 1.17660). It follows that the amount for which the debentures were issued was $101,287,977 ($102,517,158 minus the 1.199% discount). [45] I note that applying Gaynor to the determination of the "principal amount" of the debentures on October 16, 1989, when they were issued, and again on October 15, 1999, when they were redeemed, results in an increase in the "principal amount" of the debentures from $102,517,158 to $129,119,689. In other words, the "principal amount" of the debt has increased during the term of the debentures. The Crown disputes the validity of that result. [46] Although the Crown accepts that the "principal amount" of a debt can increase during its term, the Crown argues that this can occur only if the increase is mandated by a contractual term governing the debt. I agree with that limitation. It flows directly from the language of the definition of "principal amount", which refers to "the amount that, under the terms of the obligation or any agreement relating thereto, is the maximum amount ... payable on account of the obligation". [47] The Crown accepts that such an increase may occur in the case of a commodity based loan, where the amount to be repaid fluctuates with the market value of some commodity. For example, at one time the Farm Credit Corporation had a program under which a loan could be made to a farmer at an interest rate that was substantially lower than the market rate. Under the contract governing the loan, the amount payable by the borrower to discharge the loan would increase as a function of any increase in the value of certain crops grown by the borrower within a stipulated period. It is common ground that this would be a case in which, for income tax purposes, the "principal amount" of the loan could increase. [48] However, the Crown argues that in the case of the Imperial Oil debentures, there was no contractual term that required Imperial Oil to pay more Canadian dollars to redeem the debentures in 1999 than it had received when the debentures were issued in 1989. For that reason, the Crown argues that it is wrong to conclude that the "principal amount" of the debentures increased over that period. I cannot accept that argument. A foreign currency loan is the loan of a specified number of units of foreign currency on terms that require the same number of units of that foreign currency to be returned to the lender at the end of the term. It is implicit in the terms of repayment that the Canadian dollar equivalent of the repayment may be more or less than the Canadian dollar equivalent of the amount borrowed. Thus, the fluctuation in the "principal amount" of the debt, as that term is defined in the Income Tax Act, is mandated by the contractual terms governing the debt. [49] The Crown also relies upon subsection 248(26) of the Income Tax Act, which reads as follows: 248 (26) For greater certainty, where at any time a person or partnership (in this subsection referred to as the "debtor") becomes liable to repay money borrowed by the debtor or becomes liable to pay an amount (other than interest) (a) as consideration for any property acquired by the debtor or services rendered to the debtor, or (b) that is deductible in computing the debtor's income, for the purposes of applying the provisions of this Act relating to the treatment of the debtor in respect of the liability, the liability shall be considered to be an obligation, issued at that time by the debtor, that has a principal amount at that time equal to the amount of the liability at that time. 248 (26) Il est entendu que, dans le cas où une personne ou une société de personnes (appelées "débiteur" au présent paragraphe) devient obligée, à un moment donné, de rembourser de l'argent qu'elle a emprunté ou de payer un montant (sauf des intérêts) soit en contrepartie d'un bien qu'elle a acquis ou de services qui lui ont été rendus, soit qui est déductible dans le calcul de son revenu, l'obligation est considérée, pour l'application des dispositions de la présente loi concernant le traitement du débiteur par rapport à l'obligation, comme une dette émise par le débiteur à ce moment dont le principal, à ce moment, est égal au montant alors à rembourser ou à payer. [50] I am unable to conclude that subsection 248(26) compels the conclusion that the "principal amount" of the debentures on October 15, 1999 was necessarily the same as its "principal amount" on October 16, 1989. Subsection 248(26) was enacted in 1994 to aid in the application of certain amendments to section 80 of the Income Tax Act, which deals with the tax consequences of the discharge of a debt for less than its "principal amount". The notion of the "issuance" of debt is central to the operation of section 80. It must have been thought that clarification was needed to ensure that section 80 would apply to debts that are not evidenced by a typical loan instrument, such as a note or debenture, because it is difficult to conceive of the "issuance" of a debt for which there is no such instrument. In this case, of course, there is no need for a clarifying rule, because there is no doubt about the date on which Imperial Oil "issued" the debt evidenced by the debentures, or the "principal amount" of the debt at that time. [51] Even if subsection 248(26) were to be applied in this case, what would its effect be? Subsection 248(26) says that if, at a certain point in time, a person becomes liable to pay an amount that meets a certain description, the liability must be treated for income tax purposes as an obligation (a debt obligation) issued at that time by the debtor, and to have a principal amount at that time equal to the amount of the liability at that time. In this case, one could say that on October 16, 1989, when Imperial Oil issued the debentures, it became liable to pay the original principal amount, $102,517,158. By virtue of subsection 248(26), that debt obligation would be considered to be issued on October 16, 1989, and to have a principal amount at that time equal to $102,517,158. Thus, the effect of subsection 248(26) would simply be to confirm the conclusion that the original principal amount of the debentures is $102,517,158. That is not surprising, since subsection 248(26) is said to have been enacted for greater certainty. The important point about subsection 248(26), however, is that it does not say that, for income tax purposes, the principal amount of a debt denominated in a foreign currency is always equal to the principal amount of the debt at its date of issuance. [52] For these reasons, I agree with Imperial Oil and Inco that, for the purposes of paragraph 20(1)(f), the "principal amount" of a debt denominated in foreign currency fluctuates with the Canadian dollar conversion rate, and that in this case, the principal amount of the debentures redeemed on October 15, 1999, increased as described above. [53] I return now to the discussion of paragraph 20(1)(f). As the threshold test for its application was met, the issue is whether the deduction is permitted under subparagraph 20(1)(f)(i) or subparagraph 20(1)(f)(ii). [54] Subparagraph 20(1)(f)(i) sets out two conditions. If both conditions are met, a deduction is permitted under paragraph 20(1)(f)(i). If one of the two conditions in subparagraph 20(1)(f)(i) is not met, then the deduction is permitted under subparagraph 20(1)(f)(ii). [55] The first condition in subparagraph 20(1)(f)(i) reads as follows: ... where the obligation was issued for an amount not less than 97% of its principal amount ... ... le titre a été émis pour une somme non inférieure aux 97 % de son principal ... [56] As indicated above, it is common ground that the amount for which the debentures was issued is $101,287,977, which is the Canadian dollar equivalent, on October 16, 1989, of the principal amount of the debentures less the original issue discount. [57] However, the parties do not agree on whether, for the purposes of the first condition in subparagraph 20(1)(f)(i), the "principal amount" of the debentures must be determined as of the date of the issuance of the debentures or as of the date of their redemption. The Crown argues for the use of the date of the issuance of the debentures, October 16, 1989. Imperial Oil and Inco argue for the use of the date of redemption, October 15, 1999. As the following table illustrates, the first condition in subparagraph 20(1)(f)(i) is met only if the Crown is correct on this point: Position of the Crown Position of Imperial Oil and Inco (A) Principal amount $102,517,158 (A) Principal amount $129,119,689 (B) 97% of (A) $99,441,643 (B) 97% of (A) $125,246,098 (C) Proceeds of issuance $101,287,977 (C) Proceeds of issuance $101,287,977 (D) Is (C) < (B)? NO: test is met (D) Is (C) < (B)? Yes: test is not met The Crown supports its interpretation by reference to the purpose of paragraph 20(1)(f), which the Crown says is to provide tax relief only for original issue discounts. [58] There are three difficulties with the Crown's position on this point. First, there is nothing in the language of paragraph 20(1)(f) itself that, expressly or by necessary implication, limits the application of paragraph 20(1)(f) to original issue discounts. [59] Second, the argument that paragraph 20(1)(f) applies only to original issue discounts is not consistent with the Crown's position on commodity based loans. The Crown has admitted that a paragraph 20(1)(f) deduction may arise if the amount required to repay a commodity based loan is more than the amount advanced. That may occur whether or not there was an original issue discount. [60] Third, the Crown's interpretation leads to an anomalous result. Adopting the Crown's interpretation, the "principal amount" of the debentures, for the purposes of the first condition in paragraph 20(1)(f), is the Canadian dollar equivalent of their U.S. dollar face amount as of the date of issuance, October 16, 1989, which is $102,517,158. As explained above, that would lead to the conclusion that the first condition in subparagraph 20(1)(f)(i) is met. For the purposes of this part of the discussion, I will assume, without deciding, that analogous reasoning would lead to the conclusion that the second condition in subparagraph 20(1)(f)(i) is also met. The amount of the deduction under subparagraph 20(1)(f)(i) would then be determined by this formula: ... the amount by which the lesser of the principal amount of the obligation [$102,517,158] and all amounts paid in the year or in any preceding year in satisfaction of its principal amount [$129,119,689] exceeds the amount for which the obligation was issued [$101,287,977] ... ... l'excédent du moins élevé du principal du titre [$102,517,158] et du total des sommes payées au cours de l'année ou d'une année antérieure en acquittement du principal de ce titre [$129,119,689] sur la somme pour laquelle le titre a été émis [$101,287,977] ... [61] The difference between the lesser of the first two amounts ($102,517,158) and the third amount ($101,287,977) is $1,229,181, which is (and mathematically must be) the original issue discount in 1989 Canadian dollars. Thus, the interpretation proposed by the Crown appears to suffer from the same flaw as the interpretation adopted by the Judge, which is that it does not correctly apply the Gaynor principle. It is, as counsel for Imperial Oil put it so well, only a half-Gaynor, in the sense that it results in a deduction measured in 1989 Canadian dollars for a financing cost that is paid in 1999 and which, under paragraph 20(1)(f), is deductible only in the year of payment. [62] In my view, the more straightforward interpretation proposed by Imperial Oil and Inco is the correct one. Simply put, they argue that, for the purposes of the first condition in subparagraph 20(1)(f)(i), the phrase "principal amount" must be determined as of the date of redemption, October 15, 1999, because it is not until that date that it is possible to determine the "maximum amount payable on account of the obligation," as required by the definition of "principal amount". [63] It is worth noting that where Parliament wishes to specify, for income tax purposes, a certain date for the conversion of a foreign currency amount, the Income Tax Act says so. Two examples are found in subsection 79(7) and paragraph 80(2)(k) of the Income Tax Act, relating to the tax consequences of the discharge of certain debts: 79. (7) Where a debt is denominated in a currency (other than Canadian currency), any amount determined for A, B, C or D in subsection 79(3) in respect of the debt shall be determined with reference to the relative value of that currency and Canadian currency at the time the debt was issued. 79. (7) Dans le cas où une dette est libellée en monnaie étrangère, les éléments A, B, C ou D de la formule figurant au paragraphe (3) sont déterminés relativement à la dette en fonction de la valeur de cette monnaie par rapport au dollar canadien au moment de l'émission de la dette. ... ... 80(2) ... (k) where an obligation is denominated in a currency (other than Canadian currency), the forgiven amount at any time in respect of the obligation shall be determined with reference to the relative value of that currency and Canadian currency at the time the obligation was issued; 80(2) ... k) dans le cas où une dette est libellée en monnaie étrangère, le montant remis sur la dette est déterminé en fonction de la valeur de cette monnaie par rapport à la valeur du dollar canadien au moment de l'émission de la dette; There is no such language for paragraph 20(1)(f). [64] Returning to the discussion of paragraph 20(1)(f), it is now established that the threshold test was met but the first condition in subparagraph 20(1)(f)(i) was not met. Therefore, subparagraph 20(1)(f)(i) does not apply, and subparagraph 20(1)(f)(ii) does apply. The next step is to determine the amount of the subparagraph 20(1)(f)(ii) deduction according to the statutory formula in subparagraph 20(1)(f)(ii), which reads as follows: ... 3/4 of the lesser of the amount so paid [$129,119,689] and the amount by which the lesser of the principal amount of the obligation [$129,119,689] and all amounts paid in the year or in any preceding taxation year in satisfaction of its principal amount [$129,119,689] exceeds the amount for which the obligation was issued [$101,287,977] ... ... dans les autres cas, les 3/4 du moins élevé de la somme ainsi payée [$129,119,689] et de l'excédent du moins élevé du principal du titre [$129,119,689] et du total des sommes payées au cours de l'année ou d'une année d'imposition antérieure en acquittement du principal du titre [$129,119,689] sur la somme pour laquelle le titre a été émis [$101,287,977] ... [65] In table form, the computation is as follows: (A) "Principal amount" of the debentures $129,119,689 (B) "Amount" paid in satisfaction of the "principal amount" of the debentures $129,119,689 (C) Lesser of (A) and (B) $129,119,689 (D) "Amount" for which the debentures were issued $101,287,977 (E) Difference between (C) and (D) $ 27,831,712 (F) Lesser of (B) and (E) $ 27,831,712 (G) 75% of (F) $ 20,873,784 [66] I conclude that Imperial Oil is entitled to a deduction under subparagraph 20(1)(f)(ii) of $20,873,784. Subsection 39(2) [67] Imperial Oil argues that the difference between its total redemption cost ($27,831,712) and the amount of its subparagraph 20(1)(f)(ii) deduction ($20,873,784) is a deemed capital loss under subsection 39(2). In my view, this argument cannot prevail in the face of subsection 248(28) of the Income Tax Act, the relevant parts of which read as follows: 248 (28) Unless a contrary intention is evident, no provision of this Act shall be read or construed 248 (28) Sauf intention contraire évidente, les dispositions de la présente loi n'ont pas pour effet: (a) to require the inclusion or permit the deduction, either directly or indirectly, in computing a taxpayer's income ... of any amount to the extent that the amount has already been directly or indirectly included or deducted, as the case may be, in computing such income ... a) d'exiger l'inclusion ou de permettre la déduction, directement ou indirectement, d'une somme dans le calcul du revenu ... dans la mesure où cette somme a été incluse ou déduite, directement ou indirectement, dans le calcul de ce revenu ... [68] Subsection 248(28) (like its predecessor, subsection 4(4), now repealed) was enacted because Parliament recognized that, in a statute involving as many complex computations as the Income Tax Act, a transaction may fall literally within the scope of two separate provisions and so be counted twice as an income inclusion, a deduction or a tax credit. Subsection 248(28) is intended to avoid such double counting unless the Income Tax Act clearly compels such a result. [69] The argument of Imperial Oil is that, because only 75% of its total redemption cost is deductible under subparagraph 20(1)(f)(ii), the non-deductible 25% is excluded from the computation of its income, and so it falls by default into subsection 39(2). I am unable to accept this argument. The total redemption cost incurred by Imperial Oil on its debentures is a loss on capital account for which Parliament permits a deduction according to a certain formula. Because the total redemption cost happens to fall within subparagraph 20(1)(f)(ii) rather than subparagraph 20(1)(f)(i), the amount of the deduction is designed to be equivalent to the tax relief for a capital loss which, for the taxation year under appeal, is also limited to 75% of the actual loss sustained upon the disposition of a capital property. In substantive terms, allowing a further deduction under subsection 39(2) in respect of the non-deductible 25% of the total redemption cost would be tantamount to allowing more tax relief for a capital loss than Parliament intended. Conclusion [70] I would allow the appeal and the cross-appeal, set aside the judgment of the Tax Court, and replace it with a judgment answering the three questions as follows: (a) No amount is deductible under subparagraph 20(1)(f)(i). (b) The amount of $ 20,873,784 is deductible under subparagraph 20(1)(f)(ii). (c) There is no deemed capital loss under subsection 39(2). [71] As Imperial Oil was substantially successful in this appeal, it should have its costs in this Court and in the Tax Court. I do not consider it necessary to deal with the Crown's cross-appeal on costs. The result of this case is substantially the position advocated by the intervener Inco, but Inco is not seeking costs. For that reason, no costs are awarded to Inco. (s) "K. Sharlow" J.A. "I agree. G.L." "I agree. JBDM" FEDERAL COURT OF APPEAL NAMES OF COUNSEL AND SOLICITORS OF RECORD DOCKET: A-142-04 STYLE OF CAUSE: IMPERIAL OIL LIMITED and HER MAJESTY THE QUEEN and INCO LIMITED PLACE OF HEARING: OTTAWA, ONTARIO DATE OF HEARING: SEPTEMBER 7, 2004 REASONS FOR JUDGMENT: SHARLOW J.A. CONCURRED IN BY: LÉTOURNEAU J.A. MALONE J.A. DATED: OCTOBER 26, 2004 APPEARANCES: Mr. Al Meghji FOR THE APPELLANT Mr. Edward Rowe Mr. Luther P. Chambers, Q.C. FOR THE RESPONDENT Ms. Rhonda L. Nahorniak Mr. Warren J.A. Mitchell, Q.C. FOR THE INTERVENER Mr. Michael W. Colborne SOLICITORS OF RECORD: Osler Hoskin & Harcourt LLP FOR THE APPELLANT Toronto, Ontario Mr. Morris Rosenberg FOR THE RESPONDENT Deputy Attorney General of Canada Thorsteinssons FOR THE INTERVENER Toronto, Ontario