Principal Issues: [TaxInterpretations translation] Is the issuance of a note, to recognize a loan evidenced by a note and the capitalized interest on the loan, a payment or novation?
Position: no
Reasons: There is no payment of the original debt and the creditor still has recourse under the first note.
July 21, 2009
|
Eastern Quebec Tax Services Office Attention: Mr. Jean-François Paradis |
Headquarter Michel Lambert, CA, M.Fisc. 2009-03225 |
Interest Deduction
Dear XXXXXXXXXX,
This is further to our telephone conversations and refers to a document you sent us by fax on May 14, 2009. This opinion is also a follow-up to another opinion we issued to you on April 21, 2008 (2007-025176).
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
Name of the parties
XXXXXXXXXX The Vendor
XXXXXXXXXX The Taxpayer
The Facts
1. On XXXXXXXXXX, the Vendor sold its assets to the Taxpayer in consideration for shares of the Taxpayer and a debt of $XXXXXXXXXX bearing interest at an annual rate of XXXXXXXXXX%. This indebtedness was evidenced by a note maturing on XXXXXXXXXX.
2. The note provided in the third paragraph that interest could be added to the principal amount of the debt. It stated the following:
"XXXXXXXXXX"
3. The Taxpayer had not paid interest at the end of each year and the provisions of the above clause applied. On XXXXXXXXXX, a new note was issued in the amount of $XXXXXXXXXX representing the original indebtedness of $XXXXXXXXXX plus accrued and capitalized interest. The new note also bears interest. You have faxed us a copy of the new note.
Your Questions
4. You asked whether it can be concluded that the original debt of $XXXXXXXXXX evidenced by the issuance of a note on XXXXXXXXXX and the accrued and capitalized interest on that debt was paid by the issuance of the note on XXXXXXXXXX.
You also wish to know whether the issuance of the note on XXXXXXXXXX resulted in the creation of new indebtedness in an amount equal to the principal amount of the indebtedness incurred on XXXXXXXXXX plus accrued interest thereon. If so, was it a novation by change of debt?
Opinion of the Taxpayer
5. The Taxpayer's representative did not express an opinion on the issues raised.
Our Opinion
6. The main issue to be resolved is whether the issuance of the second bill constitutes a payment through novation by change of debt.
7. In the book Les obligations published by Éditions Yvon Blais, Professor Jean-Louis Beaudoin and his collaborators state the following: [TaxInterpretations translation]
"Novation by change of debt occurs when, between the same persons, a new debt with a new element is substituted for the old one (Article 1660, paragraph 1 of the CCQ). The same debtor thus undertakes to the same creditor, but assumes a new obligation (and not only a modified obligation) while being discharged from the old one."
Furthermore, Article 1661 of the Civil Code of Québec provides that novation is not presumed; it is effected only where the intention to effect it is evident.
8. In Noranda1 , the Quebec Court of Appeal had to determine whether the issuance of a bill constituted a payment resulting in novation. The court concluded that the issuance of such a bill did not entail novation and made the following comment: [TaxInterpretations translation]
"In itself, the delivery of a promissory bill does not entail novation, as recognized by doctrine and jurisprudence:
Jean-Louis BAUDOUIN et Pierre-Gabriel JOBIN 2 :
Jurisprudence also generally accepts that the mere delivery by the debtor of a bill of exchange (bill, cheque) to the creditor does not have the effect of nullifying the obligation to pay and, consequently, that the creditor may still claim payment from the debtor under the original claim, even though recourse under the bill of exchange would already be time-barred. [TaxInterpretations translation]
Chamberland (Syndic de)3 , Judge Vallerand for the Court:
It has long been well established by law that the mere fact of accepting a bill of exchange in payment of one's debt does not establish or even create a presumption of an intention to novate:
Our jurisprudence provides us with several cases of changes in debt that do not effect novation unless the intention of the parties to effect novation is formally declared.
Thus, it has been decided in several cases that bills signed by the debtor and given to a creditor in payment of a debt do not effect novation of that debt, if the intention to novate is not expressly declared by the creditor who accepts them: and if these bills are not paid at maturity, the creditor will be able to claim the original debt. [TaxInterpretations translation]
Chodakowski c. Carter 4 :
As a general rule, the mere delivery of a promissory note does not entail novation of the pre-existing obligation, and its accessory security interests, if any. The promissory bill is then considered as a simple means of acknowledging the debt, like a credit instrument. Its surrender does not establish a presumption of intention. A decision of the Court of Appeal, frequently cited on this subject, Bertrand v. Paquin, referenced this rule, that there must be a clear intention to novate.
[...] In the case at bar, there is no evidence that would lead to the obvious conclusion (art. 1171 C.C.L.C.) that Ontario and Kerr intended to pay the original debt (balance of sale price) to create a new debt arising solely from a bill of exchange (a loan). The appellant did not prove that the parties had a clear intention to effect novation." [TaxInterpretations translation]
The Court of Appeal found that the amount owed remained the original debt.
9. In our view, the conclusions of the Court of Appeal can be applied to the situation under review. Thus, we are of the opinion that the issuance of the note on XXXXXXXXXX did not constitute a payment and that there was no novation of the original debt by reason of the issuance of this second note.
Part XIII tax
10. With respect to the application of paragraph 212(1)(b), we refer you to our opinion of April 21, 2008 where we referred to the Québec Cartier decision.5 In that decision, the Court made the following comment as to the meaning to be given to the expression "pays or credits him".
“The words “as, on account or in lieu of payment of, or in satisfaction of … interest” taken together with the word “credits” seems to me to confirm that the word “credit” make available to, must be given the meaning “make available to” [sic].
“Replacing a debt of interest” by an acknowledgment of debt as, on account or in lieu of payment of, or in satisfaction* of interest seems to me to be more the application of a compound formula than crediting “as, on account or in lieu of payment of, or in satisfaction of interest”.
In short, the Court was of the view that a strict interpretation of s. 212(1)(b) leads to interpreting the word “credit” according to its substance, “making available to”, and not according to the form of making an entry “on the right side of an account”.6
11. We are of the view that the comments of the Tax Court of Canada in this case can be recognized in the file under review in order to conclude that the Taxpayer did not pay the increased and annually capitalized interest and did not credit the Vendor with such interest when the note payable on XXXXXXXXXX was issued on XXXXXXXXXX.
Access to Information
12. For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance.
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
ENDNOTES
1 Noranda Inc. c. Québec (Sous-ministre du revenu) [2002] R.D.F.Q.61, 500-09-008568-990, paras. 45 and 46, Court of Appeal of Quebec.
2 Jean-Louis BAUDOUIN et Pierre-Gabriel JOBIN, Les Obligations, 5e édition, Cowansville, Éditions Yvons Blais Inc., 1998, p.753.
3 [1988] R.J.Q. 1159,1160-1161 (C.A.).
4 [1987] R.L. 225,232 (C.A.).
5 La Compagnie minière Québec Cartier v. The Minister of National Revenue, 84 DTC 1348, TCC.
6 Id., p. 1366.