The Canadian Rock Salt Company Limited v. Minister of National Revenue, [1973] CTC 143, 73 DTC 5122

Heald, J:—This is an appeal from assessments of the appellant by the respondent for the 1959 and 1960 taxation years.

Appellant was incorporated in 1952 under the Companies Act of Canada. Its main object was to explore for, develop and operate a rock salt mine in Canada, and more particularly in the Windsor area of Ontario. The appellant was, at all relevant times, a wholly owned subsidiary of The Canadian Salt Company Limited. The parent corporation of The Canadian Salt Company Limited was The Morton Salt Company, a United States corporation. It is not in dispute that, at all relevant times, the appellant was not dealing at arm’s length with The Morton Salt Company.

Under date of November 1, 1952 the appellant executed a deed of trust and mortgage with a trust company securing first mortgage bonds with a view to raising money for its corporate purposes. The face value of the bond issue was $6,000,000 and was comprised of 5% first mortgage bonds. The bond issue was secured by a a first mortgage and a floating charge on all of the company’s assets. Interest was payable at 5% per annum. In the original trust deed of November 1, 1952 interest was payable half-yearly on May 1 and November 1 each year commencing May 1, 1953.

On August 31, 1955, by a supplemental deed of trust and mortgage relating to said first mortgage bonds, the interest clause in the original deed was amended so that the bond interest was made payable in the calendar year 1960 for bonds bearing a certification date of or prior to August 31, 1955 and payable in the calendar year 1961 for bonds bearing a certification date after August 31, 1955.

On December 26, 1958, by a further supplemental deed of trust and mortgage relating to first mortgage bonds, the interest clause in the deed was further amended so that the bond interest was payable as follows:

(i) on December 26, 1958 as to interest accrued to August 31, 1956;

/ (ii) on January 2, 1959 as to interest accrued to August 31, 1957;

(iii) on September 2, 1959 as to interest accrued to August 31, 1958;

(iv) on September 2, 1959 as to interest accrued from September 1, 1958 to December 31, 1958;

(v) on December 31, 1959 as to interest accrued from January 1, 1959 to December 31, 1959; and

(vi) thereafter on December 31 of each year in respect of interest accrued during such year ending on December 31, commencing on December 31, 1960 and continuing to December 31, 1966 and thereafter on November 1, 1967.

The net effect of the said supplemental deed of trust dated December 26, 1958 was to make payable in the appellant’s 1959 taxation year (the calendar year) interest accruing during the period September 1, 1956 to December 31, 1959.

At December 31, 1952 only the sum of $429,000 of the said bond issue had been issued. By August 31, 1955 appellant’s parent corporation, Morton Salt, had advanced some five million dollars to the appellant. This was the period during which the appellant acquired and built its salt mine and said monies were used for this purpose. By August 31, 1956, said advances had been normalized by the issue of the above described first mortgage bonds to Morton Salt. The result was that appellant’s balance sheet of August 31, 1956 showed that first mortgage bonds had been issued in the principal amount of $5,427,341.

By certificate dated November 10, 1955 the respondent granted to the appellant an exemption certificate covering the income from the operation of appellant’s salt mine for the period commencing on September 1, 1955 and ending on August 31, 1958 pursuant to the provisions of subsection 83(5) of the Income Tax Act which reads as follows:

83. (5) Subject to prescribed conditions, there shall. not be included in computing the income of a Corporation income derived from the operation of a mine during the period of 36 months commencing with the day on which the mine came into production.

Under the provisions of the bond issue as amended, the interest payable in respect to the period of September 1, 1956 to August 31, 1957 was to be paid on January 2, 1959, and the interest payable in respect to the period of September 1, 1957 to August 31, 1958 was payable on September 2, 1959. In accordance therewith, the appellant, during its 1959 taxation year (which was the calendar year) paid as interest for these periods the sum of $542,734 and claimed the said amount as a deduction in computing its taxable income for the said taxation year. The respondent disallowed the said payment of interest as a proper deduction from income and this is the sole issue in the appeal. There was also an appeal respecting the 1960 assessment but counsel have agreed that it is not in issue and will abide the determination of the issue concerning the 1959 assessment.

It is not in dispute that the funds in respect of which the interest in question was paid were all used to acquire initially the land in question, to pay the pre-production expenses and then used to acquire and construct the mine and to bring it into production. It is also not in dispute that subject interest monies accrued during the exempt period (September 1, 1955 to August 31, 1958) and that the balance sheet of the company for the exempt years showed said interest as accrued and payable. The evidence is also clear that the mine came into production on September 1, 1955 and started to earn income from that time forward.

The appellant submits that said interest payments are deductible by virtue of the provisions of subparagraph 11(1)(c)(i) which reads as follows:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire an interest in a life insurance policy),

Appellant submits that the money here borrowed was used for the purpose of earning income from its business of mining thus bringing it within the provisions of subparagraph 11 (1)(c)(i). I consider that the evidence supports appellant’s submission on this point as does the established jurisprudence.* [1] However, unfortunately for the appellant, that is not an end of the matter because subparagraph 11(1)(c)(i) imposes a second condition for deductibility, namely, the borrowed money in question must not be used to acquire property the income from which would be exempt. The respondent’s submission is that, in this case, all of the money borrowed was used to “acquire property the income from which would be exempt” as specifically set out in said subparagraph 11(1)(c)(i). Respondent is correct in stating that the interest paid in the taxation year 1959 was interest which accrued during the period when appellant’s income was exempt under subsection 83(5). Respondent is also correct, in my opinion, when he submits that the borrowed money was used to acquire appellant’s “property” in question because the definition of “property” in the Act is wide enough to include both real and personal property (paragraph 139(1)(ag)).

However, counsel for the appellant submits that subparagraph 11(1)(c)(i) distinguishes income from business and income from property and that the exception therein contained relates only to income from property and not income from business and that, since in this case, subject income was income from the business of mining, the exception contained in subparagraph 11(1)(c)(i) does not apply. The meaning of the word “property” as used in said section was considered by Mr Justice Rand of the Supreme Court of Canada in the case of Canada Safeway Limited v MNR, [1957] CTC 335 at 345-6; 57 DTC 1239 at 1244-5. Rand, J after observing that subparagraph 11(1)(c)(i) in the new Act said “used for the purpose of earning income from a business” and that said language corresponded with the language of the repealed Act had this to say additionally:

The word “property” is introduced in paras. (i) and (ii) but I cannot see that it can help the appellant; the language

“borrowed money used for the purpose of earning income from . . . property (other than property the income from which is exempt)”

in (i) means the income produced by the exploitation of the property itself. . . .

Thus, adopting the interpretation of Rand, J of the word “property” as used in the exception contained in subparagraph 11(1)(c)(i) as including income produced by the exploitation of the property itself, then said exception is certainly wide enough to cover the facts of this case. In this case, the exempt income came from the exploitation of appellant’s property, that is, its salt mine including its real property and all of its mining and processing equipment.

I am therefore of the opinion that the subject interest was interest on borrowed money used to acquire property the income from which was exempt and that the appellant is, accordingly, not entitled to deduct said interest from its 1959 income.

The respondent’s position is further strengthened by the provisions of paragraph 12(1)(c) of the Income Tax Act which reads as follows:

12. (1) In computing income, no deduction shall be made in respect of

(c) an outlay or expense to the extent that it may reasonably be regarded as having been made or incurred for the purpose of gaining or producing exempt income or in connection with property the income from which would be exempt,

Cameron, J had occasion to consider the relationship between paragraph 12(1)(c) and subparagraph 11(1)(c)(i) in the case of Interior Breweries Ltd v MNR, [1955] CTC 143; 55 DTC 1090, where he said at page 149 [1093]:

It will be noted that this subsection is not referred to in the opening words of Section 11(1):

“11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year.”

It seems to me, therefore, that the statutory provisions of Section 11(1 )(c) are not to be construed by themselves but must be read in connection with the provisions of Section 12(1)(c) thereof, which relates to deductions affecting exempt income as does Section 11(1)(c). On the facts of this case I think I must find that the whole of the outlays here in question may reasonably be regarded as having been incurred in connection with property the income from which would be exempt, and that they are therefore barred from deduction.

I agree with the view of Mr Justice Cameron that, since paragraph 11(1)(c) does not specifically except paragraph 12(1)(c) from consideration as it does so except paragraphs 12(1)(a), (b) and (h), that it is necessary to read the two subsections together. When the two subsections are read together, it is clear that if there is any question that paragraph 11(1)(c) does not disallow interest payments in the circumstances of this case, paragraph 12(1)(c) most certainly disallows them. The evidence in this case is clear that the interest in question was an expense to the extent that it may reasonably be regarded as having been made for the purpose of producing exempt income. The interest in question was payable for the period after the mine came into production and during a period while the company was carrying on business and is properly a charge against income as opposed to interest expense incurred during a construction period which can be treated as part of the capital cost of property.* [2]

I have therefore concluded that the respondent quite properly disallowed the subject interest payments as a deduction from income in the taxation year 1959.

It seems to me that to hold otherwise would be to produce a result which could hardly have been intended by Parliament. The obvious intention of subsection 83(5) was to provide an incentive to encourage exploration and development of Canada’s mineral resources by allowing such an explorer and developer to have a tax holiday for the first three years after his mine came into production. Since the income is exempt and attracts no income tax, surely the expenses incurred in earning that exempt income cannot be used as a deduction against income which is not exempt. Surely the intention of Parliament as expressed in subparagraph 11(1)(c)(i) and paragraph 12(1)(c) is to provide that when the income is exempt, the corresponding expenses are to be disallowed. I am satisfied that was the intention of Parliament and I am also satisfied that such an intention has been clearly expressed in the above noted provisions of the Act.

The appeal is therefore dismissed with costs.