The taxpayer (K & D), which along with three other lenders, advanced funds in 1996 to a Uruguay farming corporation (Interan) of which the taxpayer was a 44% shareholder. K & D annually recognized interest on the loan equal to the prescribed rate under s. 17, although acknowledgement was received from Interan that the loan was interest-bearing. In 2005, K&D determined that the total amount booked as interest receivable of $495,083 on the loan would not be received and as such it was written-off as a bad debt. In 2006, an amount equal to approximately 83% of the loan principal of $1.6 million owing to K & D was repaid by Interan, and the balance of the loan was a bad debt. On a CRA audit in 2009, a copy of the loan agreement was obtained by K & D from Uruguay, and it was determined that the loan was non-interest-bearing.
K & D now argued that its deduction of an amount equal to the amounts it had previously recognized as interest income was authorized under s. 20(21). In rejecting this position, Russell J stated (at paras. 37, 54):
I do not concur. That would bring the result of the subsection 17(1) calculation of imputed income to be nil, relying on delayed awareness that the Loan was interest-free. This would fly in the face of the above-noted purpose of subsection 17(1), being to impute income in respect of Canadian corporations that have made interest free or unreasonably low interest loans to non-residents that remained in place for more than a year. …
Subsection 20(21) cannot apply where subsection 17(1) does. Allowing a subsection 20(21) deduction for reported income on the basis of fictional receivable interest would completely nullify the intended purpose and effect of subsection 17(1). It would leave the appellant in a better place than if the true situation of the Loan being non-interest bearing had governed from the start.
Russell J found in the alternative that even if the accumulated interest could be treated as an interest receivable amount, there could still be no s. 20(21) deduction given that the terms of the loan provided that repayments were to be applied to interest before principal, i.e., all of the loss was in the collection of principal rather than interest.