28 September 1990 Internal T.I. 9014577 F - Debt Rescheduling Costs

SUBJECT: 24(1) Debt Rescheduling Costs

We are writing in response to Mr. Fitzgerald's memoranda dated June 25, 1990 in which he requested our opinion  24(1)

Facts

Our understanding of the facts is as follows:

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Your opinion

You agree with the position of the Calgary District Office.

Our opinion

Treatment under GAAP 

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b)     The decision in Metropolitan Properties (supra) has, in our view, been misconstrued by the taxpayer's representatives as justification for paralleling tax treatment with GAAP treatment.  In his concluding remarks (items 1 and 2 at page 5137) Walsh, J. stated that a taxpayer should normally apply GAAP in determining his profit unless a section of the Act requires a departure from GAAP.  We believe the Act requires a departure from  GAAP in this situation since paragraph 18(1)(b) specifically precludes the deduction of capital expenditures.

Capital Treatment

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However, as noted by Mr. Justice Abbott in British Columbia Electric Railway Co. Ltd. v. MNR 58 DTC 1022 at p. 1027 in his comments on the predecessor to paragraph 18(1)(a): 

     Since the main purpose of every business undertaking is presumably to make a profit, any expenditure made "for the purpose of gaining or producing income" comes within the terms of s. 12(1)(a) whether it be classified as an income expense or as a capital outlay.

     Once it is determined that a particular expenditure is one made for the purpose of gaining or producing income, in order to compute income tax liability it must next be ascertained whether such disbursement is an income expense or a capital outlay.  

This statement was cited with approval by Mr. Justice Cattanach in deciding Riviera Hotel Co. Ltd. v. MNR 72 DTC 6142  24(1)  in determining that a premium paid to discharge a mortgage was on capital account, Mr. Justice Cattanach reviewed the authorities supporting the principle that the cost of financing a business is a capital expense (See page 6144).  Again, in The Queen v. MerBan Capital Corporation Limited 89 DTC 5404 at page 5411 the Chief Justice emphasized that paragraph 18(1)(a) does not authorize the right to deduct an amount.

Indirectly addressing the test of paragraph 18(1)(b), 24(1)

Mr. Justice Joyal reviews the principles in the case 19(1) cited as support for income treatment (noted above) and other leading cases in Kaiser Petroleum Ltd. v. The Queen (supra) starting on page 6037.  As he states on that page:

     The genesis of these cases may aptly be summarized in the dictum of Lord Pearce in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia (1966) A.C. 227, found at page 264:

     The solution to this problem is not to be found by any rigid test or description.  It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other.  One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction.  It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

Mr. Justice Urey further illustrates this view in The Queen v. Jager Homes Ltd. et al 88 DTC 6119 at 6121 by quoting Van Den Ber Bergs, Limited v. Clark (1935) A.C. 431:

Consequently it is to the decided cases that one must go in search of light.  While each case is found to turn upon its own facts, and no infallible criterion emerges, nevertheless the decisions are useful as illustrations and as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem.

Using this approach  24(1)

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Deductibility under paragraph 20(1)(e)

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The test in Yonge-Eglinton Building Ltd. v MNR (supra), is that the expenses are incurred "... in connection with..." or "... incidental to..." the borrowing. 24(1) As emphasized by the preamble to subsection 20(1) there must be a clear connection between the amount to be deducted and the source of the borrowing.  24(1)

We also note 19(1) quotation of a passage from the same case which indicates that paragraph 20(1)(e) has a very broad scope because the section specifically excludes commissions and bonuses and payments as or on account of principal and interest.  In the years under audit the phrase "a commission or bonus paid or payable to a person ... from whom the money was borrowed..." had been removed from the law.  Although a minor point, we do not believe 19(1) reliance on this passage is warranted when the wording in question has changed. 

Deductibility as a discount

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Expenses related to financial reporting

In our opinion, expenditures, if any, incurred to issue financial reports to shareholders to inform them of the loan restructuring should be deductible under subparagraph 20(1)(g)(iii), including the cost of obtaining the necessary legal and financial advice in connection with the issuance of financial reports.

Summary

Based on our understanding of the facts as set out above, we agree with you that the majority of the fees fall within the definition of an eligible capital expenditure in paragraph 14(5)(b) and that accordingly a deduction may be claimed under paragraph 20(1)(b) of  the Act.  As noted above, any financial reporting expenses would be deductible under paragraph 20(1)(g).

C.C. B. DarlingngDirectorFinancial Industries DivisionRulings Directorate