The taxpayer borrowed NZ$150 million from three non-resident banks by issuing five-year debentures bearing interest at 15.40%. A comparable U.S.-dollar borrowing would have yielded approximately 9.1%. Immediately prior to the borrowing, the taxpayer entered into forward agreements with a different bank that effectively converted the NZ dollar receipts and payments into U.S. dollars, thereby locking in a foreign exchange gain on repayment of the principal.
McLachlin J. found that as the counterparty to the forward contracts was separate from the lenders under the debentures, the principal of the borrowing by the taxpayer was New Zealand dollars and should not be treated as a synthesized U.S.-dollar loan from those lenders - and the fact that the borrowed New Zealand dollars were converted by the taxpayer into U.S. dollars did not detract from the fact that all of the money borrowed under the debentures was used in the business of the taxpayer. Accordingly, interest was deductible at the Canadian-dollar equivalent of the New Zealand dollar coupons actually payable.