In order to utilize the losses of its U.S. subsidiary, the taxpayer borrowed funds in Canada from an arm's length bank and made a capital contribution of those funds to the U.S. subsidiary. The U.S. subsidiary purchased a term deposit from the bank bearing a lower rate of interest than that charged on the bank loan to the taxpayer and pledged the deposit to the bank as security for that loan. The interest generated by the term deposit was paid as a dividend to the taxpayer.
The interest paid to the bank was non-deductible because the absorption of business losses of the U.S. subsidiary was not a "purpose of earning income". However, Bowman J. rejected the Crown's submission that "income" in s. 20(1)(c) referred to net income as essentially defined in s. 9 of the Act. "Amounts of income such as dividends which must be included in income under paragraphs 12(1)(j) and (k) do not cease to be income merely because they are exceeded by the cost of their production."