Digests

Novopharm Ltd. v. Canada

A-24-02

2003 FCA 112, Rothstein J.A.

5/3/03

27 pp.

Appeal from decision of Tax Court (2002 DTC 1307) dismissing Novopharm's appeal from assessment disallowing deductions--Four issues addressed in appeal--(1) Whether appellant entitled to interest deductions in 1987, 1988 tax years, pursuant to Income Tax Act, s. 20(1)(c)(i)--40 transactions created interest deduction in profitable Novopharm while allocating earnings from borrowed funds to company with accumulated non-capital losses and unused Canadian exploration and development expenses--Tax Court Judge found transactions had no purpose other than tax avoidance--S. 20(1)(c)(i) requiring use of borrowed money for purpose of earning income from business or property in order to deduct interest--Tax Court holding borrowing herein not meeting requirement of s. 20(1)(c)(i) because purpose solely tax avoidance and not earning of income--Singleton v. Canada, [2001] 2 S.C.R. 1046 followed--S. 20(1)(c)(i) not contemplating treating individual transactions as series of transactions--Viewing transactions independently, appellant's borrowing used for purpose of earning income, meeting requirements of s. 20(1)(c)(i)--(2) Whether appellant entitled to deduct loan arrangement fee in 1987 taxation year, pursuant to s. 20(1)(e)(ii)--Reasoning applicable to interest deduction applicable to loan arrangement fee because appellant's borrowing used for purpose of earning income from business or property--Thus, loan arrangement fee incurred in course of borrowing meets requirements of s. 20(1)(e)(ii)--(3) Whether appellant entitled to deduct consulting fee in 1987 taxation year, pursuant to s. 9(1) or whether deduction prohibited by s. 18(1)(a)--In other words, whether consulting fee meets purpose test in s. 18(1)(a)--S. 18(1)(a) prohibiting deductions for expenses except those made for purposes of "gaining or producing income" while s. 20(1)(c)(i) uses words "earning income"--To be admissible as deduction from taxpayer's income, expense must have been incurred in order to make profit--Not enough expense incurred in order to obtain gross income--With respect to s. 20(1)(c)(i), income not equivalent to profit or net income: Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082--S. 18(1)(a) nowhere suggesting quantitative test, nor judicial assessment of sufficiency of income--Therefore, consulting fee incurred for purpose of gaining or producing income meets requirements for deductibility and deductibility not precluded under s. 18(1)(a) --(4) If entitled to interest, loan arrangement and consulting fee deductions, whether appellant disentitled to deductions pursuant to s. 245(1) in force in 1987 and 1988 and since repealed--In assessing whether appellant's deductions unduly or artificially reduced income for purposes of s. 245(1), two approaches possible--Tax Court Judge followed approach set out in Canada v. Fording Coal Ltd., [1996] 1 F.C. 518 (C.A.) --Other approach found in Canada v. Mara Properties Ltd., [1995] 2 F.C. 433 (C.A.)--Mara Properties approach should not be followed because even if deduction permitted by express provision of Income Tax Act, if artificially reduced income, deduction could be disallowed pursuant to s. 245(1) --Furthermore, since Fording, no court has followed Mara Properties approach with respect to interpreting s. 245(1)-- Fording approach followed--Whether entire series of transactions relevant for purpose of s. 245(1)--Having regard to series of related transactions consistent with focus of s. 245(1), which, for purposes of present case, consists of whether deductions artificially reduce income--S. 245(1) uses words "deduction . . . made in respect of . . . expense . . . incurred in respect of a transaction"--Those words cannot limit s. 245(1) inquiry to single transaction giving rise to deduction--Premise of s. 245(1) that transaction takes place resulting in expense being incurred which taxpayer seeks to deduct from income--Narrowing focus in present case solely to deduction in respect of interest expense incurred would not address question of whether deduction would unduly or artificially reduce income--Rather, necessary to have regard to other facts to determine question--Under s. 245(1), question whether deduction made in respect of expense would artificially reduce income, or, more colloquially, would unnaturally reduce income--In accordance with Fording approach, all circumstances must be considered to properly answer question of artificiality--Applying Fording approach, result of series of related transactions took place over short period of time solely to create net interest deduction for appellant thus reducing income, antithesis of object of s. 20(1)(c)(i) of creating incentive to accumulate capital with potential to produce income--In deducting own net interest expense, appellant solely engaging in tax avoidance, and as found by Tax Court Judge, not acting in accordance with object and spirit of s. 20(1)(c)(i)--Series of related transactions entered into pre-ordained, circular and limited in time--At end of relatively brief period during which transactions completed, nothing had changed except for appellant's claimed tax deductions--Combination of pre-ordination of transactions, circularity and limited amount of time during which completed took transactions out of normal business practice and rendered deduction for interest expense by appellant artificial--Because interest deduction artificially reduced income, Tax Court Judge correct in finding Novopharm's appeal failed on basis of s. 245(1)--Appeal dismissed--Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 9(1), 18(1)(a), 20(1)(c)(i), (e)(ii)--Income Tax Act, S.C. 1970-71-72, c. 63, s. 245(1) (as am. by S.C. 1988, c. 55, s. 185(1)).