Canadian Rock Salt Company Limited (Appel-
lant)
v.
Minister of National Revenue (Respondent)
Trial Division, Heald J.—Montreal, P.Q., Febru-
ary 16; Ottawa, February 22, 1973.
Income tax—Interest on borrowed money, deduction of—
Income from mine exempt from tax for 3 years—Interest
accrued during exemption period but paid afterward—
Whether deductible—Income Tax Act, s. 11(1)(c), 12(1)(c).
Appellant company acquired and built a salt mine between
December 31, 1952 and August 31, 1955 with money bor
rowed on 5% bonds in accordance with a trust deed dated
November 1, 1952. The mine came into production on
September 1, 1955, and under section 83(5) of the Income
Tax Act its income therefrom was exempt for the ensuing 3
years. Pursuant to supplemental deeds of trust made on
August 31, 1955 and December 26, 1958, interest of $542,-
734 which accrued on the bonds during the exemption
period was not paid until 1959.
Held, the interest so paid was "interest on borrowed
money used to acquire property the income from which
would be exempt" within the meaning of section 11(1)(c) of
the Income Tax Act and therefore not a deductible expense.
The word "property" in section 11(1)(c) includes income
produced by the exploitation of property. Canada Safeway
Ltd. v. M.N.R. (Supreme Court of Canada) 57 DTC 1239,
applied. Moreover, the deduction was also barred by section
12(1)(c), which must be read together with section 11(1)(c).
Interior Breweries Ltd. v. M.N.R. (Exch. Ct.) 55 DTC 1090,
applied.
INCOME tax appeal.
COUNSEL:
Jean-Claude Couture, Q.C. for appellant.
A. Garon, Q.C. and Louise Lamarre-Proulx
for respondent.
SOLICITORS:
Ogilvy, Cope & Co., Montreal, for
appellant.
Deputy Attorney General of Canada for
respondent.
HEALD J.—This is an appeal from assess
ments of the appellant by the respondent for the
1959 and 1960 taxation years.
Appellant was incorporated in 1952 under the
Companies Act of Canada. Its main object was
to explore for, develop and operate a rock salt
mine in Canada, and more particularly in the
Windsor area of Ontario. The appellant was, at
all relevant times, a wholly owned subsidiary of
The Canadian Salt Company Limited. The
parent corporation of The Canadian Salt Com
pany Limited was The Morton Salt Company, a
United States' corporation. It is not in dispute
that, at all relevant times, the appellant was not
dealing at arm's length with The Morton Salt
Company.
Under date of November 1, 1952, the appel
lant executed a deed of trust and mortgage with
a trust company securing first mortgage bonds
with a view to raising money for its corporate
purposes. The face value of the bond issue was
six million dollars and was comprised of 5%
first mortgage bonds. The bond issue was
secured by a first mortgage and a floating
charge on all of the Company's assets. Interest
was payable at 5% per annum. In the original
trust deed of November 1, 1952, interest was
payable half-yearly on May 1 and November 1
each year commencing May 1, 1953.
On August 31, 1955, by a supplemental deed
of trust and mortgage relating to said first mort
gage bonds, the interest clause in the original
deed was amended so that the bond interest was
made payable in the calendar year 1960 for
bonds bearing a certification date of or prior to
August 31, 1955 and payable in the calendar
year 1961 for bonds bearing a certification date
after August 31, 1955.
On December 26, 1958, by a further supple
mental deed of trust and mortgage relating to
first mortgage bonds, the interest clause in the
deed was further amended so that the bond
interest was payable as follows:
(i) on December 26, 1958, as to interest
accrued to August 31, 1956;
(ii) on January 2, 1959, as to interest accrued
to August 31, 1957;
(iii) on September 2, 1959, as to interest
accrued to August 31, 1958;
(iv) on September 2, 1959, as to interest
accrued from September 1, 1958 to Decem-
ber 31, 1958;
(v) on December 31, 1959, as to interest
accrued from January 1, 1959 to December
31, 1959; and
(vi) thereafter on December 31 of each year
in respect of interest accrued during such
year ending on December 31, commencing on
December 31, 1960 and continuing to Decem-
ber 31, 1966 and thereafter on November 1,
1967.
The net effect of the said supplemental deed
of trust dated December 26, 1958 was to make
payable in the appellant's 1959 taxation year
(the calendar year) interest accruing during the
period September 1, 1956 to December 31,
1959.
At December 31, 1952, only the sum of
$429,000 of the said bond issue had been
issued. By August 31, 1955, appellant's parent
corporation, Morton Salt, had advanced some
five million dollars to the appellant. This was
the period during which the appellant acquired
and built its salt mine and said monies were
used for this purpose. By August 31, 1956, said
advances had been formalized by the issue of
the above described first mortgage bonds to
Morton Salt. The result was that appellant's
balance sheet of August 31, 1956 showed that
first mortgage bonds had been issued in the
principal amount of $5,427,341.
By certificate dated November 10, 1955, the
respondent granted to the appellant an Exemp
tion Certificate covering the income from the
operation of appellant's salt mine for the period
commencing on September 1, 1955 and ending
on August 31, 1958 pursuant to the provisions
of section 83(5) of the Income Tax Act which
reads as follows:
83. (5) Subject to prescribed conditions, there shall not
be included in computing the income of a corporation
income derived from the operation of a mine during the
period of 36 months commencing with the day on which the
mine came into production.
Under the provisions of the bond issue as
amended, the interest payable in respect to the
period of September 1, 1956 to August 31, 1957
was to be paid on January 2, 1959, and the
interest payable in respect to the period of Sep-
tember 1, 1957 to August 31, 1958 was payable
on September 2, 1959. In accordance therewith,
the appellant, during its 1959 taxation year
(which was the calendar year) paid as interest
for these periods the sum of $542,734 and
claimed the said amount as a deduction in com
puting its taxable income for the said taxation
year. The respondent disallowed the said pay
ment of interest as a proper deduction from
income and this is the sole issue in the appeal.
There was also an appeal respecting the 1960
assessment but counsel have agreed that it is
not in issue and will abide the determination of
the issue concerning the 1959 assessment.
It is not in dispute that the funds in respect of
which the interest in question was paid was all
used to acquire initially the land in question, to
pay the pre-production expenses and then used
to acquire and construct the mine and to bring it
into production. It is also not in dispute that
subject interest monies accrued during the
exempt period (September 1, 1955 to August
31, 1958) and that the balance sheet of the
Company for the exempt years showed said
interest as accrued and payable. The evidence is
also clear that the mine came into production on
September 1, 1955 and started to earn income
from that time forward.
The appellant submits that said interest pay
ments are deductible by virtue of the provisions
of section 11(1)(c)(i) which reads as follows:
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may be
deducted in computing the income of a taxpayer for a
taxation year:
(c) an amount paid in the year or payable in respect of the
year (depending upon the method regularly followed by
the taxpayer in computing his income), pursuant to a legal
obligation to pay interest on
(i) borrowed money used for the purpose of earning
income from a business or property (other than bor
rowed money used to acquire property the income from
which would be exempt or to acquire an interest in a
life insurance policy),
Appellant submits that the money here bor
rowed was used for the purpose of earning
income from its business of mining thus bring
ing it within the provisions of section 11(1)(c)(i).
I consider that the evidence supports appellant's
submission on this point as does the established
jurisprudence. (See: Trans-Prairie Pipelines Ltd.
v. M.N.R. 70 DTC 6351 at p. 6354.) However,
unfortunately for the appellant, that is not an
end of the matter because section 11(1)(c)(i)
imposes a second condition for deductibility,
namely, the borrowed money in question must
not be used to acquire property the income from
which would be exempt. The respondent's sub
mission is that, in this case, all of the money
borrowed was used to "acquire property the
income from which would be exempt" as
specifically set out in said section 11(1)(c)(i).
Respondent is correct in stating that the interest
paid in the taxation year 1959 was interest
which accrued during the period when appel
lant's income was exempt under section 83(5).
Respondent is also correct, in my opinion, when
he submits that the borrowed money was used
to acquire appellant's "property" in question
because the definition of "property" in the Act
is wide enough to include both real and personal
property (section 139(1)(ag)).
However, counsel for the appellant submits
that section 11(1)(c)(i) distinguishes income
from business and income from property and
that the exception therein contained relates only
to income from property and not income from
business and that, since in this case, subject
income was income from the business of
mining, the exception contained in section
11(1)(c)(i) does not apply. The meaning of the
word "property" as used in said section was
considered by Mr. Justice Rand of the Supreme
Court of Canada in the case of Canada Safeway
Limited v. M.N.R. 57 DTC 1239 at pages 1244
and 1245 thereof. Rand J. after observing that
section 11(1)(c)(i) in the new Act said "used for
the purpose of earning income from a business"
and that said language corresponded with the
language of the repealed Act had this to say
additionally:
The word "property" is introduced in paras. (i) and (ii) but
I cannot see that it can help the appellant; the language
borrowed money used for the purpose of earning income
from ... property (other than property the income from
which is exempt)
in (i) means the income produced by the exploitation of the
property itself.
Thus, adopting the interpretation of Rand J.
of the word "property" as used in the exception
contained in section 11(1)(c)(i) as including
income produced by the exploitation of the
property itself, then said exception is certainly
wide enough to cover the facts of this case. In
this case, the exempt income came from the
exploitation of appellant's property, that is, its
salt mine including its real property and all of its
mining and processing equipment.
I am therefore of the opinion that the subject
interest was interest on borrowed money used
to acquire property the income from which was
exempt and that the appellant is, accordingly,
not entitled to deduct said interest from its 1959
income.
The respondent's position is further strength
ened by the provisions of section 12(1)(c) of the
Income Tax Act which reads as follows:
12. (1) In computing income, no deduction shall be made
in respect of
(c) an outlay or expense to the extent that it may reason
ably be regarded as having been made or incurred for the
purpose of gaining or producing exempt income or in
connection with property the income from which would
be exempt,
Cameron J. had occasion to consider the rela
tionship between section 12(1)(c) and section
11(1)(c)(i) in the case of Interior Breweries Ltd.
v. M.N.R. 55 DTC 1090 at p. 1093, where he
said:
It will be noted that this subsection is not referred to in
the opening words of section 11(1):
11. (1) Notwithstanding paragraphs (a), (b) and (h) of
subsection (1) of section 12, the following amounts may
be deducted in computing the income of a taxpayer for a
taxation year.
It seems to me, therefore, that the statutory provisions of
section 11(1)(c) are not to be construed by themselves but
must be read in connection with the provisions of section
12(1)(c) thereof, which relates to deductions affecting
exempt income as does section 11(1)(c). On the facts of this
case I think I must find that the whole of the outlays here in
question may reasonably be regarded as having been
incurred in connection with property the income from which
would be exempt, and that they are therefore barred from
deduction.
I agree with the view of Mr. Justice Cameron
that, since section 11(1)(c) does not specifically
except section 12(1)(c) from consideration as it
does so except section 12(1)(a), (b) and (h), that
it is necessary to read the two sections together.
When the two sections are read together, it is
clear that if there is any question that section
11(1)(c) does not disallow interest payments in
the circumstances of this case, section 12(1)(c)
most certainly disallows them. The evidence in
this case is clear that the interest in question
was an expense to the extent that it may reason
ably be regarded as having been made for the
purpose of producing exempt income. The inter
est in question was payable for the period after
the mine came into production and during a
period while the company was carrying on busi
ness and is properly a charge against income as
opposed to interest expense incurred during a
construction period which can be treated as part
of the capital cost of property. (See: Sherritt
Gordon Mines Ltd. v. M.N.R. [1968] C.T.C. 262
at p. 290.)
I have therefore concluded that the respond
ent quite properly disallowed the subject inter
est payments as a deduction from income in the
taxation year 1959.
It seems to me, that to hold otherwise, would
be to produce a result which could hardly have
been intended by Parliament. The obvious inten
tion of section 83(5) was to provide an incentive
to encourage exploration and development of
Canada's mineral resources by allowing such an
explorer and developer to have a tax holiday for
the first three years after his mine came into
production. Since the income is exempt and
attracts no income tax, surely the expenses
incurred in earning that exempt income cannot
be used as a deduction against income which is
not exempt. Surely the intention of Parliament
as expressed in section 11(1)(c)(i) and section
12(1)(c) is to provide that when the income is
exempt, the corresponding expenses are to be
disallowed. I am satisfied that was the intention
of Parliament and I am also satisfied that such
an intention has been clearly expressed in the
above noted provisions of the Act.
The appeal is therefore dismissed with costs.
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