A-7-80
The Queen (Appellant)
v.
The Bank of Nova Scotia (Respondent)
Court of Appeal, Heald and Urie JJ. and Kelly
D.J.—Toronto, April 9; Ottawa, April 23, 1981.
Income tax — Income calculation — Deductions — Foreign
tax credit — Respondent claimed tax credit for income tax
paid to United Kingdom for doing business there — Appeal
from judgment of the Trial Judge allowing respondent's
appeal from a reassessment of its 1972 income tax return
Whether the amount of tax credit, when translated into
Canadian dollars, is to be calculated according to the weighted
average rate of exchange prevailing in 1972 taxation year or
according to the rate of exchange prevailing when the income
tax was paid — Appeal dismissed — Income Tax Act, R.S.C.
1952, c. 148, as amended, s. 126(2) — Canada-United King
dom Income Tax Agreement, S.C. 1966-67, c. 75, Part IV,
Schedule IV, Art. 21(2).
This is an appeal from the judgment of the Trial Judge
allowing the respondent's appeal from a reassessment of its
1972 income tax return. Respondent claimed tax credit for
income tax paid to the United Kingdom for doing business
there. The issue is whether, for purposes of paragraph
126(2)(a) of the Income Tax Act and Article 21(2) of the
Canada-United Kingdom Income Tax Agreement, the United
Kingdom income tax imposed on the respondent should be
translated into Canadian funds at the weighted average rate of
exchange prevailing in the 1972 taxation year or at the rate of
exchange prevailing when the income tax was paid. Counsel for
the appellant submitted that the Trial Judge erred in failing to
hold that, pursuant to paragraph 126(2)(a) of the Income Tax
Act, the right to the tax credit arises upon actual payment of
the foreign income tax and in failing to hold that the credit
should be computed on the basis of the rate of exchange
prevailing at the date of actual payment. He further submitted
that the Judge erred in concluding that the tax credit under
subsection 126(2) was "a matter of commercial and taxation
accounting" since it may be inferred from paragraph 126(2)(a)
that the cash method, as distinct from the accrual method, is to
be used in computing the tax credit.
Held, the appeal is dismissed. The respondent's liability for
the United Kingdom income taxes for the 1972 taxation year
arose in 1972 since that is the year when the income creating
the liability was earned, even though, by the United Kingdom
law, the tax was not required to be paid until some 14 months
later. The liability for the United Kingdom tax attached to the
respondent at fiscal year end, namely, October 31, 1972. The
amount of tax credit should not be affected by variations in the
rate of foreign exchange. Parliament clearly intended, in enact-
ing paragraph 126(2)(a), to relieve against double taxation by
providing for a tax credit based on the amount of tax payable
for a taxation year, by a Canadian resident, on income earned
in a foreign country in that taxation year, regardless of when,
by the law of that foreign country, the foreign tax was required
to be paid. The rate of exchange is purely an outside circum
stance which has nothing to do with the liability for tax. Based
on the evidence before him and applying the relevant statutory
provisions to that evidence, the learned Trial Judge was justi
fied in reaching his conclusions.
Greig (Inspector of Taxes) v. Ashton [1956] 1 W.L.R.
1056, referred to.
INCOME tax appeal.
COUNSEL:
W. Lefebvre and J. Côté for appellant.
S. E. Edwards, Q.C. and G. R. Hiseler for
respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Fraser & Beatty, Toronto, for respondent.
The following are the reasons for judgment
rendered in English by
HEALD J.: This is an appeal from a judgment of
the Trial Division [[1980] 2 F.C. 545] which
allowed the respondent's appeal from a reassess
ment for income tax in respect of the respondent's
1972 fiscal year which ended on October 31, 1972.
The Trial Division judgment referred the matter
back to the Minister of National Revenue for
reassessment of respondent's foreign tax credit of
£179,596 for taxes paid to the United Kingdom
(U.K.) for that year, by using the weighted aver
age exchange rate of $2.52122 Canadian dollars to
the pound sterling.
The issue in the appeal is whether, for purposes
of paragraph 126(2)(a) of the Income Tax Act,
R.S.C. 1952, c. 148, as amended, and Article
21(2) of the Canada-United Kingdom Income Tax
Agreement', the U.K. income tax which was im-
1 Those provisions read as follows:
126....
(2) Where a taxpayer who was resident in Canada at any
time in a taxation year carried on business in the year in a
country other than Canada, he may deduct from the tax for
posed on the respondent in respect of the income
from its branches in the U.K. for the 1972 taxation
year should be translated into Canadian funds:
(a) at the weighted average rate of exchange
prevailing in the 1972 taxation year as con
tended by the respondent and accepted by the
learned Trial Judge, or
(b) at the rate of exchange prevailing on Janu-
ary 1, 1974 when the U.K. income tax was paid,
as contended by the appellant.
An agreed statement of facts was filed at the trial
(Appeal Book, pages 141 to 144 inclusive) from
which the following circumstances emerge:
The law of the United Kingdom during the
relevant period imposed tax on the respondent
based on the amount of business transacted
there during its 1972 fiscal year but only re
quired such tax to become payable 14 months
thereafter, i.e., on January 1, 1974. The entire
the year otherwise payable under this Part by him an amount
not exceeding the least of
(a) such part of the aggregate of the business-income tax
paid by him for the year in respect of businesses carried on
by him in that country and his foreign-tax carryover in
respect of that country for the year as the taxpayer may
claim,
(b) the amount determined under subsection (2.1) for the
year in respect of businesses carried on by him in that
country, and
(e) the amount by which
(i) the tax for the year otherwise payable under this Part
by him
exceeds
(ii) the amount or the aggregate of amounts, as the case
may be, deducted under subsection (1) by him from the
tax for the year otherwise payable under this Part.
ARTICLE 21.
(2) Subject to the provisions of the law of Canada regard
ing the deduction from tax payable in Canada of tax paid in
a territory outside Canada (which shall not affect the general
principle hereof), United Kingdom tax payable in respect of
income from sources within the United Kingdom shall be
deducted from any Canadian tax payable in respect of that
income. Where such income is a dividend paid before 6
April, 1966, by a company which is a resident of the United
Kingdom, the deduction shall take into account any United
Kingdom income tax appropriate to the dividend.
U.K. tax due and payable was accordingly paid
by the respondent on January 1, 1974, except
for the sum of î15,209 which had been withheld
at source during the period, in respect of interest
on certain U.K. bonds.
The net profits of each of respondent's seven
U.K. branches for each quarter of its 1972 fiscal
year were taken into the respondent's income in
Canada at the end of the quarter in Canadian
funds determined by translating sterling into
Canadian funds at the exchange rate prevailing
at the end of the quarter. The net profits for
each quarter which remained, after deducting a
provision for estimated U.K. taxes, were remit
ted to Canada and converted into Canadian
funds at the end of the quarter. The said esti
mate for U.K. taxes was retained in sterling in
the U.K., as required by the policies of the Bank
of England and was permitted to be used by the
respondent in its U.K. business until the U.K.
taxes were paid.
The learned Trial Judge details at page 548 the
practical difference which results on the facts of
this case, depending on whether the approach of
the appellant or of the respondent is adopted:
For Canadian taxation purposes the foreign currency profits
and losses obviously must be expressed in terms of Canadian
currency. Due to the constantly fluctuating foreign exchange
situation, where there is an accounting for profits and losses on
an accrual basis of accounting for a given fiscal period, it would
be impossible to translate each entry as it occurs into Canadian
funds in accordance with the prevailing rate of exchange
existing at that time. It is therefore not only common account
ing practice and good sense but it is a practice fully accepted
and recognized by the defendant, that an average rate of
exchange known as the weighted average of the rates prevailing
during the period in question is used to translate into Canadian
funds, at the end of the period the foreign profits realized and
the losses incurred during that period. In the case at bar, it is
common ground that the weighted average figure of currency
exchange for the fiscal period ending the 31st of October 1972,
was 2.52122 Canadian dollars to the pound sterling. Therefore,
if that figure is used, the credit for £179,596 amounts to
$452,794. On the other hand, if the rate of exchange existing
on the date of payment is used, namely, 2.3131 for the £15,209
withheld at source and 2.2954 for the balance of the tax paid
on the 1st of January 1974, the resulting tax credit would only
be $412,514. The difference between the two figures amounts
to $40,280.
Then, after a comprehensive review of the factual
situation, the evidence adduced, and the argu-
ments of opposing counsel, he concludes (at pages
559-562):
On the assumption that the foreign tax must be paid and not
merely be payable before the right to a tax credit for same
arises, I arrive at the following conclusions based on the above
facts, expert opinion and considerations:
I. That both the law and generally accepted good accounting
practice require that the plaintiff carry out its accounting on
an accrual basis, as in fact it did during the year in issue.
2. That generally accepted good accounting practices do not
apply only to the calculation of profits and losses under
section 9 of the Income Tax Act but to all matters of account
unless there exists some statutory impediment to the applica
tion of those practices.
3. That generally accepted good accounting practice would
normally require, the unpaid United Kingdom taxes, which
accrued in 1972, to be carried in the books of the plaintiff for
that year and until payment at the weighted average rate of
exchange for 1972.
4. That there exists no specific provision in the Income Tax
Act itself, which would require the credit in pounds sterling
to be translated into Canadian dollars according to the rate
of exchange existing at the date of actual payment, nor
would the translation in accordance with the weighted aver
age rate in effect for the year during which the liability for
the foreign tax was incurred, offend against the general
scheme or purpose of the Act or any of its specific provisions.
5. That no double taxation would be involved if the exchange
rate at time of payment were used.
6. That neither method of calculation is basically unfair to
either party nor more likely than the other to work to the
disadvantage of anyone since the rate of exchange may
always vary either way.
7. The procedural anomaly which would appear to prevent a
foreign tax liability paid after the ninety-day period for
appeal has expired, from being claimed as a tax credit, is of
no assistance to the plaintiff.
8. That the following considerations, although not in any way
compelling, would, if anything, tend to favour the weighted
average rate of the fiscal year in question being used:
(a) It is more logical and simpler for the taxpayer (and
especially a corporate taxpayer who must account to its
shareholders) who is accounting on an accrual basis, to
carry in his tax returns as well as in his general financial
statements the same yardstick for tax liabilities and tax
credits as for normal profits and losses before taxes.
(b) It is more consistent that the same measure be appli
cable to paragraphs (a) and (b) of section 126(2), than to
have two different methods of calculating tax credits in the
same section.
(c) Except for section 127(1) pertaining to certain provin
cial logging tax credits, the credit under section 126(2)(a)
is the only one in the Income Tax Act where a credit must
be allocated to a specific taxation year which is not
necessarily the year of payment of the amount.
9. When section 126(2)(a) is considered by itself or in
isolation and without taking into account normal accounting
practices or any other factors, it would seem to be more
natural and normal to calculate the value of tax in Canadian
dollars at the rate of exchange in effect at the date of
payment,- although there is nothing in the section which
actually requires this.
Notwithstanding paragraph 9 above, because of consider
ations 1, 2, 3, 4 and 8, I would find that the translation into
Canadian dollars should be carried out in accordance with the
weighted average rate of exchange in effect for the taxation
period in question.
Should I be in error in finding that this principle applies to
all foreign tax credit cases, then, I would find that, in the
particular circumstances of this case, because United Kingdom
law requires that the tax be set aside in sterling during the
taxation year when it accrued and be kept in sterling until
ultimate payment in sterling, the weighted average rate of
foreign exchange should apply in any event.
III—Finding
I therefore conclude that whether the right to a credit arises
at the time when the United Kingdom tax accrues and becomes
payable or whether it arises only when the tax is actually paid
the credit must in both cases be calculated by translating the
amount of tax payable in sterling into Canadian dollars in
accordance with the weighted average rate of exchange pre
vailing during the taxation year under consideration.
Since it is not necessary for me to decide the question of
when the right to the tax credit for United Kingdom taxes
actually arises in order to dispose of the litigation between the
parties, I am deliberately refraining from doing so.
Counsel for the appellant submitted firstly, that
the learned Trial Judge erred in failing to hold
that, pursuant to paragraph 126(2)(a), the right to
the tax credit conferred thereby, only arises upon
actual payment of the foreign business income tax
and in failing to hold that such tax credit should
be computed on the basis of the rate of exchange
prevailing at the date of actual payment. Appel
lant's further submission was that the learned
Trial Judge erred further in concluding that the
tax credit under subsection 126(2) was "a matter
of commercial and taxation accounting" since, in
counsel's view, by paragraph 126(2)(a), Parlia
ment had specifically directed that the right to
such tax credit could only arise upon actual pay
ment of the foreign business income tax which, in
his view, necessitated the use of the cash method
as distinct from the accrual method for purposes of
computing such tax credit.
Dealing now with the first submission of counsel
for the appellant, I am unable to agree with his
view of this matter. It is my opinion that the
respondent's liability for U.K. income taxes for the
1972 taxation year arose in 1972 since that is the
year when the income creating the liability was
earned, even though by U.K. law, the tax was not
required to be paid until some 14 months later. I
consider that the liability for the U.K. tax
attached to the respondent at fiscal year end,
namely, October 31, 1972. To adopt the appel
lant's view would necessarily require that the
amount of the tax credit be calculated using the
rate of exchange prevailing on the date of pay
ment. On the facts of this case, that date would be
January 1, 1974. However, in order to test the
validity of this submission, it is interesting to pose
a different factual situation. Conceivably, in some
situations and with some taxpayers, the amount of
the tax liability and, consequentially, the amount
of the U.K. tax credit could become known at year
end or a few days thereafter. If, again, one were to
assume a year end of October 31, 1972, and a
taxpayer who decided to prepay the U.K. tax in
November or December of 1972, or sometime in
1973, then the appellant's submission as to date of
calculation produces rather strange results.
Because the tax credit would be based on the date
of payment of the tax, it would fluctuate in
accordance with the daily fluctuations of the rate
of exchange. If the appellant is correct, the
amount of U.K. tax credit would have changed
almost daily during the period from October 31,
1972 to January 1, 1974, depending on when the
U.K. tax was paid. I do not believe that Parlia
ment intended such a result—namely, that the
amount of tax credit should be affected by varia
tions in the rate of foreign exchange. In my view,
Parliament clearly intended, in enacting paragraph
126(2)(a) to relieve against double taxation by
providing for a tax credit based on the amount of
tax payable for a taxation year, by a Canadian
resident, on income earned in a foreign country in
that taxation year, regardless of when, by the law
of that foreign country, the foreign tax was
required to be paid. Similarly, I am unable to
agree with the second submission of appellant's
counsel that it was a necessary inference, from the
language used by Parliament in paragraph
126(2)(a), that the cash method, as distinct from
the accrual method, was to be used in computing
the tax credit. In this regard, based on the evi
dence before him, the learned Trial Judge held:
1. That both the law and generally accepted
good accounting practice required the respondent
to carry out its accounting on an accrual basis as
in fact was done in the 1972 fiscal and taxation
year.
2. That generally accepted good accounting
practices apply not only to the calculation of prof
its and losses under section 9 of the Income Tax
Act but, as well, to all matters of accounting unless
there exists some statutory impediment to the
application of those practices.
3. That generally accepted good accounting
practice would normally require the unpaid U.K.
taxes, which accrued in 1972, to be carried in
respondent's books for that year and until pay
ment, at the weighted average rate of exchange for
1972.
4. That there is no specific provision in the
Income Tax Act requiring the credit in pounds
sterling to be translated into Canadian dollars at
the rate of exchange on January 1, 1974, the date
of actual payment, nor would the translation in
accordance with the weighted average rate for
1972 offend against the general scheme or purpose
of the Act or any of its specific provisions.
In my view, based on the evidence before him,
and applying the relevant statutory provisions to
that evidence, the learned Trial Judge was justified
in making those findings and in reaching those
conclusions.
I am fortified in my view of this matter because
of another unusual and unjust result which could
flow from the interpretation urged upon us by
counsel for the appellant. The Canadian Income
Tax Act requires a Canadian corporation to file its
tax return for a taxation year, within six months
from the end of that year (in this case, the return
was required to be filed on or before April 30,
1973). If the appellant is right, since the respond
ent could not determine its foreign tax credit until
January 1, 1974, it would be unable to file its tax
return accurately claiming the foreign tax credit
within the six-month period set out in the statute.
It should also be noted that there is no provision in
the Act for reassessment in respect of the foreign
tax credits. On the other hand, the respondent's
method would permit the taxpayer to compute the
foreign tax method when its accounts are prepared
following the year end thus enabling the taxpayer
to estimate its tax and file its return as required
under the Act. In my view, where possible, the
provisions of the Act should be interpreted in such
a way as to enable a taxpayer to compute its tax
and comply with the statute within the time con
straints imposed thereby. Since, in my view, the
language of the section does not foreclose such an
interpretation, it should be adopted in this case.
Counsel for both parties made reference to the
provisions of Article 21(2) of the Canada-United
Kingdom Income Tax Agreement quoted supra.
Both counsel agreed that there was no inconsisten
cy between Article 21(2) of the Agreement and
subsection 126(2) of the Act. I agree with respond
ent's counsel that neither provision specifies the
basis for translation of the U.K. income tax to
Canadian funds and that both provisions make it
clear that the U.K. tax to be deducted by the
respondent from its Canadian tax otherwise pay
able for the 1972 taxation year is the U.K. tax on
its U.K. source income for that year.
Both counsel submitted a number of authorities
in support of their position but I do not find those
authorities to be directly applicable to the issue to
be decided here. There is, however, one English
case to which we were referred that I find helpful
to some extent, namely the case of Greig (Inspec-
tor of Taxes) v. Ashton 2 . In that case, a taxpayer
resident in the U.K. in 1946 paid some $24,000 to
the U.S. tax authorities in respect of her earnings
as a writer there. In 1950 she was repaid approxi
mately $12,000 by the U.S. in respect of tax
overpaid. In 1946 the rate of exchange was $4 to
the pound sterling but by 1950 the rate of
exchange had fallen to $2.80 to the pound. As in
the case at bar, she was entitled, pursuant to the
U.K.-U.S. Tax Convention and under the U.K.
Income Tax Act, to a credit against any U.K.
taxes payable in respect of U.S. income which had
2 [1956] 1 W.L.R. 1056.
been taxed there. The applicable section of the
U.K. Income Tax Act provided as follows:
2.—(1) Subject to the provisions of this Schedule, where,
under the arrangements, credit is to be allowed against any of
the United Kingdom taxes chargeable in respect of any income,
the amount of the United Kingdom taxes so chargeable shall be
reduced by the amount of the credit.
The Crown contended that the alteration in the
rate of exchange when the credit was repaid
should be taken into account when the taxpayer's
credit under the Convention was adjusted by
reason of the repayment of tax in 1950. Mr.
Justice Harman, of the Chancery Division, held
that the payment of U.S. tax in 1946 and the
repayment in 1950 was one transaction, and the
fact that, owing to the delay by the U.S. fiscal
authorities, there had been an alteration in the rate
of exchange was irrelevant, and the Crown was not
entitled to take it into account in the computation
of the taxpayer's credit in respect of tax paid by
her in the U.S. At page 1061 of the report, Mr.
Justice Harman stated:
The fact that the United States authorities were slow about
repaying or that the exchange had altered in the meanwhile, so
that when they repaid her the amount repaid was worth more
to her in pounds, seems to me, when one looks at it carefully, to
be entirely irrelevant. I do not think it has anything to do with
the Crown at all. The money might have been repaid earlier
and left in the United States and the same profit would have
been made, which is not a profit which the Crown could tax. It
is a mere accident, in my judgment, and the special commis
sioners were quite right in upholding the taxpayer's contention,
and the Crown's contention in this case is wrong.
But I reject the Crown's contention because the alteration in
the rate of exchange is purely an outside circumstance which
has nothing to do with the liability for tax nor the way in which
the Convention ought to be related to the law.
I adopt the reasoning in that case as being equally
applicable to the case at bar. The exchange fluc
tuations in 1972, 1973 and 1974, are, in my view,
irrelevant circumstances in so far as the computa
tion of respondent's tax credit under subsection
126(2) are concerned. The purpose and intent of
subsection 126(2) is to provide to the taxpayer
relief against double taxation in respect of liability
for tax in a foreign country. The rate of exchange
is purely an outside circumstance which has noth
ing to do with the liability for tax.
Accordingly, and for all of the foregoing rea
sons, I have concluded that the appeal should be
dismissed with costs, both here and in the Trial
Division.
* *
URIE J.: I concur.
* * *
KELLY D.J.: I concur.
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