T-4215-81
The Queen (Plaintiff)
v.
Terra Mining & Exploration Limited (N.P.L.)
(Defendant)
Trial Division, Reed J.—Edmonton, February 7;
Ottawa, February 21, 1984.
Income tax — Income calculation — Deductions — Method
of accounting for interest expense for tax purposes differing
from method of accounting for rest of income for tax purposes
and from accounting for corporate financial reporting pur
poses — Words "depending upon the method regularly fol
lowed by the taxpayer in computing his income" in s. 20(1)(c)
requiring taxpayer to use same method of accounting to
account for interest expense as for other income — Consistent
and established practice of non-matching and multiplicity of
lenders not sufficient to justify hybrid method of accounting
— Ss. 20(1)(c) and 12(1)(c) requiring accounting in conformity
with ordinary commercial practices and/or generally accepted
accounting principles — Industrial Mortgage and Trust Com
pany v. The Minister of National Revenue distinguished
because allowing hybrid system of accounting for valid reasons
founded in ordinary commercial practice and generally accept
ed accounting principles — Income Tax Act, S.C. 1970-71-72,
c. 63, ss. 9, 12(1)(c), 20(1)(c) — Income Tax Application
Rules, 1971, S.C. 1970-71-72, c. 63, Part III, s. 28(1).
The defendant accounted for interest expense on an accrual
basis in its financial statements, but in computing income for
tax purposes interest expenses were accounted for on a cash
basis while the rest of its income was accounted for on an
accrual basis. The Minister issued a reassessment which was
appealed to the Tax Review Board. The decision of the Board
to allow the appeal respecting 1975 is appealed. The Minister
argues that there must be an identity of method between the
taxpayer's accounting for tax purposes and its accounting for
corporate financial reporting purposes, except when specifically
otherwise allowed by the Act. The defendant argues that the
words "depending upon the method regularly followed by the
taxpayer in computing his income" in paragraph 20(1)(c) were
intended to allow the taxpayer the option of choosing the
method by which to account for interest expense without
constraint by ordinary commercial practices or generally
accepted accounting principles. The defendant also argues that
because the wording in paragraph 12(1)(c) is essentially the
same as that in paragraph 20(1)(c), the interpretation applied
to paragraph 12(1)(c), that is, that a hybrid method of
accounting is allowed, should also apply to paragraph 20(1)(c).
It relied upon Industrial Mortgage and Trust Company v. The
Minister of National Revenue and Interpretation Bulletin
IT-396 for the proposition that a taxpayer is allowed under
paragraph 12(1)(c) to choose to account for interest income in
a "non-matching" fashion. The defendant submits that all it
must show to bring itself within the hybrid method of account-
ing allowed by the Industrial Mortgage case is an established
and consistent practice by the taxpayer as well as a multiplicity
of lenders.
Held, the appeal is allowed. There is a distinction between a
requirement that income for tax purposes be accounted for
generally in conformity with accounting principles and a
requirement that the taxpayer's treatment of his financial
statements and his tax returns be identical. In computing
income for tax purposes, generally accepted accounting princi
ples such as the matching of revenues and expenses should be
adopted unless the Income Tax Act expressly allows otherwise.
Ordinary commercial practices and generally accepted account
ing principles dictate that the taxpayer should have accounted
for the interest expense on an accrual basis. The words
"depending upon the method regularly followed by the taxpay
er in computing his income" instruct taxpayers who use the
cash method of accounting to account for interest expense using
the same method and they instruct taxpayers who use the
accrual method to account for interest expense by that method.
The words require compliance with generally accepted account
ing principles rather than authorizing a departure therefrom.
Nothing in paragraphs 12(1)(c) and 20(1)(c) indicates that
any difference of treatment should exist between them. The
fact that paragraph 20(1)(c) refers to "income" and paragraph
12(1)(c) refers to "profit" is not significant. It is not sufficient,
on the basis of the decisions in Industrial Mortgage and
Mid-West Abrasive cases, to justify a hybrid system of
accounts solely on the basis of a consistent and established
practice of "non-matching" and a multiplicity of lenders. The
principle from those decisions is that both paragraphs 20(1)(c)
and 12(1)(c) require accounting in conformity with ordinary
commercial practices and/or generally accepted accounting
principles. In the Industrial Mortgage case the taxpayer was
allowed to use a hybrid system of accounting either because it
was transferring from an accrual to a cash basis of accounting
or because the loans for which it adopted the accrual method
were more secure than those for which it accounted on the cash
basis. There were valid reasons founded in ordinary commercial
practice and generally accepted accounting principles for allow
ing a hybrid system of accounting. There is no such justifica
tion in this case or in the Mid-West Abrasive case.
CASES JUDICIALLY CONSIDERED
APPLIED:
Minister of National Revenue v. Mid-West Abrasive
Company of Canada Limited, [ 1973] F.C. 911 (T.D.).
DISTINGUISHED:
Industrial Mortgage and Trust Company v. The Minister
of National Revenue, [1958] Ex.C.R. 205; 58 DTC 1060.
CONSIDERED:
Associated Investors of Canada Ltd. v. Minister of Na
tional Revenue, [1967] 2 Ex.C.R. 96; 67 DTC 5096;
Neonex International Ltd. v. Her Majesty the Queen
(1978), 78 DTC 6339 (F.C.A.).
REFERRED TO:
Oxford Shopping Centres v. The Queen, [1980] 2 F.C.
89; 79 DTC 5458 (T.D.); Nowegijick v. The Queen,
[1983] 1 S.C.R. 29; 83 DTC 5041.
COUNSEL:
William Mah for plaintiff.
Gordon W. Flynn for defendant.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
Bell, Felesky, Iverach, Flynn & Struck,
Edmonton, for defendant.
The following are the reasons for judgment
rendered in English by
REED J.: This action concerns the treatment of
interest expense under paragraph 20(1)(c) of the
Income Tax Act, S.C. 1970-71-72, c. 63, as
amended. The specific issue is whether a taxpayer
can account for interest expense on a cash basis
when he accounts for the rest of his income for tax
purposes on an accrual basis and when his
accounting for corporate financial reporting pur
poses is on the accrual basis.
The facts are not in dispute. The defendant's
mine commenced production in commercial quan
tities in March 1971, with the result that the
three-year period within which it could earn
income exempt from tax pursuant to Income Tax
Application Rule 28 (1) [Income Tax Application
Rules, 1971, S.C. 1970-71-72, c. 63, Part III]
commenced at that time. Accordingly, had the
taxpayer accounted for interest expense on an
accrual basis for tax purposes, it would not have
lowered in any way its taxable income for those
years. During all relevant periods, the defendant
accounted for interest expense on an accrual basis
in its financial statements, however in computing
income for tax purposes interest expenses were
accounted for when actually paid. As a result,
reassessments were issued by the Minister of Na
tional Revenue for the fiscal periods ending
August 31, 1973, December 31, 1973, December
31, 1974 and December 31, 1975. The defendant
appealed these reassessments to the Tax Review
Board and that Board allowed its appeal by judg
ment dated April 22, 1981. The appeals with
respect to the 1973 and 1974 taxation years were
dropped at trial, these having been nil assessments.
Thus only the assessment respecting the 1975 tax
ation year is still in dispute.
The first question is whether there must be an
identity of method between the taxpayer's
accounting for tax purposes and his accounting for
corporate financial reporting purposes except, of
course, when specifically otherwise allowed by the
Act. The Minister argues that this must be so. I
find this argument miscast. It seems to me that it
has long been accepted that different methods of
accounting 'are used for different purposes. The
method will vary with the purpose for which the
financial statements are being prepared. Counsel
for the defendant referred me to an article by B. J.
Arnold entitled "Conformity Between Financial
Statements and Tax Accounting", 81 CTJ (4) 476.
He also relied on the decision in Oxford Shopping
Centres v. The Queen, [1980] 2 F.C. 89; 79 DTC
5458 (T.D.). I might also refer to a passage in
Scace, The Income Tax Law of Canada (4th ed.,
1981), at page 72:
It must be stressed, however, that while accounting principles
are the basis of the computation of profit for tax purposes, they
are not always synonymous with business practice; and income
for tax purposes is seldom the same as the income shown on the
books of the business for its own purposes. For example, capital
cost allowance is taken for tax purposes as the taxpayer wishes
(within the terms of the Regulations) while for business pur
poses capital assets are likely to be written off on a straight line
depreciation basis.
The articles mentioned above are not authorities
but they set out what I understand to be the
correct position.
A distinction must be made between a require
ment that income for tax purposes be accounted
for generally in conformity with accounting princi
ples and a requirement that the taxpayer's treat
ment of his financial statements and his tax
returns be identical.
As counsel for the taxpayer contended, section 9
of the Act is the starting point. It provides:
9. (1) Subject to this Part, a taxpayer's income for a taxation
year from a business or property is his profit therefrom for the
year.
This has been interpreted as requiring a taxpay
er to account for his profit "in accordance with
ordinary commercial principles".'
Profit from a business, subject to any special directions in the
statute, must be determined in accordance with ordinary com
mercial principles. (Canadian General Electric Co. Ltd. v.
Minister of National Revenue, [1962] S.C.R. 3 [61 DTC
1300], per Martland J. at page 12.) The question is ultimately
"one of law for the court". It must be answered having regard
to the facts of the particular case and the weight which must be
given to a particular circumstance must depend upon practical
considerations. As it is a question of law, the evidence of
experts is not conclusive. (See Oxford Motors Ltd. v. Minister
of National Revenue, [1959] S.C.R. 548 [59 DTC 1119], per
Abbott J. at page 553, and Strick v. Regent Oil Co. Ltd.,
[1965] 3 W.L.R. 636 per Reid J., at pages 645-6. See also
Minister of National Revenue v. Anaconda American Brass
Ltd., [1956] A.C. 85 at page 102 [55 DTC 1220].)
See also Neonex International Ltd. v. Her
Majesty the Queen (1978), 78 DTC 6339 (F.C.A.)
for the rule that in computing income for tax
purposes generally accepted accounting principles
such as the matching of revenues and expenses
should be adopted unless the Income Tax Act
expressly allows otherwise.
There is no doubt that ordinary commercial
practices and generally accepted accounting prin
ciples would dictate that the taxpayer in this case
should have accounted for the interest expense on
the accrual basis.
Counsel for the taxpayer, however, argues that
paragraph 20(1)(c) of the Act specifically
authorizes a departure from such principles and
practices. This argument proceeds on two prongs:
(1) an argument on the specific wording of the
statutory provision 20(1) (c), and (2) an argument
by analogy to paragraph 12(1)(c) of the Act which
deals with interest income.
Paragraph 20(1)(c) provides:
20. (1) ... in computing a taxpayer's income for a taxation
year from a business or property, there may be deducted ...
' Associated Investors of Canada Ltd. v. Minister of Nation
al Revenue, [1967] 2 Ex.C.R. 96, at pp. 101-102; 67 DTC
5096, at p. 5099.
(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 ...
The taxpayer's argument is that the words in
parentheses in paragraph 20(1)(c) would be
redundant and unnecessary unless they were
intended to allow the taxpayer the option of choos
ing the method by which to account for interest
expense without constraint by ordinary commer
cial practices or generally accepted accounting
principles.
I do not read the words in parentheses this way.
It seems to me they do no more than instruct
taxpayers who use the cash method of accounting
to account for interest expense using the same
method and they instruct taxpayers who use the
accrual method of accounting to account for inter
est expense by that method. The literal meaning of
the words would seem to require compliance with
generally accepted accounting principles rather
than authorizing a departure therefrom. I note
that in the decision rendered in Minister of Na
tional Revenue v. Mid-West Abrasive Company of
Canada Limited, [1973] F.C. 911 (T.D.), at page
920, Sweet D.J. said of these words:
Wording to be considered is "an amount paid in the year or
payable in respect of the year" in section 11(1)(c). In my
opinion the words "paid in the year" are applicable to those
taxpayers who, in computing income, regularly follow the cash
basis accounting method and the words "payable in respect of
the year" are applicable to those who, in computing income,
regularly follow the accrual accounting method.
With respect to his second argument, counsel
for the taxpayer argues that paragraph 12(1)(c)
allows a taxpayer to choose the method by which
he will account for interest income without con
straint of ordinary commercial practices or gener
ally accepted accounting principles because the
wording of paragraph 20(1)(c) is essentially iden
tical to that of 12(1)(c). He argues that paragraph
12(1)(c) has been interpreted to allow a hybrid
method of accounting and therefore the same
result should follow for paragraph 20(1)(c). Para
graph 12(1)(c) provides:
12. (1) There shall be included in computing the income of a
taxpayer for a taxation year ...
(c) any amount received by the taxpayer in the year or
receivable by him in the year (depending upon the method
regularly followed by the taxpayer in computing his profit)
as, on account or in lieu of payment of, or in satisfaction of,
interest;
I agree that there is nothing in the statutory
wording of the two sections which would indicate
that any difference of treatment should exist be
tween them. The fact that paragraph 20(1)(c)
refers to "income" and paragraph 12(1)(c) refers
to "profit" does not seem significant. No convinc
ing argument was put to me that there was an
intention to make a distinction between the inter
pretation of the two paragraphs by the use of these
different words. I think that in the context of the
two paragraphs the words are interchangeable.
What then does paragraph 12(1)(c) allow?
Counsel for the taxpayer cites two sources for the
proposition that a taxpayer is allowed under para
graph 12(1)(c) to choose to account for interest
income in a "non-matching" fashion: the decision
of this Court in Industrial Mortgage and Trust
Company v. The Minister of National Revenue,
[1958] Ex.C.R. 205; 58 DTC 1060 and the
Department of National Revenue's Interpretation
Bulletin IT-396 dated October 17, 1977. It is
recognized that the interpretation bulletin is not
authority but has some weight as to interpretation.
See Nowegijick v. The Queen, [1983] 1 S.C.R. 29,
at page 37; 83 DTC 5041, at page 5044.
The Industrial Mortgage case involved a tax
payer who for most purposes used the cash basis of
accounting. Eighty-five per cent of its income was
interest income, most of it from mortgages and
bonds. The only deviation from accounting on a
cash basis was with respect to the interest from
federal and provincial government bonds, federal
and provincial guaranteed bonds, municipal bonds
and the interest from some pre-1942 mortgages
which had never fallen into default. These were
accounted for on an accrual basis. Mr. Justice
Thurlow (as he then was), at pages 1061-1062
[208-209 Ex.C.R.] described the reason for this
deviation:
There was an explanation for this difference in the appellant's
accounting practice in respect to the interest on these particular
mortgages. Prior to 1931 the appellant's accounts pertaining to
interest on all bonds, mortgages, agreements of sale, and collat
eral loans had been on an accrual basis, while revenues other
than interest on these items were being accounted for on a cash
received basis. Between 1931 and 1941, as a result of defaults
in payment of mortgage interest and of the appellant having
taken into revenue a large amount of mortgage interest which it
could not collect, a number of changes in the method of taking
interest into revenue were made, each tending to some extent to
bring the method nearer to a cash received basis on all items
except government bonds. By January 1, 1942, when the last of
these changes was made, the method of accounting for mort
gage interest was that of taking into revenue the interest on all
new loans on a cash received basis while carrying on on the
accrual basis in respect to the interest on old loans on which the
interest had never been in default. If the interest on such a loan
subsequently fell into default, the accounting for interest on it
was immediately put on a cash received basis.
At page 1064 [213-214 Ex.C.R.], Mr. Justice
Thurlow addressed the question of the interpreta
tion of paragraph 6(b), now paragraph 12(1)(c) as
follows:
... what is meant by the word "method" in s. 6(b) and a
further question as to whether or not the appellant regularly
followed a method of computing its profit. As I interpret it, the
word "method" is not used in s. 6(b) in any narrow or technical
sense but simply means the system or procedure which the
taxpayer has regularly followed in computing his profit. The
system or procedure, in my opinion, may be made up of a
number of practices, and I can see no valid reason why, in a
diverse business such as that of the appellant, such system or
procedure could not include different practices for accounting
for revenue from different activities or sources, depending on
the nature of such activities or sources and of the revenues
therefrom, and still be regarded as a "method" within the
meaning of that word in s. 6(b). In my opinion, the practices
followed by the appellant did amount to a "method" within the
meaning of the section and, as that method had been followed
by the appellant without change for the seven years immediate
ly preceding 1949 and for 1949 as well, I have no hesitation in
concluding that it was the "method" regularly followed by the
appellant in computing its profit within the meaning of s. 6(b).
Bulletin IT-396 issued by the Department of
National Revenue states respecting interest
income:
"Method Regularly Followed"
5. The words in paragraph 12(1)(c) "depending upon the
method regularly followed by the taxpayer in computing his
profit" are interpreted to refer to the taxpayer's method of
accounting for net interest income from a particular source and
not necessarily, if he is carrying on a business, to his method of
accounting for profit from the business. It is recognized that,
for example, a taxpayer might choose the receivable basis of
reporting interest on debts owing to him that are fully secured
and the received (cash) basis for more speculative investments.
Where such an arrangement was reasonable and was consist
ently followed, it would be acceptable as a method of reporting
interest income. While, as in the above example, interest from
all sources need not be reported on the same basis, it is a
requirement that interest from the same source must be report
ed on the same basis. For this purpose, "interest from the same
source" refers to interest derived from the same debtor on the
same type of obligation. For example, if a taxpayer owned
bonds of two different series issued by a certain corporation,
interest from all such bonds would be viewed as interest from
the same source and it would be an unacceptable method to
report interest from bonds of one series on a cash basis and
interest on bonds of another series on the receivable basis. The
words "regularly followed" indicate that there will be a consist
ency from year to year.
The Department's Interpretation Bulletin seems to
me no more than a paraphrase of the Industrial
Mortgage case.
Counsel for the taxpayer argues that all a tax
payer must show to bring himself within the
hybrid method of accounting allowed by the
Industrial Mortgage case is an established and
consistent practice by the taxpayer as well as a
multiplicity of lenders.
This last requirement results from the decision
of Sweet D.J. in Minister of National Revenue v.
Mid-West Abrasive Company of Canada Limited,
[1973] F.C. 911 (T.D.). In that case the taxpayer
attempted to take into income, interest expense in
the year that its parent company requested pay
ment. Interest on the loans borrowed from the
parent company were stated [at page 912] to be
"paid if requested, but not in excess of 6%". The
taxpayer was required by Sweet D.J. to take the
interest expense into its income on an accrual
basis. The Industrial Mortgage case was distin
guished on the ground that (1) it dealt with inter
est income and not interest expense; (2) there had
been an established practice in that case of many
years of reporting interest income on a "non-
matching" basis, and (3) there were a multiplicity
of lenders. In the Mid-West Abrasive Company
case, there was only one lender, the parent com
pany. The decision proceeds at page 921:
If the proper construction of the section did not confine the
deduction which taxpayers who follow the accrual method
(unmodified) may make in respect of interest to the year in
which the borrowed money was used and if the proper construc
tion permitted it to be deducted in some subsequent year (for
whatever cause) the result would be inconsistent with the
concept underlying the accrual method. In that event one might
have "accrual" in respect of all matters except interest and
have a cash basis for interest. In my opinion the wording of the
section does not permit such a result except in circumstances
such as existed in Industrial Mortgage and Trust Co. v.
M.N.R. (supra) and in my view such circumstances do not exist
in this case.
I do not think it is sufficient on the basis of the
decisions in the Industrial Mortgage and Mid-
West Abrasive cases to justify a hybrid system of
accounts solely on the basis of a consistent and
established practice of "non-matching" and a mul
tiplicity of lenders. The principle I take from those
decisions is that both paragraphs 20(1)(c) and
12(1)(c) require accounting in conformity with
ordinary commercial practices and/or generally
accepted accounting principles. The Industrial
Mortgage case is entirely consistent with this view.
In that case, it seems to me the taxpayer was
allowed a hybrid system of accounting either
because (1) it was transferring from an accrual to
a cash basis of accounting, or (2) because the loans
for which it adopted the accrual method were
more secure than those for which it accounted on
the cash basis. That is, even though not expressly
articulated in that case there were valid reasons
founded in ordinary commercial practice and gen
erally accepted accounting principles for allowing
a hybrid system of accounting. There was no such
justification in the Mid-West Abrasive case and
no such justification has been demonstrated in this
case. Accordingly, I would allow the appeal and
set aside the decision of the Tax Review Board.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.