Tax Court of Canada Judgments

Docket: 2002-2695(IT)G

BETWEEN:

INCO LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

________________________________________________________________________________________________

Appeal heard on June 15 and 16, 2004 at Vancouver, British Columbia

Before: The Honourable Justice M.J. Bonner
Appearances:
Counsel for the Appellant:	Warren Mitchell Michael Colborne
Counsel for the Respondent:	Luther Chambers

____________________________________________________________________

JUDGMENT

          The appeal from the assessment made under the Income Tax Act for the 2000 taxation year is dismissed with costs.

Signed at Toronto, Ontario, this 18th day of October 2004.

"M.J. Bonner"

Bonner, J.

Citation: 2004TCC468

Date: 20041018

Docket: 2002-2695(IT)G

BETWEEN:

INCO LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Bonner, J.

[1]      This is an appeal from an assessment under the Income Tax Act (the "Act") for the Appellant's 2000 taxation year.

[2]      Two issues were raised by the Notice of Appeal. The first was disposed of on May 31 of this year by decision of this Court upon application under section 58 of the Tax Court of Canada Rules (General Procedure). The second issue, which must now be decided, relates to the Appellant's claim to deduct an amount which it asserts is a foreign exchange loss which it realized on the purchase for cancellation and on redemption of certain debentures which it had issued.

[3]      The debenture issues in question were transactions on capital account. They were denominated in U.S. dollars. The U.S. dollar appreciated in value against the Canadian dollar between the time when the debentures were issued and the time when they were retired. The Appellant relies on paragraph 20(1)(f) of the Act as authority for the deduction of the foreign exchange loss which it says was realized. Paragraph 20(1)(f), which applies notwithstanding the paragraph 18(1)(b) prohibition of the deduction of losses of capital, permits a deduction in the computation of income when the issuer of a debt instrument pays an amount in satisfaction of the principal amount of the instrument and the amount paid is greater than the issuer received when the instrument was issued. Typically, as is suggested by marginal note, paragraph 20(1)(f) applies to allow a deduction in respect of bonds, debentures and other debt instruments which were issued at a discount. However, the permitted deduction is an amount computed in accordance with a statutory formula which makes no express reference to discounts and it is that formula, properly interpreted, which must govern the outcome here.

[4]      The paragraph 20(1)(f) formula limits the deductible amount by reference (inter alia) to the 'principal amount of the obligation'. The central point in dispute is whether, in cases where the obligation is expressed in a foreign currency, the Canadian equivalent of the principal amount fluctuates with the value of the Canadian dollar during the life of the obligation. The Appellant contends that it does. Moreover, according to the Appellant, it makes no difference that it did not buy U.S. dollars for the purpose of repaying the loan. The Respondent disagrees with the Appellant on both counts.

[5]      A further issue arises under paragraph 20(1)(f). That provision permits the deduction of "... an amount paid in the year in satisfaction of the principal amount of any bond, debenture, bill, note ...". The Appellant claims that the statutory language is broad enough to encompass not only a direct redemption of bonds but also transactions whereby it purchased its debentures on the open market with a view to cancelling them. The Respondent, taking a rather narrow view of the statutory language, disagrees and argues that an amount paid by an issuer to buy a debenture which it has issued is not paid "in satisfaction of the principal amount" of the instrument.

[6]      At this point it is convenient to set out the text of paragraph 20(1)(f)[1]:

20(1)      Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto: ...	20(1)       Malgré les alinéas 18(1)a), b) et h), sont déductibles dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qu'il est raisonnable de considérer comme s'y rapportant : [...]
(f) Discount on certain obligations - an amount paid in the year in satisfaction of the principal amount of any bond, debenture, bill, note, mortgage or similar obligation issued by the taxpayer after June 18, 1971 on which interest was stipulated to be payable, to the extent that the amount so paid does not exceed,	f) Rabais sur émission de certains titres - une somme payée au cours de l'année en acquittement du principal de quelque obligation, effet, billet, hypothèque ou titre semblable émis par le contribuable après le 18 juin 1971 et sur lequel un intérêt a été déclaré payable, dans la mesure où la somme ainsi payée ne dépasse pas :
(i) in any case where the obligation was issued for an amount not less than 97% of its principal amount, and the yield from the obligation, expressed in terms of an annual rate on the amount for which the obligation was issued (which annual rate shall, if the terms of the obligation or any agreement relating thereto conferred on its holder a right to demand payment of the principal amount of the obligation or the amount outstanding as or on account of its principal amount, as the case may be, before the maturity of the obligation, be calculated on the basis of the yield that produces the highest annual rate obtainable either on the maturity of the obligation or conditional on the exercise of any such right) does not exceed 4/3 of the interest stipulated to be payable on the obligation, expressed in terms of an annual rate on	(i) chaque fois que le titre a été émis pour une somme non inférieure aux 97 % de son principal et que le rendement du titre, exprimé en pourcentage annuel de la somme pour laquelle il a été émis (pourcentage annuel qui doit, si les conditions d'émission du titre ou les dispositions d'une convention y afférente donnaient à leur détenteur le droit d'exiger le paiement du principal du titre ou de la somme restant à rembourser sur ce principal avant l'échéance de ce titre, être calculé sur la base du rendement qui permet d'obtenir le pourcentage annuel le plus élevé possible soit à l'échéance du titre, soit sous réserve de l'exercice de tout droit de ce genre) ne dépasse pas les 4/3 de l'intérêt déclaré payable sur le titre, exprimé en pourcentage annuel :
(A) the principal amount of the obligation, if no amount is payable on account of the principal amount before the maturity of the obligation, or	(A) du principal du titre, si aucune somme n'est payable sur le principal avant l'échéance du titre;
(B) the amount outstanding from time to time as or on account of the principal amount of the obligation, in any other case,	(B) de la somme restant à rembourser sur le principal du titre, dans les autres cas,
the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding year in satisfaction of its principal amount exceeds the amount for which the obligation was issued, and	l'excédent du moins élevé du principal du titre et du total des sommes payées au cours de l'année ou d'une année antérieure en acquittement du principal de ce titre sur la somme pour laquelle le titre a été émis,
(ii) in any other case, 3/4 of the lesser of the amount so paid and the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding taxation year in satisfaction of its principal amount exceeds the amount for which the obligation was issued;	(ii) dans les autres cas, les 3/4 du moins élevé de la somme ainsi payée et de l'excédent du moins élevé du principal du titre et du total des sommes payées au cours de l'année ou d'une année d'imposition antérieure en acquittement du principal du titre sur la somme pour laquelle le titre a été émis;

[7]      At the hearing of the appeal the parties filed a statement of agreed facts. The body of the document reads as follows:[2]

1.          The parties to this appeal agree for the purposes of this appeal only to the hereinafter recited facts.

2.          The Appellant is a large multinational mining company which was at all times material to the present appeal resident in Canada and which carried on large-scale mining operations in Canada and outside Canada.

3.          The 1989 Debentures

a)          In or about June 1989, the Appellant issued sinking fund debentures of U.S. $150,000,000 at an interest rate of 9.875% per annum, maturing on June 15, 2019 (the "1989 Debentures").

b)          The 1989 Debentures were issued under an indenture dated June 29, 1989 between the Appellant and the Bank of New York.

c)          Prior to June 29, 1989 the Appellant issued to the public a Prospectus and a Prospectus Supplement regarding the 1989 Debentures. ... Appendices "A" and "B" are copies of the said Prospectus and Prospectus Supplement, respectively.

d)          The 1989 Debentures were issued to the public at less than their face amount, namely, at a discount of 2.6%, amounting to U.S. $3,900,000 in the aggregate (the "Discount"). The amount which the Appellant received from the public was therefore 97.4% of the face amount of the debentures, or U.S. $146,100,000 as an aggregate dollar amount (the "Discounted Amount").

e)          For income tax purposes, the Appellant converted the Discount of U.S. $3,900,000 to Cdn. $4,652,827 at the rate of exchange of 1.19305 in effect at the time of the 1989 Debentures were issued. The amount had been deducted by the Appellant as financing expenses under paragraph 20(1)(e) of the Income Tax Act at 20%, or Cdn. $930,565, per annum in the years 1989 to 1993. The Minister did not challenge these deductions in assessing the Appellant for the 1989 to 1993 taxation years.

f)           After the deduction of underwriters fees of U.S. $1,312,500 (which are not in issue), the Appellant used the net proceeds from the issue of the 1989 Debentures to finance capital expenditures.

g)          The terms of the 1989 Debentures did not provide for an increase of their face amount owing in U.S. currency.

h)          The terms of the 1989 Debentures provided that the face amount of the debentures was redeemable only in U.S. dollars, and they did not contain any provisions allowing the Appellant to redeem them in amounts of non-U.S. currency equivalent to the stipulated U.S. dollar amounts or for a hedging of the Appellant's U.S. dollar obligation against foreign exchange fluctuations.

i)           The Respondent calculated the yield from the 1989 Debentures, as it set out in Appendix "C" ...

j)           The Appellant did not hedge the U.S. dollar face amount of the 1989 Debentures against a perceived decline in the value of the Canadian dollar relative to the U.S. dollar.

k)          Since the U.S. dollar face amount of the 1989 Debentures was not hedged pursuant to their terms against a perceived decline in the value of the Canadian dollar relative to the U.S. dollar, the face amount, in Canadian dollar terms, was, for financial purposes, Cdn. $178,957,500 at the time of their issuance (U.S. $150,000,000 multiplied by 1.19305 rate of exchange at the time of issuance).

l)           While the Appellant hedged against perceived appreciations of the value of the Canadian dollar relative to the U.S. dollar in order to reduce a potential adverse impact on its future Canadian dollar production costs, it did not hedge against any perceived depreciation of the value of the Canadian dollar relative to the U.S. dollar in order to reduce the potential adverse impact on its Canadian dollar costs of repaying or repurchasing the 1989 Debentures.

m)         Because the Appellant received a substantial portion of its revenues in U.S. dollars, which it deposited in U.S. dollar bank accounts, the Appellant always had sufficient U.S. dollar funds on hand to redeem or to purchase in the open market those portions of the said 1989 Debentures it wished to redeem or purchase, and therefore found it unnecessary to hedge against any perceived depreciation of the value of the Canadian dollar relative to the U.S. dollar with respect to the 1989 Debentures.

n)          Under the terms of the 1989 Debentures, the debentures were redeemable through the operation of a sinking fund on each June 15, commencing June 15, 2000 to and including June 14, 2018, at 100% of the face amount thereof. The annual mandatory sinking fund payment was U.S. $7,500,000. The Appellant had the option of making an additional annual sinking fund payment of up to U.S. $15,000,000.

o)           Under the terms of the 1989 Debentures, the Appellant also had the option to redeem them on any date on or after June 15, 1999 and up to June 14, 2009, otherwise than through the sinking fund, as a whole or in part, at redemption prices ranging from 103.638% to 100.364% of the face amount of the debentures, and thereafter at 100% of the face amount of the debentures.

p)           Because the said redemption premiums would have been payable by the Appellant if it exercised its said option to redeem the 1989 Debentures, other than through the sinking fund, the Appellant purchased, between February 21 and May 9, 2000, a total of U.S. $29,120,000 of the said 1989 Debentures (the "Purchased Amount"), as detailed in Appendix "D" ..., in the open market through various brokers for a total of U.S. $29,012,850 (the "Purchase Price of the 1989 Debentures"), as also detailed in Appendix "D" .... On the Appellant's instructions these purchased debentures were then cancelled on May 9, 10 and 11, 2000.

q)           On June 15, 2000, the Appellant made mandatory and optional sinking fund payments to redeem part of the 1989 Debentures with an aggregate face amount of U.S. $22,500,000 (the "Redeemed Amount") at 100% of the face amount, as reflected in Appendix "D" ....

r)            The Appellant obtained all U.S. dollar amounts required for the said purchases and redemptions of the 1989 Debentures by drawing on its U.S. dollar bank account and at no time converted any Canadian dollars into U.S. dollars for these purposes.

s)            The Canadian dollar equivalent of the Purchased Amount, determined at the exchange rate at the time of issuance, was Cdn. $34,741,616 (U.S. $29,120,000 x 1.19305).

t)            The Canadian dollar equivalent of the Purchase Price, determined at the exchange rate at the various dates of purchase between February and May 2000, was Cdn. $42,943,971, as is also detailed in Appendix "D" ....

u)           The Canadian dollar equivalent of the Redeemed Amount determined at the exchange rate at the time of issuance was Cdn. $26,843,625 (U.S. $22,500,000 x 1.19305), as is also reflected in Appendix "D" ....

v)           The Canadian dollar equivalent of the sinking fund payments, determined at the exchange rate on June 15, 2000, was Cdn. $33,284,023 (U.S. $22,500,000 x 1.4793), as is also reflected in Appendix "D" ....

4.          The 1992 Debentures

a)           On or about June 17, 1992, the Appellant issued debentures in the amount of U.S. $200,000,000 at an interest rate of 9.6% per annum, maturing on June 15, 2022 (the "1992 Debentures").

b)           The 1992 Debentures were issued as a new series of Debt Securities under an Indenture dated June 29, 1989, as amended and supplemented by a First Supplemental Indenture dated March 31, 1992.

c)           On March 31, 1992, the Appellant issued to the public a Prospectus regarding the 1992 Debentures. ... Appendix "E" is a copy of the said Prospectus.

d)          On June 10, 1992 the Appellant issued to the public a Prospectus Supplement regarding the 1992 Debentures. ... Appendix "F" is a copy of the said Prospectus Supplement.

e)          The 1992 Debentures were issued to the public at their face amount of U.S. $200,000,000.

f)           After the deduction of underwriters fees of U.S. $1,750,000 and other expenses (all of which are not in issue), the Appellant used the net proceeds from the issue of the 1992 Debentures to repay long-term U.S. dollar indebtedness, consisting of long-term floating rate bank indebtedness, 11% U.S. Dollar Notes and Sinking Fund payments of 12 3/8% U.S. Dollar Debentures.

g)          The terms of the 1992 Debentures did not provide for an increase of their face amount owing in U.S. currency.

h)          The terms of the 1992 Debentures provided that the face amount of the debentures was redeemable only in U.S. dollars, and they did not contain any provisions allowing the Appellant to redeem them in amounts of non-U.S. currency equivalent to the stipulated U.S. dollar amounts or for a hedging of the Appellant's U.S. dollar obligation against foreign exchange fluctuations.

i)           The Respondent did not calculate the yield from the 1992 Debentures, because these debentures having been issued at par, the Respondent took the view that the calculated yield would be approximately equal to the interest or coupon rate of 9.6%.

j)           The Appellant did not hedge the U.S. dollar face amount of the 1992 Debentures against a perceived decline in the value of the Canadian dollar relative to the U.S. dollar.

k)          Since the U.S. dollar face amount of the 1992 Debentures was not hedged pursuant to their terms against a perceived decline in the value of the Canadian dollar relative of the U.S. dollar, the face amount, in Canadian dollar terms, was for financial purposes, Cdn. $238,838,000 at the time of their issuance (U.S. $200,000,000 multiplied by the rate of exchange of 1.1919 at the time of issuance).

l)            While the Appellant hedged against perceived appreciations of the value of the Canadian dollar relative to the U.S. dollar in order to reduce a potential adverse impact on its future Canadian production costs, it did not hedge against any perceived depreciation of the value of the Canadian dollar relative to the U.S. dollar in order to reduce the potential adverse impact on its Canadian dollar costs of repaying or repurchasing the 1992 Debentures.

m)          Because the Appellant received a substantial portion of its revenues in U.S. dollars, which it deposited in U.S. dollar bank accounts, the Appellant always had sufficient U.S. dollar funds on hand to redeem or to purchase in the open market those portions of the said 1992 Debentures it wished to redeem or purchase, and therefore found it unnecessary to hedge against any perceived depreciation of the value of the Canadian dollar relative to the U.S. dollar with respect to the 1992 Debentures.

n)           Under the terms of the 1992 Debentures, the debentures were not redeemable prior to June 15, 2002. On or after June 15, 2002, and up to June 14, 2012, the debentures were redeemable at the Appellant's option, as a whole or in part, at redemption prices ranging from 104.8% to 100.48% of the face amount thereof, and thereafter at 100% of the face amount.

o)           Because the 1992 Debentures were not redeemable prior to June 15, 2002, the Appellant purchased, between March 3 and November 8, 2000, a total of U.S. $21,692,000 of the said 1992 Debentures (the "Purchased Amount"), as is also detailed in Appendix "D", in the open market through various brokers for a total of U.S. $21,269,708 (the "Purchase Price of the 1992 Debentures"), as is also detailed in Appendix "D" .... On the Appellant's instructions these purchased debentures were then cancelled on February 21, 2001.

p)           The Appellant obtained all U.S. dollar amounts required for the said purchases of the 1992 Debentures by drawing on its U.S. dollar bank accounts and at no time converted any Canadian dollars into U.S. dollars for these purposes.

q)           The Canadian dollar equivalent of the Purchased Amount determined at the exchange rate at the time of issuance was Cdn. $25,854,589 (U.S. $21,692,000 x 1.1919).

r)            The Canadian dollar equivalent of the Purchase Price determined at the exchange rates at the different dates of purchase between March and November 2000 was Cdn. $32,039,855, the details of which are reflected in Appendix "D" ....

s)            In its income tax return for the 2000 taxation year the Appellant claimed a loss of Cdn. $20,828,019 it said it sustained on account of the 1989 Debentures and 1992 Debentures, as detailed in Appendix "G" .... It claimed the said loss as a capital loss, but did not deduct any amount on account thereof in that year, because it had insufficient capital gains in that year.

t)            The said claim of Cdn. $20,828,019 is a total of foreign exchange losses which the Appellant says it sustained on the redemption of the 1989 Debentures and 1992 Debentures. It does not include the discount on the 1989 Debentures which it deducted in computing its income, as aforesaid in subparagraph 3(e) thereof.

u)           The said amount of Cdn. $20,828,019 is a total of Cdn. $14,642,753 on account of the 1989 Debentures and Cdn. $6,185,266 on account of the 1992 Debentures, as also detailed in Appendix "D" ....

v)           The said amount of Cdn. $14,642,753 is a total of the amounts of Cdn. $8,202,355 on account of the Appellant's said open market purchases of the said U.S. $29,120,000 of the said 1989 Debentures, and Cdn. $6,440,398 on account of the said sinking fund redemption of the said U.S. $22,500,000 of the said 1989 Debentures, as detailed on Appendix "G"....

w)          The said amount of Cdn. $6,185,266 was all on account of the Appellant's said open market purchases of the said U.S. $21,692,000 of the said 1992 Debentures, as reflected in Appendix "D", ....

5.          The Respondent does not agree that the Appellant sustained any foreign exchange losses on the said partial redemption and open market purchases of the 1989 Debentures and on the Appellant's purchase in the open market of the said portions of the 1992 Debentures.

6.          However, in the event the Court should find that the Appellant did sustain foreign exchange losses in the total amount of Cdn. $20,828,019 on the partial redemption and open market purchases of the 1989 Debentures and on the open market purchases of the 1992 Debentures, as alleged by the Appellant, the parties agree that

a)           a total of Cdn. $14,387,621 was sustained by the Appellant as a result of the said open market purchases of portions of the 1989 Debentures and the 1992 Debentures, as detailed in Appendix "H" ..., and

b)           Cdn. $6,440,398 was sustained by the Appellant as a result of the redemption of a portion of the 1989 Debentures, as detailed in Appendix "I" ....

7.          The parties to this appeal are at liberty to adduce as additional evidence only admissible expert evidence regarding the usage of the terms "principal amount" and "yield" in the financial/commercial industry and admissible expert evidence regarding the treatment in the financial/commercial industry of foreign exchange losses experienced or expected by non-U.S. corporate issuers of debt obligations in U.S. dollars.

[8]      The Respondent adduced evidence of the sort described in paragraph 7 of the Statement of Agreed Facts. Counsel filed the statement of David Wayne Hoyle, an expert with thirty years experience in the financial services industry. The statement was filed by agreement and was not challenged by counsel for the Appellant except as to relevance.

[9]      In my view, evidence regarding the accepted meaning of the term "principal amount" in the industry most directly involved in dealing with debt instruments is of assistance in discovering what the legislature had in mind when it used the term. It is unlikely that the Legislature would employ language having a meaning foreign to those who work in the field most directly affected by paragraph 20(1)(f). The evidence is relevant, it assists the Court and Mr. Hoyle is well qualified to give it.

[10]     The following points are made in Mr. Hoyle's statement:[3]

1.          In the financial industry, what is understood to be the "principal amount" in the context of debt instruments issued by a corporate borrower of funds, such as debentures?

■            The face amount of a bond or debenture or the amount owed on a loan separate from interest.

2.          At what point in time do the issuer of a debenture and its purchaser consider the "principal amount" of the debenture to come into existence?

          ■           When the debenture is issued.

3.          On the assumed facts in the present case, what amounts would the financial industry consider the principal amount of the debentures which the Appellant issued in 1989 (hereinafter the "1989 Debentures") and in 1992 (hereinafter the "1992 Debentures") to be?

            ■           1989 Debentures - $150,000,000

            ■           1992 Debentures - $200,000,000

4.          In the practice and experience of the financial industry, can the "principal amount" of a debenture ever increase beyond its face amount at the time it is issued?

■            Generally speaking, the face amount owing on the debenture cannot increase beyond the amount owed.

5.          What factors are responsible for debentures to be issued at less or more their face value?

■            The coupon rate offered on the debenture may be above or below the prevailing market rate of interest and this would result in the price of the debenture being above or below Par.

[11]     In argument, counsel for the Appellant pointed out that paragraph 20(1)(f) affords in subparagraph (i) a full deduction if both a discount and yield test are satisfied, and in subparagraph (ii) a fractional deduction if those tests are not met; that the deduction may only be made at the time of repayment; and that the amount eligible for the full or fractional deduction is the lesser of

(i) the principal amount of the obligation, and

(ii) all amounts paid in satisfaction of the principal amount of the obligation

MINUS

the amount for which the obligation was issued.

[12]     Thus, paragraph 20(1)(f) requires the determination of three amounts, namely:

(a)       the principal amount of the obligation;

(b)       the amount for which the obligation was issued; and

(c)       all amounts paid in satisfaction of the principal amount .

[13]     Both counsel agreed that for income tax purposes all amounts must be reported in Canadian dollars. In this regard counsel relied on Alberta Gas Trunk Line v. Minister of National Revenue[4] and on Hope Gaynor v. Her Majesty the Queen[5]. Both agreed that the (b) and (c) amounts must be determined by converting U.S. dollars into Canadian dollars at the rates of exchange in effect when the debentures were issued and repaid respectively.

[14]     It is the timing of the conversion of the "principal amount of the obligation" on which opposing counsel differed. If fluctuations in foreign exchange rates occurring after the issuance of an obligation denominated in foreign currency do, as the appellant contended, affect the principal amount of the obligation for purposes of paragraph 20(1)(f), then conversion of the principal amount to Canadian dollars must take place at exchange rates in effect when the debenture debt is retired and not, as the Respondent contends, when the debt is created.[6]

[15]     Counsel for the Appellant argued that reading "principal amount" in paragraph 20(1)(f) as a reference to principal amount at time of issue requires reading extra words into the provision. I note in passing that reading the term to mean principal amount at the time of repayment, as the Appellant says is required, also involves reading in words not present in the statutory text. Extra words arguments do not help either side.

[16]     In support of his "conversion of the principal amount at the time of repayment" argument counsel for the Appellant seeks support in the subsection 248(1) definition of "principal amount" applies. It reads:

"principal amount" - "principal amount", in relation to any obligation, means the amount that, under the terms of the obligation or any agreement relating thereto, is the maximum amount or maximum total amount, as the case may be, payable on account of the obligation by the issuer thereof, otherwise than as or on account of interest or as or on account of any premium payable by the issuer conditional on the exercise by the issuer of a right to redeem the obligation before the maturity thereof;

[17]     Counsel noted that paragraph 20(1)(f) does not expressly indicate when the principal amount of the obligation is to be determined and that where, as here, the debt must be repaid in foreign currency the "maximum amount payable" referred to in the subsection 248(1) definition cannot by reason of exchange rate fluctuations be ascertained until the debt is repaid.

[18]     Based on this interpretation of paragraph 20(1)(f), counsel for the Appellant submitted that subparagraph 20(1)(f)(ii) applies in the circumstances of this case because the discount test was not met. The principal amount of the debentures calculated using exchange rates prevailing when the debt was retired greatly exceeded the amount for which they were issued. Thus counsel claimed that the deductible amount was:

Lesser of the amount paid (CDN $108,267,849

and principal amount

(no less than CDN $108,267,849)                     CDN $108,267,849

minus

            Amount for which issued                        CDN $85,838,614

                                                                        CDN $22,429,235

            Amount deducted                                  CDN $1,601,216

                                                                        CDN $20,828,019

                                                                        CDN $13,512,308

[19]     Counsel for the Appellant argued next that calculation of the 20(1)(f) deduction on the basis of a principal amount which escalates accords with statutory intent for (a) it permits the deduction of a cost of borrowing where the borrowing is in foreign currency, and (b) it defers the determination of whether subparagraph 20(1)(f)(i) or subparagraph 20(1)(f)(ii) applies until the time when the deduction is permitted to be taken. I note in passing that it is not immediately apparent either that the Legislature intended paragraph 20(1)(f) to permit the deduction of amounts other than discounts or that foreign exchange conversion costs may accurately be described as borrowing costs.

[20]     Finally counsel argued that the Respondent's interpretation of paragraph 20(1)(f) leads to an absurdity, namely, that the amount paid in satisfaction of the principal amount would exceed the principal amount where, as here, the Canadian dollar has declined. I note that I see no such absurd result. The principal amount is one thing. What is paid in satisfaction of the principal amount of the instrument is quite another. In the present circumstances it can only be the cost expressed in Canadian dollars of repayment of a principal amount expressed in U.S. dollars computed at the exchange rate in effect at the time of repayment.

[21]     Counsel for the Respondent took a rather different view of the issues. In his submission, the first issue is whether, absent conversion of Canadian dollars to U.S. dollars for the purpose of retiring the debentures, the Appellant sustained a deductible foreign exchange loss on repayment or redemption of $22,500,000 of the 1989 debentures. This is the payment referred to in paragraph 3(q) of the Statement of Agreed Facts and is the only payment which counsel for the Respondent accepts as "... an amount paid in the year in satisfaction of the principal amount of any ... debenture ..." within the opening words of paragraph 20(1)(f).

[22]     The next issue, according to the Respondent, was whether the Appellant sustained any foreign exchange loss on the open market purchases of the U.S. $29,012,850 portion of the 1989 debentures between February and May, 2000 and on the open market purchases of the U.S. $21,269,708 portion of the 1992 debentures between March and November, 2000. He asserted, once again, that no loss was sustained in the absence of conversion of Canadian dollars into U.S. dollars for purposes of the purchases.

[23]     Counsel argued that the principal amount of the Appellant's debt was fixed by the terms of the debentures and, in accordance with those terms, could not increase after they were issued. Equally, he said, the Canadian dollar equivalent of the principal amount could not increase after issuance. Thus the section 248 maximum amount payable under the terms of the debentures was fixed at the time of issue and could not be viewed as subject to change by reason of subsequent events for which provision was not made in the debentures themselves. What did increase was the Canadian dollar measure of "amounts paid in satisfaction of the principal amount". Thus, he said, the entire basis for the Appellant's claim under paragraph 21(f) rests on a confusion of the statutory terms "principal amount" and "amount paid in satisfaction of the principal amount".

[24]     Next, counsel for the Respondent addressed the question whether foreign exchange losses, if sustained or realized (i) in respect of the repayment of the $22,500,000 portion of the 1989 debentures and (ii) in respect of the open market purchases of both 1989 and 1992 debentures are deductible at all. He reiterated his position that paragraph 20(1)(f) affords the Appellant no relief. The Appellant was obliged, according to the Respondent, to look to subsections 39(2) and 39(3) of the Act for relief in respect of foreign exchange losses, if any were sustained.

[25]     It will be noted that both sides disagree with the decision of this Court in Imperial Oil Limited v. Canada, 2004 TCC 207 in which Miller J. held that "Parliament did not intend foreign exchange losses to be deductible under paragraph 20(1)(f) as they pertained to the capital element of a borrowing". The Court stated:

Applying the [20(1)(f)] - formula in the currency of the obligation and converting the result into current Canadian dollars, not only makes the most sense in the ordinary and grammatical sense, but also does not offend any well-established principle of statutory interpretation.

[26]     With respect, I agree with Miller, J. that paragraph 20(1)(f) does not permit the deduction of foreign exchange losses arising from the issuance of debt instruments denominated in foreign currency.[7] My view however rests on grounds which are somewhat different from those expressed by my colleague.

[27]     The Appellant's claim to the deduction in issue rests on the assertion that

          (a)       it realized a foreign exchange loss on the purchase for cancellation or redemption of the debentures; and

          (b)      the loss is deductible under paragraph 20(1)(f) of the Act.

[28]     The loss which the Appellant claims is somewhat difficult to pin down. In argument, counsel for the Appellant described it as "... the foreign exchange loss realized on the purchase for cancellation or redemption of the debentures ...". Assuming, without deciding, that the cost of the purchase of a debt instrument is, for purposes of paragraph 20(1)(f), "an amount paid in satisfaction of the principal amount", and thus that the entire transaction described by counsel represents repayment of the debenture debt, the origin of the loss claimed by the Appellant remains elusive. In 1989 and 1992, the Appellant borrowed U.S. dollars. It deposited them in its U.S. dollar bank account in one case and used them to repay previously existing U.S. dollar debt in the other. In 2000, it obtained the U.S. dollars required to retire both the 1989 and 1992 debentures by drawing on its U.S. dollar bank account. I can find no basis on the facts for a conclusion that changes in the value of the Canadian dollar relative to the U.S. dollar during the term of the debentures resulted in any realized loss or cost to the Appellant at all.

[29]     I reject the notion that the Appellant sustained a loss because it returned the very thing it had borrowed. Where a taxpayer borrows something, be it $5 Canadian, $5 U.S. or a cup of sugar and subsequently returns the exact thing that was borrowed without intervening dealings, neither borrower nor lender is richer or poorer as a result of the transaction. What the Appellant seeks to deduct is a phantom loss. It is impossible to imagine that the Legislature in enacting paragraph 20(1)(f) intended to permit a deduction in the absence of a realized loss or cost. To conclude otherwise would require an assumption that the Legislature intended, without apparent reason, to carve out an exception to the general scheme of the Act which recognizes capital gains and losses only when realized by disposition.

[30]     I have no doubt that for Canadian income tax purposes the financial results of a taxpayer's transaction must be reported in Canadian dollars. In Hope Gaynor v. The Queen, supra, a case much discussed by both counsel, the Federal Court of Appeal considered the proper method of computing the capital gain realized by a taxpayer upon the disposition of shares that had been bought by the taxpayer using U.S. currency and sold by her for consideration in U.S. currency. The taxpayer sought to deduct the U.S. dollar cost from U.S. dollar proceeds and then convert the difference to Canadian dollars using exchange rates in effect at the time of sale. The Court held that the gain resulted from the comparison of two amounts, proceeds of disposition and adjusted cost base and that the Canadian equivalent of each had to be computed using rates of exchange in effect at the time of sale and purchase respectively. I cannot accept the argument that anything said in Gaynor requires conversion of the principal amount of the obligation for purposes of paragraph 20(1)(f) using exchange rates in effect at the time of repayment. No comparison of the sort required to measure the taxpayer's gain in Gaynor is needed here because the Appellant repaid exactly what it borrowed resulting in neither gain nor loss.

[31]     In my view the ordinary meaning of the term "principal amount" as used in paragraph 20(1)(f) and the meaning in the financial industry as set out by Mr. Hoyle are one and the same. The principal amount of an instrument is the face amount. It comes into existence when the instrument is issued. Logic dictates that conversion, when required, take place when the face amount is fixed. Moreover, as counsel for the Respondent submitted, the subsection 248(1) definition of the term "principal amount" requires that the principal amount of an obligation be determined "under the terms" of the obligation. Those terms do not vary. They are fixed when the obligation is issued. Since the principal amount of the obligation does not vary after it is issued there is no basis in logic for adopting the view that the expression of that principal amount in a foreign currency gives the Canadian dollar equivalent of the principal amount a variable quality. In my opinion, the Appellant's suggestion that the Canadian dollar equivalent of the U.S. dollar principal amount computed at the time of repayment is the principal amount for purposes of paragraph 20(1)(f) involves the confusion of two concepts which the provision treats as distinct, namely, the principal amount of the obligation and amounts paid in satisfaction thereof.

[32]     The Interpretation Act[8] provides:

12. Every enactment is deemed remedial, and shall be given such fair, large and liberal construction and interpretation as best ensures the attainment of its objects.

The object of paragraph 20(1)(f) is to allow the deduction, within limits, not of all costs, whether related closely or distantly to a borrowing, but rather of discounts which are closely related to interest but do not fall within the ambit of paragraph 20(1)(c) of the Act. In Krishna, the Fundamentals of Canadian Income Tax, 7th ed. (Toronto: Carswell, 2002), the following is said at page 615:

            Corporations can issue debt obligations at face value, at a discount, or at a premium from their face value. A discount or premium generally reflects economic adjustments to the nominal rate of interest to bring it into line with the effective market rate applicable at the time that the obligation is issued.

This view of the purpose underlying paragraph 20(1)(f) is supported by the marginal note which, although not part of the enactment[9], may nevertheless be of assistance.[10]

[33]     The Appellant submits that predicating the deduction in paragraph 20(1)(f) on an escalating term such as "principal amount" instead of a static term such as "face amount" accords with the legislative scheme for it permits the deduction of a cost of borrowing where debt repayment is in a medium other than Canadian currency. I do not accept the submission. In my view, foreign exchange fluctuations neither add to nor subtract from the cost of borrowing. The point was made succinctly by Templeman L.J. in Pattison v. Marine Midland Ltd.[11] as follows:

            My Lords, a profit or loss may be earned or suffered if a borrower changes the currency he borrows but that profit or loss arises from the exchange transaction and not from the borrowing.

In my opinion, an interpretation of paragraph 20(1)(f) which treats the term principal amount as an amount which fluctuates with exchange rates over the life of the instrument would expand the deduction to include amounts which were never in the contemplation of the Legislature.

[34]     In the circumstances, it is not necessary to consider whether the consideration paid on the purchase in the open market of a debt instrument by the issuer of it constitutes an amount paid in satisfaction of the principal amount of the instrument for purposes of paragraph 20(1)(f).

[35]     For the foregoing reasons this branch of the appeal fails. It fails as well on the only other issue which was dealt with by the decision of this Court on the section 58 application referred to in paragraph 2. The appeal will therefore be dismissed with costs.

Signed at Toronto, Ontario, this 18th day of October 2004.

"M.J. Bonner"

Bonner, J.

CITATION:

2004TCC468

COURT FILE NO.:

2002-2695(IT)G

STYLE OF CAUSE:

Inco Limited and H.M.Q.

PLACE OF HEARING:

Vancouver, British Columbia

DATE OF HEARING:

June 15-16, 2004

REASONS FOR JUDGMENT BY:

The Honourable Justice M.J. Bonner

DATE OF JUDGMENT:

October 18, 2004

APPEARANCES:

Counsel for the Appellant:

Warren Mitchell Michael Colborne

Counsel for the Respondent:

Luther Chambers

COUNSEL OF RECORD:

For the Appellant:

Name:

Warren Mitchell

Firm:

Thorsteinssons Toronto, Ontario

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

---