The Supreme Court’s Textual Interpretation of Tax Statutes

The Income Tax Act [ITA] “is the battlefield on which over 21 million Canadian taxpayers engage with the Minister of National Revenue” (Justice Binnie, writing in Imperial Oil Ltd v Canada; Inco Ltd v Canada, [2006] 2 SCR 447 [Imperial Oil]). The rules of engagement are immensely complex. The ITA (including historical references and various annotations) runs for more than 2000 pages (in small print) and weighs more than one kilogram! The Supreme Court of Canada (“SCC”) is sometimes called upon to interpret the meaning of these rules. The SCC has adopted the so-called “modern rule” of statutory interpretation:

The words of the Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament. (Stubart Investment Ltd. v. The Queen, [1984] 1 S.C.R. 536)

The SCC has also stated that the interpretation of the ITA, as with any statute, must proceed on the basis of a textual, contextual and purposive analysis (Canada Trustco Mortgage Co v Canada, [2005] 2 SCR 601).

Applying the principle of textual, contextual and purposive interpretation to the immensely detailed and complex ITA is not a small feat. This is evident in the recent 4-3 split decision of the SCC in Imperial Oil. The battle in this case was about the deductibility of C$27.8 million of foreign exchange losses from profit. The taxpayer had issued debentures denominated in U.S. dollars. Between the date of issue and the date of redemption of the debentures the U.S. dollar had appreciated against the Canadian dollar.

The taxpayer suffered C$27.8 million of foreign exchange loss on redemption. The issue is whether the taxpayer can deduct this loss from its income under s. 20(1)(f) of the ITA. Section 20(1)(f) permits the taxpayer to deduct the amount by which the original issue proceeds of the debt are exceeded by the amount paid in satisfaction of the principal amount of the debt. The question is whether the deduction is limited to “discount” arising from the original issuance of the debt.

The majority of the SCC examines the wording, structure and scheme of s. 20(1)(f), other provisions of the ITA (such as s. 39(2) which allows a deduction for foreign exchange losses on capital account), as well as the intention of Parliament in enacting s. 20(1)(f). According to LeBel J., the wording of s. 20(1)(f) clearly supports the deduction of “discount”, but not foreign exchange losses. While acknowledging that “Parliament encourages companies to raise capital by allowing them to deduct virtually all costs of borrowing under the provisions of s.20(1)” (paras. 65 and 103), LeBel J. is not convinced that the cost of dealing in a foreign currency is an intrinsic cost of borrowing for the purposes of the Act. He opines that the scheme of s. 20(1), which provides deductions for virtually all costs of borrowing, does not imply that foreign exchange losses are also deductible.

The other costs enumerated in s. 20 are intrinsic costs of borrowing. Foreign exchange losses arise only where the debtor chooses to deal in foreign currency. If s. 20(1)(f) were to apply to foreign exchange losses, it would operate quite differently in relation to obligations denominated in foreign currency than it does in relation to obligations denominated in Canadian dollars. It could be applied to even where there was no original issue discount. There is no indication that Parliament intended such result. He concludes, therefore that the purpose of s. 20(1)(f) “is to address a specific class of financing costs arising out of the issuance of debt instruments at a discount” (para. 65). Other provisions of the ITA, such as s. 39(2), are helpful in establishing Parliament’s intent to treat foreign exchange losses as capital losses (para. 68).

The minority of the SCC finds that the conditions for deduction under s. 20(1)(f) are met by the taxpayer because the “principal amount” must be ascertained at the date of redemption (as opposed to the face amount of foreign debt converted into Canadian dollars at the date of issuance). As such, foreign exchanges losses are deductible under s. 20(1)(f). The minority sees the foreign exchange losses as part of the borrowing transaction and the deduction of such losses is consistent with the purpose of s. 20(1). To the minority, LeBel’s narrow interpretation of s. 20(1)(f) would act as a deterrent to corporate borrowings in a global economy.

Overall, the majority gives more weight to the integrity of the legislative scheme of ITA and the intention of Parliament, whereas the minority is more persuaded by the practical realities of the taxpayer in raising capital in foreign currencies.

The Imperial Oil case is interesting in that the Minister won the battle by relying on the text of the ITA. In most other cases, such as Shell Canada Ltd v Canada, [1999] 3 SCR 622, the role and fortune were reversed. In this sense, the SCC has been fairly consistent: “the particularity and detail of many tax provisions have often led to an emphasis on textual interpretation.”