This case concerns the tax treatment of a sophisticated financing transaction, known as a “weak currency financing scheme”, undertaken by Shell Canada.
In 1988, Shell Canada required about $100 million in United States currency (“US$”) for general corporate purposes. The market rate for a direct borrowing of US$ was 9.1 percent. Instead of borrowing US$ directly, however, Shell Canada entered into two agreements. The first agreement (the “Borrowing Contract”), involved the appellant borrowing $150 million in New Zealand currency (“NZ$”) at an interest rate of 15.4 percent per annum (which was found to be the market rate for borrowing NZ$). The second agreement (the “Purchasing Contract”), involved the appellant using the New Zealand funds to purchase US$100 million at the market price.
In order to fulfill Shell Canada’s requirement for New Zealand dollars, the Purchasing Contract provided for the appellant to purchase enough New Zealand dollars to satisfy the interest payments under the Borrowing Contract and for the appellant to purchase NZ$150 million for US$79 million on the date when the principal came due under the Borrowing Contract. The difference in the cost of the NZ$150 million at the time the Borrowing Contract was entered (US$100 million) and at the time the principal was to be repaid (US$79 million) resulted in a US$21 million “gain” to Shell Canada.
In computing its tax liability, Shell Canada deducted the 15.4 percent interest it had paid under the Borrowing Contract and characterized the US$21 million gain as a capital gain.
The tax authorities reassessed the tax liability by allowing only the cost of directly borrowing US$ (9.1 percent) as an interest expense and characterized the “gain” as income.
Shell Canada appealed to the Tax Court where the court found in favour of Shell Canada and allowed the full 15.4 percent to be deducted as an expense. The Tax Court also characterized the gain as a capital gain:
An appeal was then filed by the tax authorities with the Court of Appeal.
The Court of Appeal reversed the Tax Court’s finding with respect to the interest deduction applying an “economic substance over form” doctrine which essentially dictated that the Borrowing Contract and Purchasing Contract be considered together: [1998] 3 F.C. 64. This in turn led the Court of Appeal to a determination that the 15.4 percent interest rate expense claimed failed to comply with three of the requirements that must be satisfied for a claimed expense to qualify as “interest” under the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.): it was not interest, it was not used for the purpose of earning income and it was not reasonable. Therefore, the Court of Appeal disallowed any interest expense claimed above 9.1 percent – the direct cost of borrowing US$.
Shell Canada then filed an appeal with the Supreme Court on that issue.
Judgement of the Court
Excerpt
“10 The respondent’s argument on the capital gain issue would not, if accepted, uphold the judgment of the Court of Appeal. According to that judgment, the appellant may claim an interest expense of 9.1 percent per annum on the principal amount borrowed under the Borrowing Contract in the computation of its taxable income. The respondent says that if the appeal against that ruling succeeds, the respondent ought to be free to argue that the tax burden thus reduced should nevertheless be restored in whole or in part by recharacterizing the gain on the Borrowing Contract as income rather than capital.
11 In my view, the respondent would be required to obtain leave to cross-appeal before raising this issue at the hearing of the appeal.
12 In the first place the judgment of the Federal Court of Appeal dated February 18, 1998 refers the matter back to the Minister “to be reassessed in accordance with the Reasons for Judgment herein”. The Minister’s authority is thus closely circumscribed by the reasons as well as the outcome of the appeal to that court.
13 Secondly, there is no reason to believe (and the respondent has not offered any proof) that the net effect of reclassifying the US$21 million gain as income would be the same as the net effect on the appellant’s tax burden of the reasons for judgment of the Court of Appeal. If the tax burden calculated under the respondent’s alternative argument differs from the tax burden calculated under the Court of Appeal’s judgment, then recharacterizing the gain as income rather than capital would not uphold even the outcome, much less the reasons for judgment of the Federal Court of Appeal.
14 Accordingly, if the respondent wishes to keep the capital gain issue alive in this Court, she cannot do so without leave. The proper procedure would be to now serve and provide the Court with the proposed leave application with respect to the cross appeal, accompanied by an application for an extension of time within which to file same, as set out in the Notice to the Profession dated January 1996. The leave panel may then determine whether it is appropriate to have all aspects of the “weak currency financing scheme” before the Court on the main appeal.
1999scr3_616