A-147-80
The Queen (Appellant)
v.
Melford Developments Inc. (Respondent)
Court of Appeal, Thurlow C.J., Urie J. and Kelly
D.J.—Toronto, January 14 and 15, 1981.
Income tax — Non-residents — Withholding tax — Appeal
from Trial Division decision vacating assessments respecting
guarantee fees paid by respondent to non-resident corporation,
a German commercial bank — Whether Canada-Germany
Income Tax Convention exempts corporation from Canadian
tax liability and thus respondent from deducting and remitting
tax otherwise payable — Submission by appellant that since
the payment of guarantee fees is deemed a payment of interest,
the fee itself is interest and the income received by the corpo
ration is income from "interest" payments and taxable under
Art. 111(5) of the Convention — Income Tax Act, S.C. 1970-
71-72, c. 63, ss. 212(1)(b), 214(15)(a) and 215(1),(6) — Cana-
da-Germany Income Tax Agreement Act, 1956, S.C. 1956, c.
33, ss. 2, 3, Convention, Arts. 11(2), 1!1(1),(5).
This is an appeal from a judgment of the Trial Division
vacating assessments by the Minister of National Revenue
arising as a result of the respondent's failure to deduct and
remit tax on the guarantee fees paid by it to a non-resident
corporation, a German commercial bank. The issue is whether
the Canada-Germany Income Tax Convention exempts the
corporation from Canadian tax liability on such payments and
thus exempts the respondent from deducting and remitting the
tax otherwise payable. Appellant contends that since subsection
214(15) of the Income Tax Act deems the payment of guaran
tee fees to be a payment of interest, the fee itself is interest, and
the income received by the corporation is income from "inter-
est" payments and thus subject to tax liability pursuant to
Article III(5) of the Convention.
Held, the appeal is dismissed. Subsection 214(15) does not
deem that the guarantee fee is "interest" but only that the
payment of it shall be deemed to be "a payment of interest".
The deeming of the payment to be what it is not does not
change the character or nature of the thing that was paid. It
could never in fact be a payment of interest because it was
always a payment of a fee which a guarantor receives for
assuming a risk for which he may never be called upon to
indemnify the lender, as opposed to "interest". Furthermore,
the Convention does not encompass a conversion of guarantee
fees into interest. Article III(5) is referable to the kinds of
income specifically dealt with later in the Convention (i.e. those
which Canada may tax). Deemed payments of interest, or even
something which is not interest but is deemed to be interest, are
not included. The meaning of "interest" cannot be enlarged.
Article II(2) of the Convention refers to the meaning of the
terms as accepted by the parties from the taxing statutes as
they existed when the Convention was negotiated.
In re Farm Security Act, 1944 [1947] S.C.R. 394, con
sidered. Attorney-General for Ontario v. Barfried Enter
prises Ltd. [1963] S.C.R. 570, considered. R. v. The
County Council of Norfolk (1891) 60 L.J.Q.B. 379,
considered.
INCOME tax appeal.
COUNSEL:
C. G. Pearson for appellant.
J. R. Dingle for respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Blaney, Pasternak, Smela & Watson,
Toronto, for respondent.
The following are the reasons for judgment
delivered orally in English by
THURLOW C.J.: I agree with Mr. Justice Urie's
reasons for concluding that the guarantee fees in
question in this appeal are exempted from tax
under the Income Tax Act, R.S.C. 1952, c. 148,
by the Canada-Germany Income Tax Agreement
Act, 1956, S.C. 1956, c. 33, and that the appeal
fails and should be dismissed with costs.
* * *
The following are the reasons for judgment
delivered orally in English by
URIE J.: This is an appeal from a judgment of
the Trial Division [[1980] 2 F.C. 713] vacating
assessments made by the Minister of National
Revenue which required payment of tax and
penalties for the 1975, 1976 and 1977 taxation
years. These assessments arose as a result of the
respondent's failure to deduct and remit tax of
$9,000 in each of the years 1975 and 1976 on the
sum of $60,000 paid by the respondent in each of
those years to a non-resident of Canada and of the
sum of $4,500 in 1977 on the $30,000 paid by it in
1977 to that non-resident.
The decision was determined at trial on an
agreed statement of facts. Summarized, those facts
follow. The respondent, which is in the business of
developing real property for resale, arranged to
borrow the sum of $6,000,000 (Canadian) in 1973
from The Bank of Nova Scotia. The lender
required a guarantee for the loan. As a result one
was obtained for the full amount of the indebted
ness from Bayerische Vereinsbank Incorporating
Bayerische Staatsbank AG (hereinafter called
"Vereinsbank"), a German commercial bank. For
providing the guarantee Vereinsbank charged a fee
calculated at the rate of 1% per annum of the
principal sum, payable in quarterly instalments of
$15,000 each. Vereinsbank was not a resident of
Canada nor did it have a permanent establishment
of any kind in Canada. In remitting the moneys
required to be paid by it to Vereinsbank, the
respondent did not deduct or withhold any tax
from the quarterly payments in any of the periods
which are the subject of the assessments in issue,
as it is alleged by the appellant it was required to
do by virtue of Part XIII of the Income Tax Act,
R.S.C. 1952, c. 148 as amended by s. 1 of c. 63,
S.C. 1970-71-72.
It is common ground that unless the provisions
of the Canada-Germany Income Tax Convention
entered into in 1956, made part of the Canadian
law by the enactment of the Canada-Germany
Income Tax Agreement Act, 1956, S.C. 1956, c.
33, exempt Vereinsbank from liability for Canadi-
an income tax, Part XIII of the Income Tax Act
imposed a duty on the respondent to withhold tax
on each payment made to the bank at the rate of
15% and to remit such withheld amounts to the
Receiver General of Canada. The issue, then, is
whether the Convention exempted Vereinsbank
from Canadian tax liability on such payments and
thus exempted the respondent from deducting and
remitting the tax otherwise payable. The learned
Trial Judge held that it did.
The relevant sections of Part XIII of the Income
Tax Act follow:
212. (1) Every non-resident person shall pay an income tax
of 25% on every amount that a person resident in Canada pays
or credits, or is deemed by Part Ito pay or credit, to him as, on
account or in lieu of payment of, or in satisfaction of,
(b) interest except
214. (15) For the purposes of this Part,
(a) where a non-resident person has entered into an agree
ment under the terms of which he agrees to guarantee the
repayment, in whole or in part, of the principal amount of a
bond, debenture, bill, note, mortgage, hypothec or similar
obligation of a person resident in Canada, any amount paid
or credited as consideration for the guarantee shall be
deemed to be a payment of interest on that obligation; ...
215. (1) When a person pays or credits or is deemed to have
paid or credited an amount on which an income tax is payable
under this Part, he shall, notwithstanding any agreement or any
law to the contrary, deduct or withhold therefrom the amount
of the tax and forthwith remit that amount to the Receiver
General of Canada on behalf of the non-resident person on
account of the tax and shall submit therewith a statement in
prescribed form.
(6) Where a person has failed to deduct or withhold any
amount as required by this section from an amount paid or
credited or deemed to have been paid or credited to a non-resi
dent person, that person is liable to pay as tax under this Part
on behalf of the non-resident person the whole of the amount
that should have been deducted or withheld, and is entitled to
deduct or withhold from any amount paid or credited by him to
the non-resident person or otherwise recover from the non-resi
dent person any amount paid by him as tax under this Part on
behalf thereof.
It should be noted that the non-resident tax rate
of 25% in respect of interest is reduced by the
Convention to 15%.
It is also common ground that Vereinsbank was
not taxable under Part I of the Income Tax Act
because it was not resident in Canada. Neither
was it employed in nor did it carry on business in
Canada, nor did it dispose of taxable Canadian
property at any time during the taxation years in
question. However, the appellant contends that the
above quoted sections provide the basis for
Vereinsbank's liability for tax and for the respond
ent's liability to deduct and remit the tax to the
Receiver General arising from any of the quarterly
payments made to the guaranteeing bank.
On the other hand, the respondent contends that
the guarantee fees paid to Vereinsbank were
"industrial and commercial profits" within the
meaning of that term in the Convention and were
thus exempt from Canadian tax liability. Conse-
quently, the respondent had no duty to withhold
and remit tax pursuant to subsection 215(1) of the
Income Tax Act.
The Canada-Germany Income Tax Agreement
Act, 1956 contains, inter alia, the following
provisions:
2. The Agreement entered into between Canada and the
Federal Republic of Germany, set out in the Schedule, is
approved and declared to have the force of law in Canada.
3. In the event of any inconsistency between the provisions of
this Act, or the Agreement, and the operation of any other law,
the provisions of this Act and the Agreement prevail to the
extent of the inconsistency.
The Convention, annexed as a Schedule to the
above Act, discloses that among the taxes which
are the subject of the Convention are Canadian
income taxes.
Article II(2) provides that:
ARTICLE II
(2) In the application of the provisions of this Convention by
one of the contracting States any term not otherwise defined in
this Convention shall, unless the context otherwise requires,
have the meaning which it has under the laws in force in the
territory of that State relating to the taxes which are the
subject of this Convention.
Article III(1) provides the foundation for the
respondent's claim that Vereinsbank is exempt
from Canadian tax liability by reason of the fact
that the fees for guaranteeing the respondent's
loan received by it are "industrial or commercial
profits" from an enterprise which does not carry
on a trade or business in Canada through a perma
nent establishment situated therein. That Article
reads as follows:
ARTICLE III
(I) The industrial or commercial profits of an enterprise of
one of the territories shall not be subject to tax in the other
territory unless the enterprise carries on a trade or business in
the other territory through a permanent establishment situated
therein. If it carries on a trade or business in that other
territory through a permanent establishment situated therein,
tax may be imposed on those profits in the other territory but
only on so much of them as is attributable to that permanent
establishment.
The appellant, on the other hand, takes the
position that Vereinsbank is excluded from that
exemption by virtue of Article III(5) which reads:
ARTICLE III
(5) Paragraphs (1) and (2) shall not be construed as prevent
ing one of the contracting States from imposing pursuant to
this Convention a tax on income (e.g. dividends interest, rents
or royalties) derived from sources within its territory by a
resident of the other territory if such income is not attributable
to a permanent establishment in the first-mentioned territory.
The learned Trial Judge held that the quarterly
instalments for the guarantee fees were in the
nature of "industrial and commercial profits"
within the meaning of Article III(1). As I under
stood him, counsel for the appellant did not contest
that finding. However, his submission was that by
virtue of paragraph (5) of Article III the income
received by Vereinsbank being income arising
from "interest" payments "derived from sources
within its territory by a resident of the other
territory" (i.e. Germany) was excluded from the
exemption arising from paragraph (1) of Article
III. That contention was founded on his view that
the effect of subsection 214(15), which deems the
payment of guarantee fees to be payments of
interest on the obligation is to deem the fee itself
to be interest.
I am unable to agree with this contention.
Whatever is the meaning of the phrase concluding
the subsection, namely, "shall be deemed to be a
payment of interest on that obligation" (presum-
ably that obligation referring to the repayment of
the mortgage) it is clear that it does not deem that
the guarantee fee is "interest" but only that the
payment of it shall be deemed to be "a payment of
interest." Clearly the deeming of the payment to
be what it is not does not change the character or
nature of the thing that was paid. It could never in
fact be a payment of interest because it was always
a payment of a fee as consideration for the provi
sion of the guarantee.
Even if subsection 214(15) could be read to
mean that guarantee fees are deemed to be interest
and not just a payment of interest, it would not in
fact be interest. In the case of The Queen v. The
County Council' of Norfolk' it was said that:
... generally speaking, when you talk of a thing being deemed
to be something, you do not mean to say that it is that which it
is deemed to be. It is rather an admission that it is not what it is
' (1891) 60 L.J.Q.B. 379 at pp. 380 and 381.
to be deemed to be, and that, notwithstanding it is not that
particular thing, nevertheless, for the purposes of the Act, it is
to be deemed to be that thing.
That being so, there being no definition of "in-
terest" in the Convention, by virtue of Article
II(2), supra, the term for the purposes of the
Convention must have the meaning attributable to
it in Canada. In In re Farm Security Act, 1944 2
"interest" was defined as follows:
Interest is, in general terms, the return or consideration or
compensation for the use or retention by one person of a sum of
money, belonging to, in a colloquial sense, or owed to, another.
This definition was adopted in The Attorney-
General for Ontario v. Barfried Enterprises Ltd. 3
Accepting this as a proper definition of interest it
is difficult to see how guarantee fees can be char
acterized as "interest". A lender who receives in
terest from the money he lends, has, until the
money is repaid, lost control over his money. For
that loss of control and the risk inherent therein he
is paid interest. On the other hand, a guarantor
retains complete control of his money until, if ever,
he is called upon to honour his guarantee. The fee
he receives for providing the guarantee cannot,
therefore, be characterized as interest for provision
of money on loan, over which money he has lost
control. It is strictly a fee which he receives for
assuming a risk for which he may never be called
upon to indemnify the lender. 4
On the basis of these authorities, therefore, I am
of the opinion that the payment of the guarantee
fees was not a "payment of interest". That being
so, a fortiori, the guarantee fees cannot be said to
be "interest".
Furthermore, even if the appellant's submission
is accepted that subsection 214(15) has the effect
of converting guarantee fees into interest, for the
purpose of the Income Tax Act, it is my opinion
that Article III, paragraph (5), of the Convention
does not encompass such a conversion. I hold this
view for two reasons.
First, as earlier stated it is common ground that
the guarantee payments in question are "industrial
2 [1947] S.C.R. 394 at p. 411.
3 [1963] S.C.R. 570 at p. 575.
° Compare—Holder v. Inland Revenue Commissioners
[1932] All E.R. Rep. 265 at p. 271 and Bennett and White
Construction Co. Ltd. v. M.N.R. [ 1949] C.T.C. 1, at p. 4.
or commercial profits". Paragraph (5) of Article
III provides that notwithstanding this, Canada
could, pursuant to the Convention, impose tax on
income derived from Canadian sources by a resi
dent of Germany if the income is not attributable
to a permanent establishment in Canada. In paren
theses, examples of the kinds of income envisaged
as being encompassed by the paragraph are set out
viz. dividends interest, rents or royalties. The
underlined words above—pursuant to the Conven-
tion—provide the key to the meaning to be
ascribed to the paragraph. In my view the word
"pursuant" in the context can only mean "within
the limits of" or "as circumscribed by" the Con
vention. There may be other limiting words which
could assist in defining the meaning of the word,
but I think those illustrate it. If that is so then one
must look to the rest of the Convention to ascer
tain the kinds of income which Canada could
exclude by its tax laws from the exemption for
industrial or commercial profits provided by para
graph (1) of Article III.
It will immediately be seen that Article VI deals
with dividends, Article VII with "interest on
bonds, securities, notes, debentures or any other
form of indebtedness (exclusive of ...)", Article
VIII with copyright and industrial property and
Article XIII with income from immovable prop
erty. All of the types of income referred to in those
Articles are referred to parenthetically in para
graph (5) of Article III and as such they exemplify
the kinds of income which Canada could tax not
withstanding that each might also be considered
"industrial or commercial profits". The paragraph
does not enable Canada to declare that a kind of
income that was accorded exemption in the Con
vention as such profits and is not specifically pro
vided for in the Articles that follow shall be tax
able. Such a unilateral action would not be
possible, in my view, because it would be in viola
tion of the terms of a binding agreement freely
entered into by sovereign states. Such an agree
ment can only be varied or amended by agreement
of the parties not by the action of one party in
changing its tax laws by the enactment of a section
such as subsection 214(15) in 1974 some eighteen
years after the agreement was entered into.
In summary then it is my opinion that the
paragraph (5) of Article III is referable to the
kinds of income specifically dealt with later in the
Convention which are of a type parenthetically
referred to in the paragraph. Actual interest is one
of those. Deemed payments of interest, or even
something which is not interest but is deemed to be
interest, are not included.
The second reason which I believe leads to the
conclusion that paragraph (5) does not assist the
appellant is that I think that what is referred to in
Article II(2) of the Convention as the meaning of
terms is the meaning of the terms in the statutes in
force when the Convention was negotiated. That
accords with what is generally recognized as the
rule that is used in determining the meaning of
words or terminology embodied in an agreement
(and the Convention here in issue is essentially an
agreement between the contracting States) which
is that such words or terminology ought to be
given the meaning ordinarily ascribed to them in
the contracting States at the time the agreement
was entered into. I find it difficult to believe that it
could have been intended that some years after the
negotiation of the Convention, one of the parties
could, without further negotiation or discussion or
without entering into an amendment to the Con
vention, enlarge, restrict or otherwise vary the
meaning of the words or terminology as accepted
by the parties from the taxing statutes as they
existed at the time of the negotiation and execu
tion of the Convention. That is, in effect, what the
appellant urges us to do by enlarging the meaning
of "interest" as it was and is ordinarily understood,
through the application of subsection 214(15) of
the Act, enacted eighteen years after the Conven
tion, and so reading it in conjunction with para
graph (5) of Article III of the Convention. I do not
think that we ought to accept that submission.
I am, therefore, of the view that the learned
Trial Judge did not err in concluding that the fees
paid for Vereinsbank's guarantee were not taxable
in Canada and that, thus, subsection 215 (1) did
not impose any obligation on the respondent to
deduct and remit to the appellant taxes withheld
from the fees paid to Vereinsbank.
Accordingly, I would dismiss the appeal with
costs.
* * *
KELLY D.J.: I concur.
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.