http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/108430/index.do 
The TDL Group Co. v. The Queen (March 6, 2015 – 2015 TCC 60, Pizzitelli J.).
Précis: On March 18, 2002 Wendy’s International Inc. (“Wendy’s”) the ultimate parent of the Wendy’s/Tim Horton group advanced $234 million Cdn. ($147,654,000 US) to its US subsidiary, Delcan Inc. (“Delcan”). The loan bore interest at a rate not to exceed 7%. Delcan loaned the full amount to the appellant, The TDL Group Co. (“TDL”). The loan bore interest at a rate of 7.125%. On March 26, 2002 the full loan proceeds were used by TDL to buy an additional 1,840 common shares of its wholly-owned subsidiary Tim Donut U.S. Limited, Inc. (“Tim’s U.S.”). On March 27 Tim’s U.S. advanced the funds to Wendy’s on an interest free basis. The funds were repaid by Wendy’s on November 4, 2002 in the form of a new note bearing interest at 4.75%. [The repayment was to a new U.S. subsidiary of Tim’s U.S., Buzz Co., to which the March 27, 2002 note had been transferred in June of 2002 in exchange for common shares of Buzz Co.] CRA denied TDL the deduction of interest on the funds borrowed from Delcan for the period from March 28 to November 3, 2002. The basis for the denial of the deduction was two-fold:
1. That the funds were not borrowed for the purpose of earning income from a business or property; and
2. That the expense was not reasonable.
CRA allowed the deduction of interest on the Delcan loan for periods after November 3, 2002.
TDL’s argument was threefold:
1. TDL borrowed the funds to earn future dividends from Tim’s U.S. and the immediate use of the funds by Tim’s U.S. was irrelevant;
2. The funds advanced to Wendy’s were ultimately available to Tim’s U.S. through intragroup funding mechanisms; that satisfied the indirect purpose test through “exceptional circumstances”; and
3. Even if the primary purpose of the borrowing from Delcan was to loan funds to Wendy’s it was sufficient that the secondary purpose was to earn future dividend income from Tim’s U.S.
The Tax Court held that there was no dispute as to the direct use of the funds. The essential question then was whether the additional common shares of TDL were acquired “for the purpose of earning non-exempt income”. In order to ascertain the “purpose” of the borrowing all relevant circumstances must be considered including the indirect use of the funds, i.e., the loan to Wendy’s. The Court did not agree that TDL had any reasonable expectation of increased future dividends, or even enhanced capital gains, from Tim’s U.S. at the time the common shares were acquired. The evidence reviewed by the Court simply did not support TDL’s arguments about the purpose of the borrowing or TDL’s reasonable expectations. While the contemporaneous plan contemplated the possibility of interest being payable on the loan to Wendy’s it also contemplated the possibility of the loan being interest free, which is what occurred. TDL chose the interest free route out of “potential tax problems with State taxes, and the Thin Capitalization and Foreign Accrual Property provisions of the Act and that they were aware at the time of the loan that the plan would have to be changed but needed to go ahead”. The Court concluded that the evidence “clearly and unambiguously only points to the sole purpose of the borrowed funds as being to facilitate an interest free loan to Wendy’s while creating an interest deduction for the Appellant.” As a result the Court found it was not necessary to deal with the Crown’s alternative argument that the expense was not reasonable. The appeal was dismissed with costs.
Decision: This decision was solely concerned with the deduction of interest on funds borrowed by TDL from Declan, which was a wholly-owned U.S. subsidiary of Wendy’s:
[1] The Appellant, a Nova Scotia unlimited liability Company, appeals a reassessment denying interest deductions in respect of its 2002 taxation year totalling $10,094,856 on loans from a parent corporation used to acquire additional common shares in a U.S. wholly-owned subsidiary. The interest claimed and denied was in respect of interest paid for the period from March 28, 2002 to November 3, 2002 ( the “Period” ). The Minister of National Revenue (the “Minister”) disallowed the interest deduction pursuant to subparagraph 20(1)(c)(i) of the Income Tax Act (the “Act”) on the basis that the funds borrowed were not used for the purposes of earning income from a business or property; namely from a U.S. subsidiary’s shares acquired with the borrowed funds.
[2] Most of the relevant facts are not in dispute. A chronology of transactions started with Wendy’s International Inc. (“Wendy’s”), the ultimate parent of the group loaning $234,000,000 Cdn. ($147,654,000 US) to its U.S. subsidiary, Delcan Inc. (“Delcan”) before March 18, 2002 at an interest rate not to exceed 7 percent. Delcan in turn loaned the full amount to the Appellant on March 18, 2002 at a rate of 7.125 percent pursuant to a loan agreement and subsequently assigned this loan receivable to another affiliate in the group. The Appellant in turn used the full amount of the loan from Delcan to purchase 1,840 additional common shares in its already wholly-owned U.S. subsidiary, Tim Donut U.S. Limited, Inc. (“Tim’s U.S.”) on March 26, 2002 which in turn made an interest‑free loan to Wendy’s the next day, on March 27, 2002 evidenced by a Promissory Note dated as of that date (the “Note”). A schematic drawing of these transactions was entered as Exhibit R-1. In short, monies that started from Wendy’s was loaned out at interest and found its way back to Wendy’s interest free through these series of transactions. The evidence is that the Note was originally intended to be on an interest bearing basis according to planning memorandums entered into evidence, although no rate was specified, but that due to concerns an interest bearing note would have on state taxes in the U.S. and concerns with the Thin Capitalization and Foreign Accrual Property Income Rules in Canada under the Act, it was decided the loan would proceed on a non‑interest basis until the matter was sorted out.
[3] Sometime in June of 2012, following a revised plan evidenced in May of 2012, Tim’s U.S. incorporated a new U.S. subsidiary, Buzz Co., which later changed its name to TD US Finance Co. (“Tim’s Finance”). Tim’s U.S. assigned the Note to Buzz Co. as payment for its shares in Buzz Co. and Buzz Co. then issued a Demand for Payment on the Note to Wendy’s which repaid the Note in full by issuing a new promissory note to Buzz Co. on November 4, 2002 (the “New Note”) for the same full amount bearing an interest rate of 4.75 percent, thus effectively replacing the non-interest bearing loan with a new interest bearing one. The delay in effecting these plan changes was explained by the preoccupation of the parties of the group in purchasing the interests of one of the group’s founders.
[4] It should be noted that the Canada Revenue Agency (“CRA”) has in effect denied the Appellant the deduction of interest paid on its loan from Delcan during the Period, which coincides with the time the Appellant’s US subsidiary loaned the money back to Wendy’s on an interest free basis pursuant to the Note. Once the loan back to Wendy’s was effectively repaid and replaced with an interest bearing loan evidenced by the New Note, the Minister allowed interest deductibility from that date onwards.
TDL’s position was threefold:
[6] The Appellant takes the position that the purchase of common shares by the Appellant in Tim’s U.S., the property it acquired from the proceeds of its borrowings from Delcan, is a garden variety transaction that satisfies the test in subparagraph 20(1)(c)(i) and that the “use” of the Appellant as “borrower” is what must be looked at, not the use that Tim’s U.S., the subsidiary, made of the funds invested in it which it accuses the Crown of wrongfully considering. In essence says the Appellant, the act of purchasing shares that capitalizes its subsidiary to allow it to acquire capital assets and operate its business for the Appellant’s ultimate benefit and payment of future dividends is sufficient, regardless of whether Tim’s U.S. actually earned income from the new capital injection. The Appellant argues there is evidence that Tim’s U.S had a 10 year plan to significantly expand its U.S. operations for income earning reasons and in fact ultimately did resulting in substantial future dividends paid to the Appellant starting in 2007, thus demonstrating an income earning purpose to the purchase of the shares.
[7] Notwithstanding this, the Appellant says that even if the Minister is correct in looking at what use the Appellant’s subsidiary made of the funds, there is ample evidence that the monies lent by Tim’s U.S. to Wendy’s were indirectly available for Tim’s U.S. use when needed through the groups internal funding mechanisms in place, thus satisfying such indirect purpose test in any event through what the Appellant termed to be “exceptional circumstances”.
[8] Finally argues the Appellant, even if the Minister succeeds in its position that the purposes of the loan was to facilitate the making of an interest free loan to Wendy’s, it argues such purpose was not the sole purpose as alleged by the Respondent and that the additional purpose of earning ultimate dividend income is sufficient to meet the purpose test.
The Crown argued that the purpose of the borrowing was to give TDL a tax deduction and to make an interest free loan to Wendy’s. They also argued that the expense was unreasonable:
[9] The Respondent’s takes the position that the transactions undertaken by the Appellant are nothing more than a series of predetermined steps to lend money to Wendy’s interest free while at the same time giving it an interest expense and that the Appellant had no purpose of earning income from investing in Tim’s U.S. shares at the time of the initial loan evidenced by the Note. In any event says the Respondent, the interest deducted by the Appellant would not be a reasonable expense under paragraph 20(1)(c) of the Act in the circumstances.
There was no dispute as to the use of the funds, the central issue was the purpose of the borrowing:
[22] In this case, like
Ludco, there is no dispute the funds were used to purchase shares and likewise the focus of our inquiry must be on whether there was an income-earning purpose in acquiring those shares as earlier stated.
[23] It must be noted and there is no dispute between the parties that
Ludco also made it clear that it is not necessary that the sole purpose must be to earn non‑exempt income and that such purpose may also be an ancillary purpose. In fact here the Appellant argues that if the Court finds the investment in shares was not to earn dividend income as its main purpose, it was at least an ancillary one. The Respondent’s position is that the Appellant’s sole purpose for investing in the new common shares was to arrange for funds to be available to Wendy’s at zero percent interest while generating an interest expense in the hands of the Appellant, and hence there was no other purpose.
The Court rejected the notion that the use of the borrowed funds by other group members could not be considered:
[25] It is clear from
Ludco that the test must be applied at the time the investment is made, namely at the date the Appellant acquired the shares in Tim’s U.S., and furthermore that “all the circumstances must be considered”.
[26] The language of “all the circumstances must be considered” is very broad. In my view, such language cannot be consistent with any position that would suggest the use of the funds by the subsidiary or other members of the group cannot be considered nor that any series of transactions related to the direct investment cannot be considered. While Singleton made it clear that there was no room to consider a series of transactions in determining the “use” of the funds for the “use” test components, i.e. that the direct use is the test that must be ascertained, the determination of the “purpose” for buying the shares does not preclude looking at the indirect use of the funds or any other relevant factor. All circumstances must be considered. In this regard, it seems that the Respondent’s reference to “use” in paragraph 14(m) of the Amended Reply above discussed accords with this premise. [The Court’s emphasis]
The Court held that considering the use of the borrowed funds by other group members did not constitute piercing the corporate veil:
[29] The Appellant also suggests that the Court should not treat the Appellant and Tim’s U.S. or its subsidiary Tim’s Finance (Buzz Co.) as the same taxpayer who borrowed the funds in deference to the principle of respecting their individual existence or not piercing the corporate veil and relies on the Federal Court of Appeal’s decision in
The Queen v Merban Capital Corp., [1989] FCJ No. 712, 89 DTC 5404. Frankly, there is no dispute here that it is the Appellant and not any of its subsidiaries who borrowed the funds in this matter so such decision has little relevance to the matter at hand. In
Merban the Court found the subsidiaries were the borrower and in essence the taxpayer there could not deduct interest incurred by it as a guarantor. In any event, the Supreme Court of Canada has addressed the tests as to “use” and “purpose” since the 1989 decision in
Merban through
Bronfman Trust,
Singleton and
Ludco as above discussed and it is clear that for the “purpose” test in paragraph 20(1)(c), the use of the funds by the borrower subsidiaries can be considered as part of all the circumstances.
The Court then went on to an extensive discussion of the underlying circumstances:
1. The Appellant was already the sole shareholder of Tim’s U.S. at the time of purchase of additional shares. The evidence is clear that Tim’s U.S. had lost substantial monies in the previous 4 years prior to the purchase date. The evidence is that the losses went from $12,000,000 in 1999, to $8,000,000 in 2000 to $4,000,000 in 2001 to $480,000 in 2002. Regardless of the obviously reversing trend which the Appellant points to, it is pretty clear Tim’s U.S. was not in a position financially to pay any immediate or short term dividends at the time of purchase of shares. This is particularly relevant when one considers that the loan evidence by the Note was only intended to be outstanding for a short period of time and was in fact only outstanding for about 7 months. There was also no history of payment of past dividends, obviously due to past losses at least in part.
2. The evidence of the Appellant’s own witnesses, namely P.H, the former CEO and T.M., the former CFO confirmed that the group had a policy of no returns on investments, i.e. dividends, until all capital expenditures were funded. The evidence from these witnesses and the 10 year plan submitted into evidence suggest at least a plan for substantial capital investments to increase the number of stores in the U.S. over the next 10 years. The net income projected from such increased stores shown on the plan for 2003 to 2010 are not projected to exceed the increase in capital expenditures for any years during that period, let alone in total so there is no indication of any monies being available for dividends during that period in light of the stated policy.
3. The 10 year plan itself has a line item for dividends to be paid and zero dividends were planned.
…
6. The Appellant was already the sole shareholder of Tim’s U.S. at the time of purchasing additional shares in March, 2002. Whatever quantative income earning capacity or benefit it had per se in its capacity as sole owner did not change as a result of its new investment in Tim’s U.S. unless it can be demonstrated that the new investment could be expected to create or increase the chances for dividends or at least an increase in the value of its Tim’s U.S. shares. The fact the funds used to buy the new shares were immediately loaned to Wendy’s without interest for about 7 months after which funds were paid back in full suggests no obvious expectation that those funds created or were expected to create any income for Tim’s U.S. so as to increase its ability to pay dividends or increase the value of its shares for the future income benefit of the Appellant.
7. The funds loaned to Wendy’s on an interest free basis were also intended to be a short term temporary loan at the time of its advance. The Appellant’s own witnesses testified, as earlier mentioned, that they were aware the loan evidenced by the Note had to be reorganized and replaced and evidence from the planning memorandum of J.G., the tax advisor to the group indicates a revised plan as early as May 2002 that was put into effect resulting in the repayment of the Note in full in November of 2002, with delays explained due to the group’s preoccupation with other matters, including the repurchase of the shares of one of the Tim Horton’s group initial founders. The testimony explaining why there were delays in implementing the revised plan suggests it was the intention to loan funds out for an even shorter period of time. The testimony of the Appellant’s witnesses also confirmed that they knew of the potential tax problems above mentioned prior to the initial loan advance under the Note and that it had to be fixed thus the revised memorandum and repayment of the Note.
8. There is no credible evidence any portion of the funds invested in Tim’s U.S. were used or intended to be used for any other purpose other than to loan monies to Wendy’s on an interest free basis at the time of the investment in Tim’s U.S. shares. Notwithstanding the Appellant pointing to the Director’s Resolution of the Appellant dated March 8, 2002 that monies be used to purchase the shares in Tim’s U.S. were expected was to be used to repay debt by Tim’s U.S. and fund future capital expenditures, thus supporting an argument the purpose of the funds was to create wealth through the accumulation of capital for the subsidiary and thus indirectly for it, it is clear no repayment of debt was made and no direct capital expenditures were made as all the funds were lent to Wendy’s. In fact, the Resolution of the Board of Directors of Tim’s U.S. dated the same date as the Appellant’s Director’s Resolution refers to a current indebtedness of the subsidiary to Wendy’s of $50,000 and authorizes the company, “upon receipt of the aforesaid capital contribution” to repay accounts payable to Wendy’s up to the amount of the capital contribution and to lend any remaining amounts to Wendy’s at such interest rate (including without interest). The capital contribution far exceeded the amount of the stated indebtedness to Wendy’s yet none was paid. No mention is even made of a capital expenditure. Interesting enough, the CEO of the Appellant, P.H. was a director of Tim’s U.S. and attended both meetings as did a few other directors or invitees of both meetings. Notwithstanding both companies being represented by many of the same people at meetings held at the same day and time, no funds were used to pay any indebtedness of Tim’s U.S. to Wendy’s nor used for capital expenditures. The only logical conclusion I can draw from this is that all the members of the group intended and were aware all the money was going back to Wendy’s.
…
The Court rejected the appellant’s “exception circumstances” argument:
It also follows that such structure cannot support any special circumstances exception that would warrant the granting of interest deductibility within the meaning the Appellant alleges was created in
Bronfman Trust. In fact, I do not take
Bronfman Trust to create an exceptional circumstances test that allows deductibility of interest where the court looks at an ineligible indirect use of the funds and grants a deduction of interest in special circumstances as it is clear to me Dickson C.J. was actually referring to looking at the indirect use of funds as part of focusing on the “purpose” test, not the “use” test.
In the result the Court found that the evidence of purpose was clear and unambiguous and dismissed the appeal, with costs:
[32] In analyzing all the evidence pertaining to the circumstances of this case, I simply cannot find that the Appellant had any reasonable expectation of earning non-exempt income of any kind, directly or indirectly, at the time of its purchase of additional shares in Tim’s U.S. on or about March 26, 2002.The evidence clearly and unambiguously only points to the sole purpose of the borrowed funds as being to facilitate an interest free loan to Wendy’s while creating an interest deduction for the Appellant. Accordingly, there is no need for me to consider the Respondent’s other argument that the interest in question would not be reasonable under the provision in issue.
[33] The appeal is dismissed with costs to the Respondent. If either party is not satisfied with this cost order, they may make submissions as to costs within 45 days for my consideration.
Comment: Interest deductibility cases are notoriously difficult to assess. It is clear however that this is a robust decision with a detailed analysis of the underlying facts as well as a thorough analysis of the salient jurisprudence on the deduction of interest. TDL may have some hope on an appeal, possibly by asking the Federal Court of Appeal to consider the original interest free loan to Wendy’s and the subsequent interest bearing loan (where CRA allowed a deduction) as part of one transaction. It is not clear from the decision however whether the record would support that approach.