Harry Erlichman

The appellant taxpayer entered into debenture agreements to borrow New Zealand dollars at a high interest rate, and simultaneously entered into a forward exchange contract to convert the funds to US dollars for use in its business, while hedging the exchange rate risk.

The taxpayer deducted the high interest payments under s. 20(1)(c)(i) of the Income Tax Act and reported the resulting foreign exchange gain on capital account.

The Minister reassessed the taxpayer, arguing the interest deduction should be limited to the lower rate applicable to US dollars based on the economic realities of the transaction.

The Supreme Court of Canada held that the taxpayer's legal relationships must be respected and that the borrowed New Zealand dollars were directly used to earn income.

The Court allowed the appeal, permitting the full interest deduction, and dismissed the Minister's cross-appeal, holding the foreign exchange gain was on capital account.

The applicant brought a motion for directions to determine whether the respondent was required to seek leave to cross-appeal under Rule 29 of the Rules of the Supreme Court of Canada.

The respondent sought to argue that a currency gain realized by the applicant should be characterized as income rather than a capital gain, an issue decided against the respondent in the courts below.

The Supreme Court of Canada held that because the respondent's argument would not uphold the judgment of the Court of Appeal, the respondent was required to obtain leave to cross-appeal before raising the issue.

The Crown appealed a decision regarding the applicable tax rate for the respondent corporation, which depended on whether it was controlled by another company, Validor Limited, under s. 39(4) of the Income Tax Act.

Following a corporate reorganization, voting rights were split equally between Validor and a minority shareholder group, but Validor retained the right to wind up the company and receive the majority of the assets.

The Supreme Court of Canada allowed the appeal, holding that control in the real sense was not surrendered by Validor, as it retained the critical right to terminate the corporate existence and distribute the assets in its favour.