The Appellant, the TDL Group Co. (TDL), was denied an interest
deduction on money it borrowed to purchase additional common shares
of its wholly-owned U.S. subsidiary, Tim Donut U.S. Limited, Inc.
(Tim’s U.S.). TDL appealed the reassessment and was
unsuccessful at the Tax Court. Osler was subsequently retained as
counsel for TDL’s successful appeal to the Federal
Court of Appeal (FCA).
Wendy’s International Inc. (Wendy’s), TDL’s
ultimate parent company at the time, lent C$234 million to a
U.S. subsidiary, Delcan Inc., which lent the full amount to TDL at
a rate of 7.125%. TDL used the borrowed money to purchase shares of
Tim’s U.S. Tim’s U.S. used the funds it received to
make an interest-free loan to Wendy’s. Seven months later on
November 4, 2002, Buzz Co. (a newly incorporated subsidiary of
Tim’s U.S., which had assumed the loan from Tim’s U.S.)
demanded repayment of the loan from Wendy’s and the loan was
replaced with a new interest bearing promissory note.
Although not mentioned in the reasons from the FCA, the ultimate
purpose of these transactions was to fund a long-term expansion of
Tim Hortons in the U.S.
In order for interest to be deductible under subparagraph
20(1)(c)(i) of the Income Tax Act (Canada), the borrowed
funds must be used for the purpose of earning non-exempt income.
The Tax Court found that TDL had no reasonable expectation of
income at the time it acquired the shares in Tim’s U.S., as
evidenced by the fact that Tim’s U.S. used the money to make
an interest-free loan back to Wendy’s. The Tax Court
disallowed TDL’s interest deduction for the seven-month
period in which Tim’s U.S. was not earning interest on its
loan to Wendy’s. (Only the interest payable over the initial
seven-month period was before the Tax Court; the CRA accepted that
the interest after that period, once the interest bearing
promissory note was in place between Wendy’s and Buzz Co.,
Applying Ludco Enterprises Ltd. v The Queen, 2001 SCC
62, the FCA held that a taxpayer’s purpose when using
borrowed monies is to be assessed at the time the monies are
used. Therefore, the correct inquiry is what TDL’s
purpose was at the time it subscribed for the shares in Tim’s
U.S. This point in time test meant that the reasoning of the Tax
Court was flawed: it would be paradoxical for there to be no income
earning purpose for the loan for the first seven months, followed
by an income earning purpose for the rest of the life of the
According to the FCA, this paradox arose from two errors of law:
i) the Tax Court imported into subparagraph 20(1)(c)(i) a
requirement that TDL have a reasonable expectation of receiving
income on the shares within the first seven months of ownership;
and, ii) the Tax Court’s conclusion was coloured by a concern
with tax avoidance, which was specifically cautioned against in
ShellCanada Limited v. Canada,  3 SCR
On the basis of these errors, the FCA allowed the appeal and
awarded costs to TDL at both levels.
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