Overview
In its recent decision of Bank of Montreal v The King,1 the Tax Court of Canada denied the deductibility of interest paid on unpaid foreign tax under theIncome Tax Act(the "Act").2 This decision applied theRoenisch3 principle, whereby interest arising because of unpaid taxes is not incurred to earn income. The Court ruled that the fact that an expense arose as a consequence of a business activity does not equate to an income-earning purpose.
Background
In the 1997-2001 taxation years, the Bank of Montreal ("BMO") conducted business in the United States through a permanent establishment situated in New York City. Due to its US business operations, BMO was subject to US federal income tax on the business profits attributable to its US permanent establishment. BMO paid all outstanding tax balances it believed it owed on its US tax returns, as filed, by the applicable return-filing date.
In 2004, the Internal Revenue Service (the "IRS") audited BMO's US branch for its 1997-2000 taxation years. Similarly, in 2006, the IRS audited BMO's US branch for its 2001 taxation year. The IRS assessed BMO for additional US federal income tax and interest on its business profits attributable to its US permanent establishment. BMO was also assessed for additional New York City municipal income tax and interest.
For Canadian tax purposes, BMO claimed a deduction of the foreign interest paid to the U.S. tax authorities in the calculation of its income for its 2004 and 2006 taxation years. The Minister of National Revenue (the "Minister") disallowed these deductions, pursuant to section 9 and paragraph 18(1)(a). BMO appealed to the Tax Court of Canada on the basis that the deduction of foreign interest in 2004 and 2006 provided an accurate picture of income and it was a business decision to risk incurring foreign interest. As foreign business-income tax may be deductible under the Act,4 nothing explicitly prohibits the deduction of foreign interest.
The Tax Court of Canada Decision
The Tax Court of Canada upheld the denial of the deductions. The Tax Court followed the Federal Court of Appeal's decision inPotash Corporation of Saskatchewan Inc. v The King,5 which affirmed theRoenischprinciple: taxes on income are generally6 not considered to be incurred for the purpose of gaining or producing income, but rather as a consequence of the income-earning process. As put by the Minister, the interest at issue is "an after-the-fact expense".7 Such amounts are therefore prohibited from being deducted by paragraph 18(1)(a).8
The Tax Court also concluded that paragraph 18(1)(a) acts as a general, catch-all provision, that can overlap with a more specific deduction prohibition set out under the Act. For example, paragraph 18(1)(t) prohibits the deduction of any amount paid or payable under the Act.9 In BMO's specific circumstances, the silence of paragraph 18(1)(t) on the deductibility of foreign tax and interest on the foreign tax did not preclude paragraph 18(1)(a) from operating to disallow the deduction of an expense held not to be incurred for the purpose of earning income.
Takeaways
The Bank of Montreal decision confirms that unless explicitly permitted by the Act, foreign interest is not deductible, even though there are provisions that allow for a portion of the underlying foreign tax to be deducted. The decision in BMO maintains the policy symmetry that the deduction of foreign interest on foreign tax is also non-deductible, although paragraph 18(1)(t) only explicitly prohibits deduction of arrears interest on Canadian tax.
Footnotes
1. Bank of Montreal v The King, 2025 TCC 113 [Bank of Montreal].
2. Income Tax Act, RSC 1985, c. 1 (5thSupp), as amended. All references to a legal provision herein represent a reference to the Act.
3. Roenisch v Minister of National Revenue, 1930 CarswellNat 26 [Roenisch].
4. See subsections 126(2), 20(11), 20(12) and 20(12.1).
5. Potash Corporation of Saskatchewan Inc. v The King, 2024 FCA 35 [Potash].
6. Deferring the payment of overdue income taxes could, in some circumstances, constitute a business decision. The evidence did not support such a finding in the present circumstances. SeeBank of Montreal, para. 58
7. Bank of Montreal, para. 24.
8. Bank of Montreal, paras. 60 and 61.
9. Bank of Montreal, para. 70.
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