Where an Interest Deduction Dispute Is Effectively Shaped

Keybrand Foods Inc. v. HMQ, shows how interest-deductibility disputes, and others like them, are shaped after reassessment as the objection record crystallizes the explanation of the business situation that will carry forward into the Tax Court appeal.

Key Takeaways

• Keybrand's ABIL claim turned on how the share subscription was characterized at the time of acquisition, including whether the parties were dealing at arm’s length and what that meant for cost base.
• In parallel, the record related to CRA's decision to deny Keybrand's interest deduction under s. 20(1)(c) reflected a single explanation of what the financing was understood to accomplish, with no competing account gaining traction through objection or appeal.
• By the time the objection concluded, the CRA's framing was dominant and constrained how the Tax Court would read the transaction, regardless of the arguments that Keybrand advanced at the appeal stage.
  
  

The Situation

After its subsidiary Vidabode defaulted on a major obligation, Keybrand borrowed $14.4 million, subscribed for additional shares, and used the funds immediately to repay Vidabode’s lender. During the same period, Vidabode had no sales, no external financing, and no clear operational path forward. Keybrand began preparing for insolvency, and a receiver followed shortly afterward.

CRA denied Keybrand’s interest deduction under s. 20(1)(c) on reassessment. Keybrand also claimed an allowable business investment loss (ABIL) in respect of the Vidabode shares. The matter proceeded through objection and ultimately to court, where the reassessment was upheld, and Keybrand’s appeal was dismissed.

What Made the Difference

The case did not turn on the technical structure of the borrowing in isolation. It turned on which explanation of the business reality was reflected consistently after reassessment, as that explanation took shape in the notice of objection, settled through the objection stage, and carried forward into the Tax Court appeal.

As the file progressed, the record increasingly centred on a single account: the borrowing functioned to remove third-party pressure and manage downside risk in a distressed situation, rather than to support a forward-looking income-earning strategy. That account fit the timing, sequencing, and surrounding decisions without requiring further inference.

By the time the dispute reached Tax Court, that explanation was no longer competing with another. It had become the reference point.

What Keybrand Actually Shows

Keybrand does not stand for a simple preference for “substance over form.” The borrowing and share subscription could have been described in more than one way.

What proved determinative was the absence of a competing explanation in the record linking the financing to a defined, forward-looking business objective capable of supporting the interest deduction.

The record showed how the money moved, but not what the business expected that money to change or generate in terms of income. Insolvency planning ran alongside the financing, with no clear distinction between a fallback and the intended path forward. And nothing about how the equity was put in changed how the business was run or what success would have looked like if the financing worked.

Read together, those signals left no clear basis in the record for treating the borrowing as income-oriented.

The Signal for Business Leaders

Interest deductibility under s. 20(1)(c) provides a clear illustration, but the pattern is broader. In disputes involving financing, restructurings, or distressed investments, outcomes often turn on whether the objection-stage record was established and supports more than one credible explanation of what the business understood itself to be doing.

When a dominant explanation takes hold, later advocacy is either constrained or given room to operate.

Case Reference: Keybrand Foods Inc. v. Canada, 2020 FCA 201