Gagnon v. The Queen, 86 DTC 6179, [1986] 1 CTC 410, [1986] 1 SCR 264

Beetz, J. [TRANSLATION]:—

I — Facts

The facts are not in dispute. They are summarized as follows by Walsh, J., delivering the judgment of the Federal Court Trial — Division, Gagnon v. The Queen, [1981] 1 F.C. 249 at 250; [1980] C.T.C. 324 at 324-5:

Plaintiff was married on December 29, 1948, to Mary Edith Laughlin and of the children of the marriage only one is still a minor. On March 29, 1972 the marriage was terminated by a judgment of divorce the pertinent portion of which reads as follows:

[TRANSLATION] C) As alimentary pension for herself and for her children petitioner agrees to pay and respondent accepts

1. A monthly amount payable in advance on the first day of each month at the residence of respondent of $300.00 Canadian;

2. For the benefit of respondent petitioner will pay the monthly payments due or to become due with respect to the immovable which becomes the property of the respondent, the obligation with respect to the said monthly payments being more fully described in the agreement; the amount of the said monthly payments is at present $360.00 and can vary as foreseen in the said contract but represents the repayment in capital and interest of two hypothecs described therein as well as the repayment by monthly payments of municipal and school taxes affecting the said immovable, payable the first of each month, directly to respondent commencing June 1, 1971.

In accordance with this judgment plaintiff paid to his former wife alimony of $8,190 in 1974, $8,400 in 1975, and $8,400 in 1976. (The Minister claims documents submitted indicate payments of $7,690 in 1974 and $8,500 in 1975. The exact amounts can be verified on reassessment.) He claimed credit for these in his income tax returns for the said years. In his assessments the Minister reduced the deductions claimed to the sum of $3,600 a year representing the $300 a month, payable pursuant to Clause (C)1 of the aforementioned judgment.

II — Applicable legislation

The Income Tax Act, R.S.C. 1952, c. 148, as amended by S.C. 1970-71-72, c. 63, s. 1, in paragraph 60(b) allows certain amounts to be deducted in computing a taxpayer's income for a taxation year:

60. There may be deducted in computing a taxpayer's income for a taxation year such of the following amounts as are applicable:

(b) an amount paid by the taxpayer in the year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, as alimony or other allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage, if he was living apart from, and was separated pursuant to a divorce, judicial separation or written separation agreement from, his spouse or former spouse to whom he was required to make the payment at the time the payment was made and throughout the remainder of the year.

This provision thus makes the deduction authorized by it subject to four conditions. First, the amount paid by the taxpayer has to be paid pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement. Second, the amount paid has to be paid as alimony or other allowance payable for the maintenance of the recipient, children of the marriage or both the recipient and children of the marriage. Third, the amount has to be paid on a periodic basis. Fourth, at the time the payment was made and throughout the remainder of the year, the taxpayer had to be living apart from, and be separated pursuant to a divorce, judicial separation or written separation agreement from, his spouse or former spouse to whom he was required to make the payment.

The counterpart of the deduction allowed by this provision is to be found in paragraph 56(1 )(b):

56. (1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year,

(b) any amount received by the taxpayer in the year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, as alimony or other allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage, if the recipient was living apart from, and was separated pursuant to a divorce, judicial separation or written separation agreement from, the spouse or former spouse required to make the payment at the time the payment was received and throughout the remainder of the year;

Thus, the amount deductible by the taxpayer under paragraph 60(b) is taxable in the hands of the recipient under paragraph 56(1 )(b).

The purpose of these provisions, by allowing income splitting between former spouses or separated spouses, is to distribute the tax burden between them. As C. Dawe wrote in an article titled “Section 60(b) of the Income Tax Act: An Analysis and some Proposals for Reform’’, (1980) 5 Queen's L.J. 153:

(T)his allows the spouses greater financial resources than when living together, compensating in part for the lost economics of maintaining a single household.

III — Issue

The issue is whether the payments of $360 a month made by appellant to his former wife in the taxation years 1974, 1975 and 1976, for the repayment of two hypothecs and municipal and school taxes on the immovable of his former wife, can be deducted from appellant’s income under paragraph 60(b) of the Income Tax Act.

Of the four conditions stated in that section, only the second creates any difficulty: were the amounts in question paid “as alimony or other allowance payable . . . for the maintenance of the recipient"?

For the reasons given below, I have concluded that these amounts were paid “as . . . [an] allowance payable . . . for the maintenance of the recipient". It therefore does not seem necessary to discuss the other issue which was also fully argued by the parties, namely: were these amounts paid as alimony?

IV — Trial Division judgment

Appellant appealed from the Minister’s assessments to the Federal Court Trial Division. Walsh, J. allowed the appeal on the ground that the amounts in question were allowances within the meaning of paragraph 60(b) of the Income Tax Act, as defined by Pratte, J. of the Federal Court of Appeal in The Queen v. Pascoe, [1976] 1 F.C. 372; [1975] C.T.C. 656. At 252-53 (C.T.C. 326), Walsh, J. wrote:

The legal issue is one which has frequently been before the Court and unless this case can be distinguished on the facts the decision must go against plaintiff on the basis of the findings of the Court of Appeal in the case of The Queen v. Morton Pascoe. In that case the defendant taxpayer had paid certain sums of money to his ex-wife toward educational and medical expenses of their children pursuant to a separation agreement and subsequent decree nisi which payments were disallowed by the Minister on the basis that they were not allowances because they were not fixed amounts payable on a periodic basis. In rendering the judgment of the Court of Appeal Pratte J. stated at page 374:

An allowance is, in our view, a limited predetermined sum of money paid to enable the recipient to provide for certain kinds of expense; its amount is determined in advance and once paid, it is at the complete disposition of the recipient who is not required to account for it. A payment in satisfaction of an obligation to indemnify or reimburse someone or to defray his or her actual expenses is not an allowance; it is not a sum allowed to the recipient to be applied in his or her discretion to certain kinds of expense.

Walsh, J. distinguished the circumstances of the case at bar from those of Pascoe and concluded that the amounts involved here were predetermined and at the complete disposition of the recipient, without the latter having to account for them to anyone.

On the first point, which is not in dispute, he properly held that the fact that these amounts were subject to slight variations did not mean that they were not predetermined. At 256 (C.T.C. 328), he wrote:

Certainly in the present case it was intended that the payments were to be used by the former wife to make the monthly payments on the two mortgages and to pay the school and municipal taxes. The fact that they were subject to some slight variations foreseen by the judgment due to variable tax rates does not in my view prevent them from being considered as predetermined sums of money within the meaning of the Pascoe case. Any amount awarded as alimony can of course be eventually varied if the needs of the recipient or the ability to pay of the donor change with the passage of time. Children come of age and become independent and the ex-wife may secure employment and no longer need as much allowance, or conversely the former husband may suffer financial reverses [or] diminution in earnings making it impossible for him to continue the payments awarded by the agreement or judgment. These payments can then be varied by order of the Court. The fact that this can take place does not prevent them from being considered as fixed predetermined payments for the taxation years in question during which the payments were made pursuant to the divorce order. The fact that in due course, therefore, one hypothec has been repaid and the other nearly repaid does not affect the situation in the taxation years 1974, 1975 and 1976 which are before the Court but merely gave the former husband the right to have judgment revised so as to free him from these payments or to reduce them to the amount required to cover taxes only. Similarly, as was argued, there was nothing to prevent the wife from selling the house which became her property following the dissolution of the community. In that event also presumably the husband could properly have sought a judgment from the Court to be relieved of the said portion of the alimony payment.

On the second point, he came to the following conclusions, at 257-58 (C.T.C. 329):

The fact that in determining the amount of the payment it was necessary to calculate what monthly payments would be required for the mortgage payments and taxes on the property, which it must be emphasized is now solely her property, appears to me to indicate that the sums paid were at her complete disposition even if it were assumed that she would use them to satisfy the obligations which they were designed to cover and thereby relieve the ex-husband of personal claims against him for them.

V — Federal Court of Appeal judgment

The Federal Court of Appeal judgment was published sub nom. The Queen v. Gagnon, [1982] 2 F.C. 255; [1981] C.T.C. 463. It was a unanimous judgment reversing the judgment of the Trial Division and disallowing the deductions claimed by the taxpayer on the ground, inter alia, that the amounts in question were not allowances within the meaning of paragraph 60(b) of the Income Tax Act, as defined in Pascoe. At 257 (C.T.C. 464), the judgment cited the definition of “allowance” given in Pascoe; it went on:

In the case at bar the Trial Judge held that payment of the sums in question constituted payment of an allowance within the meaning of Pascoe, because he was of the view that the sums were at the complete disposition of respondent's former spouse, who was not required to account for them. I cannot share this view. In my opinion respondent's former spouse was entitled to these payments of $360 only if she paid the sums owing under the deeds of hypothec registered against her property. This was consequently not an allowance within the meaning of Pascoe.

Pascoe has been applied and followed, but not without misgivings.

In Roper v. M.N.R., [1977] C.T.C. 602; 77 D.T.C. 5408, the appellant was claiming to deduct payments made pursuant to a judgment which ordered him to provide for the maintenance of a temporary residence and for the school fees of his children. Marceau, J. referred to Pascoe, and wrote at 606 (D.T.C. 5411):

While it may appear at first sight that the interpretation of the Court of Appeal is somewhat narrow, it is in keeping with the basic principle that, taxation being the rule, an exemption is an exception which must be strictly construed, and, in any case, it is binding upon me. It follows that the only question I am called upon to answer here is simply whether the payments made by the husband-appellant to various creditors as aforesaid qualify as “allowances" in the meaning of the relevant provisions of the Act according to the test laid down by Pratte, J. It is obvious that they do not.

A similar problem arose in The Queen v. Fisch, [1978] C.T.C. 438; 78 D.T.C. 6332. At 441 (D.T.C. 6335), Collier, J. wrote:

The educational costs paid by the defendant in this suit were a limited predetermined sum of money to enable the mother to meet the school fees. The monies paid were channelled and restricted to that particular purpose. But the sum was not at the former wife’s complete discretion as to how the money was to be applied by her. It was, in substance, a reimbursement of expenses incurred by the wife in the educating of the children. The payment is not within the Pascoe guidelines.

I allow the appeal with some regret. The agreement in question was drawn long before the restrictions on paragraph 60(b) imposed by the Pascoe case were known. If the defendant had agreed merely to pay to the wife a fixed sum larger than the bi-monthly amount of $533.34, (based on an arbitrary estimate of education costs), there would have been no tax difficulty. In this case, the evidence shows the defendant’s former wife has, sadly, a history of emotional and psychiatric disorders. It was because of fear of financial irresponsibility by her, and the father’s desire to see the children properly attended to and educated at the private school, that the educational costs were handled in this special way.

See also A-G Canada v. Weaver, [1976] 1 F.C. 423; [1975] C.T.C. 646 and The Queen v. Bryce, [1982] 2 F.C. 581 at 587; [1982] C.T.C. 133 at 137.

Appellant submitted that the definition of “allowance” in Pascoe is unduly limiting and should be revised. I think he is right.

VI — Definition of "allowance"

According to the definition in Pascoe, for a sum of money to be regarded as an “allowance” it must meet three conditions: (1) the amount must be limited and predetermined; (2) the amount must be paid to enable the recipient to discharge a certain type of expense; (3) the amount must be at the complete disposition of the recipient, who is not required to account for it to anyone.

The first two conditions may be explained by inference from paragraph 60(b) of the Income Tax Act. The amount must be limited and predetermined in accordance with the judgment, order or written agreement setting it. It must be paid to enable the recipient to discharge a certain type of expense, namely an expense incurred for the maintenanceof the recipient.

But what is the reason for the Pascoe judgment imposing the third condition, which clearly cannot be inferred from paragraph 60(b)?

An indication of the solution was given by counsel for the respondent who referred in his factum not to paragraph 60(b) but to paragraph 56(1 )(b), and argued that a taxpayer — the former wife of appellant in the case at bar — could not be taxed on earnings which were not at her complete disposition, in accordance with Kenneth B.S. Robertson Ltd. v. M.N.R., [1944] Ex. C.R. 170; [1944] C.T.C. 75.

It may thus be assumed that by adding this third condition to the definition of an allowance, the Federal Court of Appeal sought to avoid an anomaly which would result from an amount being deductible for the person paying it, pursuant to paragraph 60(b) of the Income Tax Act, and not being taxable to the recipient pursuant to paragraph 56(1 )(b), in view of the rule applied in Robertson, to which I will return.

It is important to specify what is meant in requiring that, to be an allowance, an amount must be “at the complete disposition of the recipient”.

According to Pascoe, this condition means that the recipient must be able to apply this amount to certain types of expense, but at her discretion and without being required to account for it.

However, the condition could also mean that the recipient must be able to dispose of the amount completely, and that, provided she benefits from it, it is not relevant that she has to account for it and that she cannot apply it to certain types of expense at her complete discretion.

It seems to me, with respect, that the second interpretation is the correct one, in light of the earlier decisions which Pascoe appears to have misinterpreted.

What matters is not the way in which a taxpayer may dispose of, or be required to dispose of, the amounts he receives, but rather the fact of whether he can dispose of them or not.

In Robertson Thorson, J., President of the Court, had to decide whether certain amounts received on deposit constituted income. At 182-83 (C.T.C. 90-91) he wrote:

. .. the question remains whether all of the amounts received by the appellant during any year were received as income or became such during the year. Did such amounts have, at the time of their receipt, the quality of income, to use the phrase of Mr. Justice Brandeis in Brown v. Helvering (1934) 291 U.S. 193. In my judgment, the language used by him, to which I have already referred, lays down an important test as to whether an amount received by a taxpayer has the quality of income. Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment?

The Federal Court of Appeal apparently found in Robertson the third aspect of what in its opinion constitutes an allowance; but if that is so, I consider that it misinterpreted the judgment in that case. What Thorson, J. meant by “restriction” in the rule which he adopted was not a restriction as to the way in which an amount is disposed of, but a restriction as to the very right to dispose of it, a restriction which has the result that a taxpayer derives no benefit from it at all. This is indicated by what he wrote at 183 (C.T.C. 91):

To put it in another way, can an amount in a taxpayer's hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue? [Emphasis added.]

See also Sura v. M.N.R., [1962] S.C.R. 65; [1962] C.T.C. 1.

In Brown v. Helvering, 291 U.S. 193 (1934), Brandeis, J. had to decide whether commissions, which were potentially subject to partial reimbursement if insurance policies were cancelled, constituted income for the agent in the year in which he received them. At 199 he wrote:

But the mere fact that some portion of it might have to be refunded in some future year in the event of cancellation or reinsurance did not affect its quality as income. Compare American National Co. v. United States, 274 U.S. 99. When received, the general agent's right to it was absolute. It was under no restriction, contractual or otherwise, as to its disposition, use or enjoyment.

Here again, in view of the facts in Brown v. Helvering, it seems clear that in formulating a rule to determine what is in the nature of income, Brandeis, J. referred to restrictions on the very right to dispose of an amount, not to restrictions on the way in which it is used.

What confirms me in this view is the restatement of this rule in Rutkin v. United States, 343 U.S. 130 (1951), affirmed in James v. United States, 366 U.S. 213 (1961), in which Warren, C.J., at 219, cites the restatement in Rutkin:

A gain “constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it.” Rutkin v. United States, supra, at p. 137.

This restatement of the rule for determining what constitutes taxable income emphasizes the benefit the taxpayer derives from income, whatever the way in which it is derived.

In The Queen v. Poynton, [1972] C.T.C. 411; 72 D.T.C. 6329, Evans, J., rendering the unanimous judgment of the Ontario Court of Appeal, specifically adopted the ratio in James, and at 419 (D.T.C. 6335) suggested additional guidelines for determining whether an amount received by a taxpayer is in the nature of income:

. .. the manner of receipt, the control over it, the liabilities and restrictions attaching to it, the use made of it by the holder, the person to whom the benefits accrue. These are but some of the circumstances to be weighed.

Seen in this context, the third condition imposed by Pascoe must be corrected: for an amount to be an allowance within the meaning of paragraph 60(b) of the Income Tax Act, the recipient must be able to dispose of it completely for his own benefit, regardless of the restrictions imposed on him as to the way in which he disposes of it and benefits from it.

To return to the circumstances of the case at bar, there is no doubt that the recipient of the amounts in question, appellant’s former wife, could dispose of them completely, and that she derived from them what Burton, J. called in Rutkin, at 137, a “readily realizable economic value". The duty which she had to apply these amounts to particular purposes does not affect the benefit she derived from them. These amounts are in the nature of income for her, and qualify as “allowances” within the meaning of both paragraphs 60(b) and 56(1 )(b) of the Income Tax Act.

This conclusion has the advantage of avoiding the artificial distinction referred to by Collier, J. in Fisch, at 441 (D.T.C. 6335):

If the defendant had agreed merely to pay the wife a fixed sum larger than the bi-monthly amount . . . there would have been no tax difficulty.

Respondent objected that the amounts in question, or at least a part of them, are not allowances since, in paying them, appellant was discharging a personal obligation which he had undertaken toward the hypothecary creditor. In my opinion, this does not in any way alter the fact that the amounts were also paid pursuant to a divorce decree, as required by paragraph 60(b). In another case, M.N.R. v. Hastie, [1974] 1 F.C. 117; [1974] C.T.C. 131, Walsh, J. refuted the same objection, at 139 (D.T.C. 128), when he wrote that the repayment of this personal debt was

. . . Strictly incidental to the fact that by making these payments . . . he was maintaining a home for his wife and his children commensurate with their standard of living.

VII — Amendment of Income Tax Act

Before concluding, it should be noted that after this appeal was heard by this Court the Income Tax Act was amended by S.C. 1984, c. 45, s. 20. As a result of these amendments, amounts like the ones at issue in the case at bar are, on certain conditions and up to certain maximum figures, deemed to be paid and received as allowances payable on a periodic basis.

VIII — Conclusions

The appeal is allowed, the judgment of the Federal Court of Appeal is set aside and the judgment of the Federal Court — Trial Division is restored, with costs in all courts.

Appeal allowed.