Wilson v. MNR, 90 DTC 1744, [1990] 2 CTC 2325 (TCC)

Christie, A.C.J.T.C.:—The dispute is about the deductibility of interest in computing the appellant's income for 1985, 1986 and 1987. The amounts involved are $19,400, $22,271 and $20,500 respectively.

In 1980 the appellant and his wife encountered serious matrimonial difficulties that led to their separation in October 1981. On November 29, 1983, they entered into a separation agreement with the benefit of legal advice. They subsequently divorced. The agreement is 18 pages in length. There are a number of clauses dealing with custody of the children, their education, payment by the appellant of maintenance and of his wife's legal fees, etc. that need not be gone into for present purposes. The appellant's assets are set out in Schedule A and the wife's assets are listed in Schedule B to the agreement. They consist of:

Schedule A

Joint Interest in 1850 West 30th Avenue, Vancouver, B.C.

Through Taja Investments Ltd., of which the Husband owns all of the outstanding shares, the following assets:

—1131 Barclay Street—28 suite apartment block

—1170 Barclay Street—16 suite apartment block

—1606 Nelson Street—13 suite apartment block

—Surrey Property—2 /2 acres

— Maui, Hawaii—1 bedroom condominium

—Scottsdale, Arizona—3 bedroom condominium

—1,000 ounce silver certificate

—1,200 shares Benson Mines Ltd.

—2,000 shares Eaglet Mines Ltd.

—2,000 shares Turbo Resources

—1,000 shares Daon Corp.

—1,000 shares Tricor Resources

—1978 Mercedes 450 SL Roadster

—1977 Cadillac Eldorado

—1975 Oldsmobile Toronado

—1969 Toyota Mark II

Through Shaughnessy Construction Ltd., of which the Husband owns all of the outstanding shares, the following assets:

—977 Broughton Street—9 unit rooming house

Pension Plan with Vancouver Fire Department

Schedule B

Joint Tenancy in 1850 West 30th Avenue, Vancouver, B.C., and household furnishings

250 shares in Rural Stores Ltd.

Jewellry —$50,000

Schedule A is misdescriptive, except with respect to 1850 West 30th Avenue and the pension plan, in the sense that the property listed in relation to Taja Investments Ltd. ("Taja") are not the assets of the appellant “through” that corporation. The listed properties belong to and are the assets of the corporation. Also Shaughnessy Construction Ltd. is a wholly-owned subsidiary of Taja. The appellant's assets are the shares he held in Taja. This kind of legal relationship is expressly recognized under British Columbia's The Family Relations Act, R.S.B.C. 1979, c. 121. Subsection 43(1) provides among other things that, subject to certain qualifications, each spouse is entitled to an undivided half interest in each family asset when a separation agreement respecting the marriage is first made. Family asset is defined by subsection 45(1) and includes, where a corporation owns property that would be a family asset if owned by a spouse, a share in the corporation owned by the spouse.

Among the things agreed to was the transfer by the appellant to his wife of his interest in the matrimonial home at 1850 West 30th Avenue; Mrs. Wilson releasing and surrendering her interest in the shares of Taja in exchange for the appellant's agreement to pay $300,000 with interest at ten per cent; and the appellant foregoing any interest in or claim to the assets in Schedule B. Clauses 2, 13, 17, 18, 19, 20, 21 and 30 provide:

2. The Husband and Wife agree that this Agreement shall enure to the benefit of the respective parties both before and after any decree or judgment or order of any court whether made under the provisions of the Divorce Act of Canada, the Family Relations Act of British Columbia, or any other statute, federal or provincial, relating to marriage or the dissolution of marriage, subject only to paragraph 30 herein.

13. The Husband hereby agrees to transfer to the Wife his interest in the former matrimonial home at 1850 West 30th Avenue in the City of Vancouver, Province of British Columbia, more particularly known and described as: Block 766, District Lot 526, Plan 6011, New Westminster District (hereinafter referred to as the "Matrimonial Home").

17. The Husband and Wife acknowledge that they have interests in the assets set out in Schedule "A" and "B" respectively and attached hereto and each of them respectively confirms the substantial accuracy of the said schedule as being a full disclosure of their respective assets.

18. In exchange for the Wife’s releasing and surrendering any interest that she may ever have had, may have now or in the future, in the assets listed on Schedule “A”, and in exchange for the Wife releasing and surrendering any claim that she may have against the Husband or his assets pursuant to the Divorce Act of Canada or Family Relations Act of British Columbia, the Husband agrees to pay to the Wife the sum of Three Hundred Thousand Dollars ($300,000) together with interest at the rate of Ten Percent (10 per cent) per annum on or before the 1st day of January, 1989, as set out in paragraph 20 below. The Wife agrees to resign as director of Taja Investments Ltd. as of January 1st, 1984.

19. As security for the payment of the said Three Hundred Thousand Dollars ($300,000), the Husband agrees to cause Taja Investments Ltd., a company of which he owns all of the shares, to grant to the Wife a mortgage in the amount of Three Hundred Thousand Dollars ($300,000) on January 1st, 1984, as first mortgage on real property owned by Taja Investments Ltd. with a civic address at 1170 Barclay Street, in the City of Vancouver, Province of British Columbia. The property is legally described as: Lot 8, Block 21, District Lot 185, Plan 92, New Westminster District.

20. The mortgage on the property at 1170 Barclay Street, in the City of Vancouver, Province of British Columbia, will bear interest at the rate of Ten Percent (10 per cent) per annum with no monthly schedule of payments other than interest which will be paid to the Wife on the 1st day of each and every month at the rate of Ten Percent (10 per cent) per annum on the outstanding balance owing to the Wife by the Husband. The balance owing to the Wife may be paid by the Husband to the Wife at any time prior to January 1st, 1989, without penalty.

21. The Husband hereby releases any interest in or claim to any of the Wife's assets listed in Schedule "B" and hereby renounces any claim that he may have had or may have to any property, shares, or assets of any kind whatsoever which have either belonged to the Wife in the past, presently belong to the Wife, or may in the future belong to the Wife and renounces any claim pursuant to the Divorce Act of Canada or the Family Relations Act of British Columbia.

30. The Husband and Wife do hereby mutually release any and all claims each may have against the other including claims pursuant to the Divorce Act of Canada, the said Family Relations Act of British Columbia and the Canada Pension Plan Act of Canada, save for enforcement of claims pursuant to this Agreement and for a divorce.

On the same date that the separation agreement was entered into an indenture was made between Taja as mortgagor and the appellant's wife as mortgagee in respect of the property at 1170 Barclay Street, Vancouver. Among other things this document recites that the appellant owns all of the issued and outstanding shares of the mortgagor; that he has entered into a separation agreement with the mortgagee; that under the agreement the appellant has agreed, inter alia, to pay the mortgagee $300,000 and he "agreed to cause the mortgagor to grant this mortgage to better secure the payment of the sum ($300,000) as aforesaid.” The mortgage also states:

Provided this mortgage to be void on payment of the principal sum of Three Hundred Thousand Dollars ($300,000) of lawful money of Canada together with interest at the rate of Ten (10 per cent) per cent per annum, calculated annually, not in advance; as well after as before maturity, as well after as before default and as well after as before judgment and with interest on overdue interest at the rate aforesaid, with consecutive monthly instalments of interest only, (computed from and including the first day of January, 1984) and payable on the first day of each month commencing on the first day of February, 1984, on so much principal as shall from time to time remain unpaid until the whole of the said principal sum is paid; and taxes and performance of statute labour.

As I see it, the substance of what transpired between the appellant and his former wife and that is relevant to this appeal was this. It was acknowledged by both that each had, at the time of entering into the separation agreement, an interest in the assets set out in Schedules A and B. It was their intention that those interests should be separated. This was accomplished by the appellant transferring his interest in the home at 1850 West 30th Avenue to Mrs. Wilson and by vesting in her his interest in the other assets described in Schedule B. The appellant also agreed to pay her $300,000 on or before January 1, 1989, with interest on the unpaid balance at 10 per cent per annum. This interest was payable monthly commencing January 1, 1984. The appellant, in turn, obtained Mrs. Wilson's interest in the shares of Taja and in the pension plan with the Vancouver Fire Department. The payment of the $300,000 was secured by the mortgage on the real estate at 1170 Barclay Street, Vancouver.

No payments of interest or principal were made by Taja. They were made by the appellant to his wife under the contractual obligations created by the separation agreement. The security afforded by the mortgage was not called on. The principal sum of $300,000 was paid by the appellant on February 1, 1990. This extension of time from January 1, 1989, was allowed by supplementary agreement between the appellant and his former wife.

At trial the appellant and the respondent focused on subparagraph 20(1)(c)(i) of the Income Tax Act ("the Act"). It provides:

20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy).

The first question that arises is whether the relationship of lender and borrower existed between the appellant and his wife. In Black's Law Dictionary, 5th (1979) ed. at page 844 "Loan" is defined as: “Delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest.”

M.N.R. v. T.E. McCool Ltd., [1950] S.C.R. 80; [1949] C.T.C. 395; 4 D.T.C. 700, is a decision of the Supreme Court of Canada. The facts that are relevant for the purposes of the appeal at hand are set out in the reasons for judgment delivered by Mr. Justice Estey at page 409 (D.T.C. 706-707):

. . . the respondent was incorporated to take over the assets of T.E. McCool and did so under an agreement setting out a list of items not separately valued. The company in consideration of the transfer of the assets agreed (a) to assume and pay all debts and liabilities of T.E. McCool in the sum of $37,684.20, (b) cash in the sum of $400 to be used in the purchase of four organization shares, (c) allot and issue to T.E. McCool or his nominees 596 fully paid up and non-assessable shares of capital stock at a par value of $100, and (d) give to the vendor a demand note for the sum of $123,097.34 with interest at 5 percent from and after the 1st day of September, 1941.

His Lordship went on at pages 412-13 (D.T.C. 708-709):

The respondent in its appeal asks that interest on the demand promissory note of $123,097.34 be allowed under sec. 5(1)(b) [The Income War Tax Act, R.S.C. 1927, c.97.], the essential part of which reads as follows:

5.(1) Income as hereinbefore defined shall for the purpose of this Act be subject to the following exemptions and deductions:-

(b) Such reasonable rate of interest on borrowed capital used in the business to earn the income as the Minister in his discretion may allow . . .

Terms such as “borrowed capital”, "borrowed money” in tax legislation have been interpreted to mean capital or money borrowed with a relationship of lender and borrower between the parties. Inland Revenue Commissioners v. Port of London Authority, [1923] A.C. 507; Inland Revenue Commissioners v. Rowntree & Co. Ltd., [1948] 1 All E.R. 482; Dupuis Freres Ltd. v. Minister of Customs and Excise, [1927] Ex. C.R. 207, [1917-27] C.T.C. 326. It is necessary in determining whether that relationship exists to ascertain the true nature and character of the transaction. In this case the promissory note arises out of an exchange in which, as already detailed, the purchase price was paid by assuming outstanding obligations, a small payment of cash, allotment of capital stock and the execution and delivering of this promissory note. Under such circumstances it cannot be held that the relationship of lender and borrower in respect to this note exists between the respondent company and the payee of the note.

In my view the facts of this case do not establish the existence of a lender and borrower relationship between Mrs. Wilson and the appellant. There was no delivery by her and receipt by the appellant of a sum of money upon agreement to repay it with interest. Undoubtedly the appellant promised to pay the $300,000 and interest and was indebted to Mrs. Wilson under the terms of the separation agreement. But a person may be financially indebted to another without the relationship of lender-borrower existing between them: A.C. Simmonds & Sons Ltd. v. M.N.R., [1990] 1 C.T.C. 2087; 89 D.T.C. 707 at page 2089 (D.T.C. 709).

The $300,000 not being "borrowed money" within the meaning of subparagraph 20(1)(c)(i), that subparagraph can have no application to the interest payments of $19,400, $22,271 and $20,500. This conclusion on the threshold issue does not, however, dispose of this matter. Subparagraph 20(1)(c)(ii) [1] of the Act provides:

20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy).

There is no reference to borrowed money in this subparagraph. It provides under specified conditions for the deduction of interest on debt other than borrowed money. The question to be answered in relation to subparagraph 20(1)(c)(ii) is: was the interest that Mrs. Wilson received from the appellant paid on an amount payable for property acquired by him for the purpose of gaining or producing income therefrom? If the answer is yes the appeal succeeds. If not it fails.

Taja was throughout the time relevant to this appeal a going business concern that generated income. Financial statements of the corporation as at December 31, 1985, 1986 and 1987 are in evidence and they show: "Net income for the year, to Retained Earnings" for 1985 and 1986 of $14,489 and $28,996 respectively. While in 1987 there was no net income, total income before expenses was $356,749. The shares in the corporation are still held by the appellant. He retires from the fire department this year and will have income from the pension fund.

While he acquired his wife’s interest in the shares of Taja in the context of an agreement designed to settle their outstanding differences on a number of issues arising out of the breakdown of the marriage, the $300,000 is directly identifiable with his securing his wife's interest in the shares of Taja and the pension fund. The appellant expressly acknowledged that his wife was entitled to an interest in the shares and the pension fund. His purpose in paying the interest and eventually the principal sum of $300,000 was to secure his wife's interest in the shares of Taja and the pension for the purpose of gaining or producing income for himself therefrom.

In the circumstances I believe the question posed a few moments ago is answerable in the affirmative. The appeal is allowed.

Appeal allowed.