Singleton v.
Canada, [2001] 2 S.C.R. 1046, 2001 SCC 61
Her Majesty
The Queen Appellant
v.
John R.
Singleton Respondent
Indexed
as: Singleton v. Canada
Neutral
citation: 2001 SCC 61.
File
No.: 27477.
2001: March 19;
2001: September 28.
Present: Gonthier,
Iacobucci, Major, Bastarache, Binnie, Arbour and LeBel JJ.
on appeal from
the federal court of appeal
Income tax – Deductions – Interest – Taxpayer using equity in law
firm to purchase house then refinancing law firm equity with borrowed money –
Whether interest payments made on borrowed money deductible – Whether borrowed
money “used for the purpose of earning income from a business” — Income Tax
Act, R.S.C. 1985, c. 1 (5th Supp .), s. 20(1) (c)(i).
The respondent used $300,000 of equity in his law firm to purchase a
house. He refinanced his law firm equity with borrowed money. All of the
relevant cheques were deposited and honoured. The respondent paid interest of
$3,688 in 1988 and $27,415 in 1989. He deducted the interest on his tax return
for those years, pursuant to s. 20(1) (c)(i) of the Income Tax
Act claiming that the borrowed money now represented his investment in the
law firm. The Minister of National Revenue reassessed and denied the interest
deduction on the grounds that the borrowed money was used to finance the
purchase of the house and not as a business investment. The Tax Court of Canada
dismissed the respondent’s appeal. The majority of the Federal Court of Appeal
allowed the respondent’s appeal.
Held (Bastarache and LeBel JJ. dissenting): The appeal
should be dismissed. The interest payments were deductible under s. 20(1) (c)(i)
of the Income Tax Act .
Per Gonthier, Iacobucci, Major, Binnie and Arbour JJ.: While
courts must be sensitive to the economic realities of a transaction and to the
general object and spirit of the provision, where the provision at issue is
clear and unambiguous, as in this case, its terms must simply be applied.
Furthermore, absent a sham, window-dressing or other vitiating circumstances,
none of which was alleged in this case, the respondent does not have to
demonstrate a bona fide purpose.
In this case, a direct link can be drawn between the borrowed money and
an eligible use, so the respondent was entitled to deduct from his income the
relevant interest payments. The transactions in question are properly viewed
independently. Regardless of the sequence of the cheques, the respondent used
the borrowed funds for the purpose of refinancing his partnership capital account
with debt. Viewing the transactions as one simultaneous transaction, thereby
treating the borrowed funds as used for financing the purchase of the home,
ignores what the respondent actually did: he used the borrowed funds to replace
the funds required for his capital account at the firm. Taxpayers are entitled
to structure their transactions in a manner that reduces taxes; the fact that
the structures may be complex arrangements does not remove the right to do so.
The respondent engaged in a legal transaction to which the Court must give
effect. It is irrelevant that he used the money he withdrew from the firm to
purchase a house, that the transactions occurred on the same day, and that the
respondent structured the transaction for tax purposes.
The $300,000 invested in the law firm was not frozen for all time in
the form of its original investment. Corporations can refinance equity with
debt and deduct the interest on the associated debt. Since fairness requires
that the same legal principles must apply to all taxpayers, irrespective of
their status as natural or artificial persons, unless the Act specifically
provides otherwise, the respondent should be entitled to refinance his
partnership equity with debt and deduct the interest. Similarly, if a partner’s
initial capital investment was financed with borrowed funds, the interest on
the original loan and on subsequent refinancing of debt is deductible. It would
be inconsistent if a partner who originally financed with his own money and
later refinanced with debt could not deduct the interest.
Per Bastarache and LeBel JJ. (dissenting): This case does
not involve a pure question of law. It turns on the purpose for which the
borrowed money was used, and determining the taxpayer’s purpose in undertaking
the transactions at issue requires an examination of the surrounding facts.
Since the Tax Court Judge heard all the evidence relevant to determining the
taxpayer’s purpose, deference should be given to his understanding of the
facts.
Although Shell Canada weakens the “economic realities”
jurisprudence, it does not reject it wholesale. Courts are still required to
look beyond the legal instruments used by the taxpayer in those cases where the
legal relations were not created bona fide. The economic realities of
the situation, however, do not grant a court licence to ignore clear statutory
language. In order to ensure that clear statutory language is not overlooked,
the words-in-total-context approach should be applied in this case.
The interest paid should not be claimed as a deduction from taxable
income. Upon considering the economic realities in this case, it is clear that
a series of transactions like the one at bar does not constitute a set of bona
fide legal relations. The respondent funnelled money through his law firm
simply to secure a tax advantage; his borrowing was not made with the bona
fide purpose of generating income from his business. A contextual reading
of s. 20(1) (c)(i) of the Income Tax Act , leads to the same
conclusion. First, the section is an exception to the general rule against
deductibility. Second, the purpose of s. 20(1) (c)(i) is to
encourage the accumulation of capital which would produce taxable income. Since
the deduction is being claimed for a use of borrowed capital that will lead to
the purchase of personal property rather than the production of income, the
deduction should be denied. Whether the transactions are considered separately
or together does not affect the legal relations created by the taxpayer.
It is not unfair to deny a deduction to the respondent even though a
corporation which refinances equity with debt would be allowed the interest
deduction. By definition, any money borrowed by a corporation will relate to
the business, but money borrowed by an individual may relate to the business
or, as in this case, to personal matters. Similarly, a partner who originally
financed the partnership with his own money will only continue to get the
interest deduction on any subsequently borrowed money if that money is related
to the business. He will not get the deduction for personal spending. The Act
requires that the court consider the actual purpose for which the borrowed
money was used. The question to be asked in order to ascertain that purpose is,
“What was changed by these transactions?” Here it was the acquisition of a
house. The financing of the law firm remained the same. Lastly, the “direct
link” analysis in Shell Canada does not suggest that, under
s. 20(1) (c)(i), a taxpayer can deduct the interest he paid on money
he borrowed for a purpose completely unrelated to his business.
Cases Cited
By
Major J.
Referred to: Bronfman Trust v. The Queen, [1987] 1 S.C.R.
32; Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298; Shell
Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; Trans-Prairie Pipelines Ltd.
v. Minister of National Revenue, 70 D.T.C. 6351; Ludco
Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, 2001 SCC
62.
By LeBel J.
(dissenting)
Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; Bronfman
Trust v. The Queen, [1987] 1 S.C.R. 32; Tennant v. M.N.R., [1996] 1
S.C.R. 305; Mark Resources Inc. v. Canada, 93 D.T.C. 1004; Backman v.
Canada, [2001] 1 S.C.R. 367, 2001 SCC 10; Dunn v. M.N.R., 74 D.T.C.
1121; Stubart Investments Ltd v. The Queen, [1984] 1 S.C.R. 536;
Harris Steel Group Inc. v. M.N.R., 85 D.T.C. 5140; The Queen v. Golden,
[1986] 1 S.C.R. 209; Symes v. Canada, [1993] 4 S.C.R. 695; Québec
(Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3;
Friesen v. Canada, [1995] 3 S.C.R. 103; Alberta (Treasury Branches)
v. M.N.R., [1996] 1 S.C.R. 963; Canada Safeway Ltd. v. Minister
of National Revenue, [1957] S.C.R. 717; Trans-Prairie Pipelines Ltd. v.
Minister of National Revenue, 70 D.T.C. 6351; Sternthal v. The Queen,
74 D.T.C. 6646.
Statutes
and Regulations Cited
Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp .), s. 20(1) (c)(i).
Authors
Cited
Duff, David G. “Interpreting the Income
Tax Act — Part 2: Toward a Pragmatic Approach” (1999), 47 Can. Tax J. 741.
APPEAL from a judgment of the Federal Court of Appeal, [1999] 4 F.C.
484, 177 D.L.R. (4th) 461, 243 N.R. 110, 99 D.T.C. 5362, [1999] F.C.J. No. 864
(QL), setting aside a judgment of the Tax Court of Canada, [1996] 3 C.T.C.
2873, 96 D.T.C. 1850, [1996] T.C.J. No. 1101 (QL), affirming the Minister’s
reassessment disallowing the respondent’s interest deduction. Appeal dismissed,
Bastarache and LeBel JJ. dissenting.
Donald G. Gibson and Deen C. Olsen, for the
appellant.
John H. Saunders, for the respondent.
The judgment of Gonthier, Iacobucci, Major, Binnie and Arbour JJ. was
delivered by
1
Major J. — This appeal
raises the issue of whether borrowed money was “used for the purpose of earning
income” within the meaning of s. 20(1) (c)(i) of the Income Tax Act,
R.S.C. 1985, c. 1 (5th Supp .) (the “Act ”). The respondent had at least $300,000
of equity in his law firm. He decided to use this money to purchase a house and
to refinance his law firm equity with borrowed money. The respondent then
deducted the interest payments made on the borrowed money pursuant to s. 20(1) (c)(i)
of the Act , claiming that the borrowed money now represented his investment in
the law firm. The Minister of National Revenue denied the deduction on the
grounds that the borrowed money was used to finance the purchase of the house
and not as a business investment.
2
The question is whether the borrowed money was used for the purpose of
earning income from the law firm or for the purpose of financing the purchase
of his house. If the former, the interest is deductible; if the latter, it is
not.
3
I conclude that the borrowed money was used for the purpose of earning
income from the law firm. As such, the interest is deductible pursuant to s.
20(1) (c)(i) of the Act . Accordingly, the appeal is dismissed.
I. Facts
4
The respondent is a partner in the law firm Singleton Urquhart. On
October 27, 1988 the amount in the respondent’s capital account at the law firm
was at least $300,000. The respondent’s original capital contributions had not
been financed with borrowed funds. On October 27, 1988 the respondent wanted to
do a number of things. He wanted to use $300,000 of his equity in the law firm
to assist in the purchase of a house. He then wanted to borrow that same amount
and use it to refinance his partnership capital account.
5
There is less than full agreement on how the respondent achieved these
results and the record is unclear as to the sequence of the transactions that
occurred on October 27, 1988. While not central to this appeal, the
transactions occurred in one of two possible ways.
6
One way was that found by the Tax Court Judge, that is that $298,750 of
money borrowed from the Bank of British Columbia, along with $1,250 of the
respondent’s own money, went into the firm trust account. A cheque for
$300,000 was then paid into the partnership general account and credited to the
respondent’s capital account. The partnership then paid $300,000 by cheque to
the respondent, who deposited this money into his personal bank account. The
respondent then issued a cheque drawn on his personal bank account, payable to
the firm, for $300,000. This amount was deposited into a client trust account.
The respondent’s spouse deposited $147,901 into the same account. The firm
issued a cheque for $440,451 drawn on the client trust account and payable to
the solicitors for the vendors of the house.
7
The other way as found by the Court of Appeal, was that on October 27,
1988, the firm paid the respondent Singleton $300,000 from his capital account.
He used the $300,000 to assist in the purchase of a house registered in his
wife’s name. Later that same day, the respondent borrowed $400,000 from the
Bank of British Columbia, only $298,750 of which is relevant to this appeal,
and together with $1,250 of his own money, paid $300,000 back into his capital
account at the law firm.
8
Counsel for the respondent conceded that the record is unclear as to
whether the $300,000 came out of the firm before the money was borrowed.
However, it is undisputed that the respondent had at least $300,000 in his
capital account on October 27, 1988. Furthermore, all of the relevant cheques
were deposited and honoured.
9
The respondent paid interest of $3,688.52 in 1988 and $27,415.46 in 1989
and deducted the interest on his tax return for those years, pursuant to s.
20(1) (c)(i) of the Act . The Minister reassessed and denied the interest
deduction on the grounds that the borrowed money was used to finance the
purchase of the house. The Tax Court of Canada dismissed the respondent’s
appeal. The majority of the Federal Court of Appeal allowed the respondent’s
appeal.
II. Statutory
Provisions
10
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .)
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 on the method regularly followed by the taxpayer in computing the
taxpayer’s 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),
.
. .
or a reasonable amount in respect thereof, whichever is the lesser;
III. Judicial
History
A. Tax
Court of Canada, [1996] 3 C.T.C. 2873
11
This case was originally heard by Kempo J.T.C.C., who retired before she
rendered judgment. As a result, Bowman J.T.C.C. decided this case relying on
the transcript and submissions made before him.
12
Bowman J.T.C.C. began his analysis of whether the interest was
deductible with an examination of what the borrowed money was used for. He
concluded that, on October 27, 1988, the borrowed money was channelled through
the firm and immediately went to the respondent for the purchase of the house.
He observed that “[w]ithout suggesting that there was a sham or dissimulation,
that is the reality of the situation” (p. 2876). He concluded, at p. 2876:
On any realistic view of the matter it could not be
said that the money was used for the purpose of making a contribution of
capital to the partnership. The fundamental purpose was the purchase of a house
and this purpose cannot be altered by the shuffle of cheques that took place on
October 27, 1988.
13
Bowman J.T.C.C. concluded that the borrowed money was used as a “matter
of economic reality” (p. 2877) for the purpose of buying the house. He added
that the steps of the transaction were “conterminous and interdependent” (p.
2877). He stated that even if the legal validity of the steps was accepted and
the tax motivation treated as irrelevant, “one is still left with the
inescapable factual determination that the true economic purpose for which the
borrowed money was used was the purchase of a house, not the enhancement of the
firm’s income earning potential by a contribution of capital” (pp. 2878-79). He
dismissed the appeal.
B. Federal
Court of Appeal, [1999] 4 F.C. 484
(1) Rothstein J.A. for the Majority
14
Rothstein J.A. first considered the proper standard of review to apply
in this case. He noted that the Tax Court judge used the term “inescapable factual
determination” in referring to the “true economic purpose for which the
borrowed money was used” (para. 41 (emphasis added by Rothstein J.A.)).
Rothstein J.A. stated that what was at issue was how to treat the transaction
for the purpose of s. 20(1) (c)(i). He held that this raised a question
of law and it was appropriate for the Court of Appeal to re-examine the
conclusion of the Tax Court judge.
15
Rothstein J.A. then considered whether the transactions should be
treated independently or as a series of connected activities. He thought the
transactions should be treated independently in order to reflect the reality of
what occurred: the respondent had his own funds in his capital account which he
withdrew and used to purchase a house and he used the borrowed funds to
replenish his capital account. Therefore, the borrowed funds were used for the
purpose of refinancing the respondent’s capital investment in the law firm. He
concluded that s. 20(1) (c)(i) does not exclude borrowed funds used for
this purpose.
16
Rothstein J.A said that two requirements for interest deductibility set
out in Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, are relevant
here. The first is tracing, which the Minister conceded was not at issue. The
second is the direct use of the borrowed funds, which he concluded was to
refinance the capital account. Rothstein J.A. held that in accordance with Bronfman
Trust, this direct use could not be ignored.
17
Rothstein J.A. relied on Continental Bank Leasing Corp. v. Canada,
[1998] 2 S.C.R. 298, per Bastarache J., who wrote for the Court on this
point, in stating that there are three important principles of law relevant to
this appeal (at para. 58):
First, a taxpayer who complies with the provisions of the Income Tax
Act should not be denied the benefit of such provisions simply because the
transaction was motivated for tax planning purposes. Second, in the absence of
evidence that the transaction was a sham or abuse . . . and where the
words of the Act are clear, it is not the role of the Court to decide
. . . whether the taxpayer is deserving of the deduction. Third, it
is an error for the Court to ignore the legal and commercial reality of a
transaction.
18
Rothstein J.A. concluded that the absence of the phrase “series of
transactions” from s. 20(1) (c)(i) implies that the legislature did not
intend that the series test be applied to transactions such as the one at
issue.
19
The majority of the Federal Court of Appeal allowed the appeal and set
aside the judgment of the Tax Court and the Minister’s reassessment.
(2) Linden J.A. in dissent
20
Linden J.A. noted that the focus of the case was whether the borrowed
funds were used for the purpose of earning income. He concluded that the Tax
Court judge was correct in deciding that the interest was not properly
deductible under s. 20(1) (c)(i). He gave three reasons for this
conclusion (at para. 4):
1. The determination of the purpose for which borrowed money was
used is primarily a factual determination which should not be interfered with.
2. Past cases have, without exception, denied deductibility of
interest in transactions such as these.
3. The task of the Court under paragraph 20(1) (c) of the Act
is to examine the commercial and economic realities underlying the transaction
to determine if the borrowed funds were “used for the purpose of earning
income,” which, in my view, they were not.
IV. Issue
21
Was the borrowed money “used for the purpose of earning income from a
business” such that the interest is deductible pursuant to s. 20(1) (c)(i)
of the Act ?
V. Analysis
A. Standard
of Review
22
Bowman J.T.C.C. concluded that it was an “inescapable factual
determination that the true economic purpose for which the borrowed money was
used was the purchase of a house” (p. 2878). Linden J.A., in dissent, held that
this was a factual determination which should not be interfered with. I respectfully
disagree. I adopt the conclusion of Rothstein J.A. That is, this appeal raises
the issue of what is the proper legal test under s. 20(1) (c)(i). That is
a question of law. For the reasons outlined, the Tax Court Judge, in searching
for the “true economic purpose”, applied the wrong legal test.
23
To the extent that the Tax Court judge’s characterization of the
sequence of the transactions differed from that of the Court of Appeal, it is
of no material consequence in the determination of this appeal.
B. The
Legal Principles to be Applied in this Case
24
The law with regard to s. 20(1) (c)(i) was recently clarified in Shell
Canada Ltd. v. Canada, [1999] 3 S.C.R. 622. The decision in Shell is
determinative of the issue in this case. The key principles from that case
bear repeating.
25
In Shell, supra, McLachlin J. (later Chief Justice),
writing for the Court, confirmed that s. 20(1) (c)(i) contains four
elements (at para. 28):
(1) the amount must be paid in the year or be payable in the year in which
it is sought to be deducted; (2) the amount must be paid pursuant to a legal
obligation to pay interest on borrowed money; (3) the borrowed money must be
used for the purpose of earning non-exempt income from a business or property;
and (4) the amount must be reasonable, as assessed by reference to the first
three requirements. [Emphasis added.]
26
Only the third element is at issue in this appeal: the borrowed money
must be used for the purpose of earning non-exempt income from a business. The Shell
case confirmed that the focus of the inquiry is not on the purpose of the
borrowing per se, but is on the taxpayer’s purpose in using the money.
McLachlin J. agreed with Dickson C.J. in Bronfman Trust that the inquiry
must be centred on the use to which the taxpayer put the borrowed funds.
McLachlin J. made it clear that the deduction is not available where the link
between the borrowed money and the eligible use is indirect. However, she made
it equally clear that “[i]f a direct link can be drawn between the borrowed
money and an eligible use” this third element is satisfied (para. 33).
27
In examining the Minister’s argument about the need to consider the
economic realities of a transaction rather than being bound to its strict legal
effects, McLachlin J. recognized that the courts must be sensitive to the
economic realities of a transaction. However, she stated that (at paras.
39-40):
. . . this Court has never held that the economic realities of a
situation can be used to recharacterize a taxpayer’s bona fide
relationships. To the contrary, we have held that, absent a specific provision
of the Act to the contrary or a finding that they are a sham, the taxpayer’s
legal relationships must be respected in tax cases. . . .
Second, it is well established in this Court’s tax
jurisprudence that a searching inquiry for either the “economic realities” of a
particular transaction or the general object and spirit of the provision at
issue can never supplant a court’s duty to apply an unambiguous provision of
the Act to a taxpayer’s transaction. Where the provision at issue is clear and
unambiguous, its terms must simply be applied. [References omitted.]
28
The Court in Shell emphasized that taxpayers are entitled to
structure their transactions in a manner that reduces taxes (see for example
paras. 45 and 46). The fact that the structures may be complex arrangements
does not remove the right to do so.
29
It is now plain from the reasoning in Shell that the issue
to be determined is the direct use to which the borrowed funds were put. “It is
irrelevant why the borrowing arrangement was structured the way it was or,
indeed, why the funds were borrowed at all” (Shell, supra, para.
47).
C. Application
to the Facts in the Case at Bar
30
The appellant, the Minister in Right of the Crown, relied on the reasons
of the Tax Court Judge and Linden J.A., in dissent, and urged the Court to
examine the “economic realities” of the taxpayer’s transactions in determining
whether the requirements of s. 20(1) (c)(i) had been met.
31
Applying Shell, I decline to do so. This Court must simply apply
s. 20(1) (c)(i) rather than search for the economic realities of the
transaction.
32
In applying s. 20(1) (c)(i) here, the relevant question is: to
what use were the borrowed funds put? The Tax Court Judge found that the
purpose in using the money was to purchase a house and that this purpose could
not be altered by the “shuffle of cheques” that occurred on October 27, 1988. I
respectfully disagree. It is this “shuffle of cheques” that defines the legal
relationship which must be given effect. The respondent had at least $300,000
of his own money in the law firm. Surely it follows that the $300,000 invested
in the law firm was not frozen for all time in the form of its original
investment. The respondent was free to change his mind and decide whether to
use his own money or borrowed money to finance the business of his law firm. In
reviewing what the respondent did, it is clear that the relevant cheques were
deposited and honoured. There is no suggestion that the transaction was a sham.
Giving effect to the legal relationships in this case, it is clear that the
respondent used the borrowed funds to refinance his capital account.
33
This characterization of the use of the funds is not altered by the fact
that the respondent used the money he withdrew from the firm to purchase a
house. Nor is it altered by the fact that the transactions occurred on the same
day.
34
In my respectful opinion, it is an error to treat this as one
simultaneous transaction. In order to give effect to the legal relationships,
the transactions must be viewed independently. When viewed that way, on either
version of the facts (i.e. regardless of the sequence), what the respondent did
in this case was use the borrowed funds for the purpose of refinancing his
partnership capital account with debt. This is the legal transaction to which
the Court must give effect. In this regard, I adopt the following reasons of
Rothstein J.A. (at para. 54):
In the case at bar, the direct use of the borrowed
funds was to refinance the appellant’s capital account at the firm. Treating
the borrowed funds as used for financing the purchase of the home ignores what
the appellant actually did, i.e. used the borrowed funds to replace the funds
required for his capital account at the firm. As stated by Dickson C.J. in Bronfman
Trust, the Court cannot ignore the direct use to which the appellant put
the borrowed money.
35
The fact that the money was borrowed in order to allow the respondent to
use his own money to purchase the house is of no moment. The Shell
decision decided that why the money was borrowed is irrelevant. The fact that
money was transferred from the firm to the respondent for the purchase of a
residential property has no impact on the application of s. 20(1) (c)(i)
to the interest incurred on borrowed money which was used directly for the
purpose of refinancing the capital, and as such used for the purpose of earning
income from the law firm.
36
As the borrowed money was used to refinance the respondent’s capital
account in his law firm, the issue arises as to whether such refinancing is a
direct, eligible use of the funds within s. 20(1) (c)(i) of the Act .
Relevant to this is the Exchequer Court of Canada decision in Trans-Prairie
Pipelines Ltd. v. Minister of National Revenue, 70 D.T.C. 6351. This case
involved a corporate taxpayer refinancing equity with debt. In Trans-Prairie,
the corporate taxpayer’s issued capital consisted of redeemable preferred
shares with a par value of $700,000 and common shares. The company borrowed $700,000
and used $400,000 of this amount, plus $300,000 obtained by issuing additional
common shares, to redeem the preferred shares. In effect, the taxpayer
refinanced share equity with debt and deducted the interest on the money
borrowed to refinance. In allowing the deduction, the court reasoned that prior
to the transaction the taxpayer’s capital consisted in part of the $700,000
subscribed by preferred shareholders and “as a practical matter of business
common sense, [the $700,000 of borrowed money] went to fill the hole left by
the redemption of the $700,000 preferred [shares]” (p. 6354).
37
In Bronfman Trust, supra, it was stated that “[f]airness
requires that the same legal principles must apply to all taxpayers,
irrespective of their status as natural or artificial persons, unless the Act
specifically provides otherwise” (p. 46). As indicated by this statement, if a
corporation can refinance equity with debt and deduct the interest on the
associated debt, so too should the respondent be entitled to refinance his
partnership equity with debt and deduct the interest.
38
If the respondent was not allowed to do this we would end up with the
inconsistency identified by Rothstein J.A. That is, the interest would be
deductible where a partner’s initial capital investment was financed with
borrowed funds. As well, it would continue to be deductible with a subsequent
refinancing of debt. However, a partner who originally financed with his own
money and later withdraws that money for personal use and refinances with debt
would be denied the deduction.
39
If a direct link can be drawn between the borrowed money and an eligible
use, then the money was used for the purpose of earning income from a business
or property. That is clearly the case in this appeal. The respondent was
entitled to deduct the relevant interest payments from his income.
40
The appellant submitted that even if there is a direct link between the
borrowed funds and an eligible use, the respondent must still demonstrate that
his bona fide purpose in using the funds was to earn income. However, as
explained in Ludco Enterprises Ltd. v. Canada, [2001] 2
S.C.R. 000, 2001 SCC 62, the appellant’s overriding concern for determining the
respondent’s bona fide purpose in using the funds is not consistent with
the express wording of s. 20(1) (c)(i). Absent a sham or window-dressing
or other vitiating circumstances, none of which was alleged in this case, the
respondent does not have to demonstrate a bona fide purpose.
41
The appellant also relied upon the following obiter dicta
statement in Bronfman Trust to support the position that even if there
is a direct eligible use, the interest is not deductible (at pp. 54-55):
Before concluding, I wish to address one final
argument raised by counsel for the Trust. It was submitted – and the Crown
generously conceded – that the Trust would have obtained an interest deduction
if it had sold assets to make the capital allocation and borrowed to replace
them. Accordingly, it is argued, the Trust ought not to be precluded from an
interest deduction merely because it achieved the same effect without the
formalities of a sale and repurchase of assets. It would be sufficient answer
to this submission to point to the principle that the courts must deal with what
the taxpayer actually did, and not what he might have
done. . . . In any event, I admit to some doubt about the
premise conceded by the Crown. If, for example, the Trust had sold a particular
income-producing asset, made the capital allocation to the beneficiary and
repurchased the same asset, all within a brief interval of time, the courts
might well consider the sale and repurchase to constitute a formality or a sham
designed to conceal the essence of the transaction, namely that money was
borrowed and used to fund a capital allocation to the beneficiary. In this
regard, see Zwaig v. Minister of National Revenue, [1974] C.T.C. 2172
(T.R.B.), in which the taxpayer sold securities and used the proceeds to buy a
life insurance policy. He then borrowed on the policy to repurchase the
securities. Under s. 20(1)(c)(i) the use of borrowed money to purchase a
life insurance policy is not a use entitling the taxpayer to an interest
deduction. The Tax Review Board rightly disallowed the deduction sought for
interest payments, notwithstanding that the form of the taxpayer’s transactions
created an aura of compliance with the requirements of the interest deduction
provision. The characterization of taxpayers’ transactions according to their
true commercial and practical nature does not always favour the taxpayer. The
taxpayer Trust in this appeal asks the Court for the benefit of a
characterization based on the alleged commercial and practical nature of its
transactions. At the same time, however, it seeks to have the commercial and
practical nature of its transactions determined by reference to a hypothetical
characterization which reflects the epitome of formalism. I cannot accept that
it should be allowed to succeed.
42
The appellant has over-stated the importance of this statement. It is
clear that Dickson C.J. was simply responding to a hypothetical question in a
somewhat tentative way. This was more musing than jurisprudence. As well, it is
noteworthy that in the Shell decision the Court, although invited to,
declined to follow other obiter dicta statements from Bronfman Trust
that similarly suggested that sophisticated transactions designed to minimize
tax liability should not be given effect.
43
In summary, it is irrelevant that by his own admission the respondent
structured the transaction for tax purposes. Courts cannot search for the
“economic reality” or the “bona fide” purpose of the transaction in this
case. In giving effect to the legal relationships underlying the transactions
here, it is obvious that the borrowed money was used directly to refinance the
respondent’s capital account. This is a direct, eligible use within the meaning
of s. 20(1) (c)(i) of the Act . The respondent was entitled to deduct the
interest expenses.
VI. Disposition
44
For the foregoing reasons, I would dismiss the appeal with costs to the
respondent throughout.
The reasons of Bastarache and LeBel JJ. were delivered by
45
LeBel J. (dissenting) — I
have had the opportunity of reading the reasons of Justice Major. I
respectfully disagree with his characterization of the findings of the trial
judge, as well as with his analysis both of the appropriate standard of
appellate review and of the requirements of s. 20(1) (c)(i) of the Income
Tax Act, R.S.C. 1985, c. 1 (5th Supp .). Accordingly, I would allow
this appeal and restore the judgment of the trial judge in this case.
1. Facts
46
The facts of this case can be summarized quickly. On October 27, 1988,
the respondent borrowed roughly $300,000 and deposited it with his law firm. On
that very same day, he put almost exactly that same amount toward the purchase
of a new house for himself and his wife. There is some disagreement as to the
order in which these transactions were carried out but there is no disagreement
that on that day, the amount of respondent’s investment in his law firm did not
change. The only change in his financial position was that he had a new house,
a new loan of $300,000 and a mortgage on his home.
2. Standard
of Review
47
In his reasons (at para. 22), Major J. endorses Rothstein J.A.’s view
that the taxpayer’s purpose in using the borrowed money is a question of law,
subject to full review by an appellate court. In so doing, of course, he also
rejects Bowman J.T.C.C. and Linden J.A.’s view that the taxpayer’s purpose in
using the borrowed money is a question of fact, best left up to the trial
judge.
48
I adopt a different approach to this question. Although I agree that
this case turns on the purpose for which the borrowed money was used, I
take the view that, the determination of this issue requires us to examine the
surrounding facts in order to determine the taxpayer’s purpose in undertaking
these transactions, as did Linden J.A. and Bowman J.T.C.C. Since it was the
trial judge who heard all the evidence that would be relevant to determining
the taxpayer’s purpose (concerning the surrounding circumstances, etc.),
deference should be given to his understanding of the facts. The issue may not
be then characterized as a pure question of law just because the determination
of the purpose of the taxpayer in his use of borrowed money is determinative of
the application of s. 20(1) (c)(i). On this basis, I will now turn to my
substantive analysis.
3. Economic
Realities
49
As I have already mentioned, I do not believe that it is necessary to
reconsider the trial judge’s analysis at this stage because his conclusion
substantially rests on determinations of facts, where he should be given
significant deference. However, given the disagreement on this issue, I will
examine the merits of the trial judge’s conclusions on the question of the
economic realities of the transaction that occurred.
a. Shell Canada
50
Major J. cites McLachlin J.’s (as she then was) unanimous decision in Shell
Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at para. 40, for the
proposition that “a searching inquiry for . . . the ‘economic
realities’ of a particular transaction . . . can never supplant a
court’s duty to apply an unambiguous provision of the Act to a taxpayer’s
transaction”. He interprets this quotation to mean that “taxpayers are
entitled to structure their transactions in a manner that reduces taxes. The
fact that the structures may be complex arrangements does not remove the right
to do so” (para. 28). This is too broad a conclusion to draw from McLachlin
J.’s comments in Shell Canada. Some structures will attract deductions
and others will not. The question at issue in this appeal is precisely which
“complex arrangements” generate tax deduction and which do not.
51
It is of course true that in Shell Canada this Court qualified
the “economic realities” jurisprudence it had spent many years constructing. In
a long history of cases at this Court, from Bronfman Trust v. The Queen,
[1987] 1 S.C.R. 32, through Tennant v. M.N.R.,
[1996] 1 S.C.R. 305, as well as in a number of important cases in the courts
below such as Mark Resources Inc. v. Canada, 93 D.T.C. 1004
(T.C.C.), it had come to be accepted as part of the jurisprudence that, in tax
cases, courts should look to the economic realities of the situation and not
merely to the legal technique adopted by the taxpayer. In Shell Canada, supra,
at paras. 39-40, this Court carved out two caveats to this general principle
which can be summarized as follows:
(1) economic realities cannot be used
to re-characterize bona fide legal relationships; and
(2) an inquiry concerning economic
realities cannot supplant a court’s duty to apply clear and unambiguous
statutory terms.
52
Although these two caveats can be considered a weakening of the
“economic realities” jurisprudence of this Court, they do not amount to a
wholesale rejection of it. The first caveat simply turns one difficult
normative question into another. Rather than asking what the economic realities
are, McLachlin J. says that we should ask whether the legal relations created
by the taxpayer were bona fide. This, of course, still requires courts
to look beyond the legal instruments used by the taxpayer. It limits such
inquiries to those cases where the legal relations were not created bona
fide, for instance where transactions simply amount to window dressing as
in Backman v. Canada, [2001] 1 S.C.R. 367, 2001 SCC 10.
Since it is still very much in question whether the legal relations in the case
at bar were created bona fide, this is an important consideration.
53
The second caveat presented by McLachlin J. is that, whatever the economic
realities of the situation might be, they can never grant a court license to
ignore clear statutory language. As I shall argue at greater length in the next
section (on statutory interpretation), however, it is not at all clear that the
statutory language itself requires us to consider two transactions in isolation
from one another. This is precisely the difficult question of statutory
interpretation which is involved in this appeal. With respect, it begs the
question to argue that the clear meaning of the section is that the
transactions must be considered separately.
b. “Economic Realities” Jurisprudence
54
As I have said, Shell Canada did not overrule the economic
realities rule. This general rule was adopted by Dickson C.J. in Bronfman
Trust, supra, at p. 53, as follows:
Assessment of taxpayers’ transactions with an eye to commercial and
economic realities, rather than juristic classification of form, may help to
avoid the inequity of tax liability being dependent upon the taxpayer’s
sophistication at manipulating a sequence of events to achieve a patina of
compliance with the apparent prerequisites for a tax deduction.
55
In that case, Dickson C.J. argued, at p. 55, that a situation such as
the very one at bar would likely be rejected, possibly as a sham, but also on
other grounds:
If, for example, the Trust had sold a particular income‑producing
asset, made the capital allocation to the beneficiary and repurchased the same
asset, all within a brief interval of time, the courts might well consider the
sale and repurchase to constitute a formality or a sham designed to conceal the
essence of the transaction, namely that money was borrowed and used to fund a
capital allocation to the beneficiary.
Dickson C.J.’s
reasons are precisely on point and should not be dismissed as mere obiter
dicta on an hypothetical issue. It appears that the then Chief Justice put
his mind precisely to this scenario and found that the economic reality of the
situation was that the two transactions should be understood as one.
56
Indeed, Linden J.A. makes clear, at [1999] 4 F.C. 484, at paras. 11 et
seq., in his thoughtful and well-reasoned dissenting judgment in this case
in the Federal Court of Appeal that Dickson C.J.’s comments should be construed
as rejecting such a scenario not simply as a sham, but on other grounds, as
well. Moreover, such a scenario was rejected by the Tax Review Board in Dunn
v. M.N.R., 74 D.T.C. 1121, not on the grounds that it was a
sham, but simply that, looking at the substance of the transaction, such money
was not used for the purpose of earning income.
57
Later, in Tennant, Iacobucci J. examined the economic realities
of the situation – this time to favour the taxpayer. He found that the taxpayer
could deduct the full amount of interest payable on a loan of $1,000,000 even
though he had exchanged the original investment for one with a market value of
only $1,000. The reason for this was that, although at the time of assessment
the taxpayer was only using $1,000 for the purposes of earning income from
property, the “economic reality” of the situation was that he had originally
borrowed $1,000,000 for the purpose of investment. The legal form of the
transaction, therefore, did not accord with the economic reality.
58
Since, as we have seen above, Shell Canada does not
overrule this Court’s “economic realities” jurisprudence, these decisions
should still be regarded as good law. Dickson C.J.’s analysis can be reconciled
with McLachlin J.’s first caveat: he is simply arguing that the legal
relationships in the Bronfman Trust hypothetical were not created bona
fide. Accordingly, it is still appropriate to consider the two steps as
part of a single transaction for the purposes of tax assessment. As for the
second caveat in Shell Canada, it applies to the construction of
statutory terms. Let us now proceed to that stage of the analysis.
4. Statutory
Interpretation
a. The Words-in-Total-Context Approach
59
In Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536,
this Court articulated a new method of statutory interpretation appropriate to
the Income Tax Act , dubbed the “words-in-total-context approach” by
MacGuigan J.A. in Harris Steel Group Inc. v. M.N.R., 85 D.T.C.
5140 (F.C.A.). In Stubart, at p. 578, citing Construction of Statutes
(2nd ed. 1983), at p. 87, Estey J. endorsed the rule of statutory
interpretation from E. A. Driedger that this Court had already adopted for
other statutes, viz., that “the words of an Act are to be read in their
entire context and in their grammatical and ordinary sense harmoniously with
the scheme of the Act , the object of the Act , and the intention of Parliament”.
60
Since Stubart, this Court has taken such an approach in a number
of other decisions, such as The Queen v. Golden, [1986] 1 S.C.R.
209, at p. 214, per Estey J., and Symes v. The Queen,
[1993] 4 S.C.R. 695, at p. 744, per Iacobucci J., and at p. 806, per
L’Heureux-Dubé J. Even cases such as Québec (Communauté urbaine) v. Corp.
Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3, at p. 15 (advocating the
teleological approach), and Friesen v. Canada, [1995] 3 S.C.R. 103, at
para. 10, per Major J. (advocating the “plain meaning” approach), still
refer to Stubart as the foundational modern Canadian case for statutory
interpretation.
61
The words-in-total-context approach steers a middle course between the
pure teleological method of Gonthier J. in Corp. Notre-Dame de Bon-Secours
and Major J.’s focus on the “plain meaning” of the statute in Friesen.
As Professor Duff points out in his article “Interpreting the Income Tax Act ”
(1999), 47 Can. Tax J. 741, at p. 787, “[i]n rejecting the
extremes of purposive interpretation on the one hand and the plain meaning rule
on the other, the words-in-total-context approach affirms a more
‘open-textured’ approach to statutory interpretation . . .”.
62
It is important to keep in mind that McLachlin J.’s second caveat in Shell
Canada does not require a simplified “plain meaning” rule of statutory
interpretation. The words-in-total-context approach ensures that clear
statutory language is not overlooked in order to carry out a broad statutory
purpose more effectively. It is the approach that should be applied here.
b. The Teleological Approach
63
This Court unanimously endorsed a “teleological approach” to the
interpretation of the tax legislation in its 1994 decision Corp. Notre-Dame
de Bon-Secours. According to Gonthier J.’s view, at p. 18, courts should
look first to the legislature’s purpose in order to determine
legislative intent. Once this intent has been determined, then courts can
identify the sorts of presumptions to be applied to a particular section:
. . . it is the teleological interpretation that will
be the means of identifying the purpose underlying a specific legislative
provision and the Act as a whole; and it is the purpose in question which
will dictate in each case whether a strict or a liberal interpretation is
appropriate or whether it is the tax department or the taxpayer which will be
favoured. [Emphasis added.]
64
This approach, however, cannot be mechanically applied for it may raise
the first of Dickson C.J.’s worries concerning statutory interpretation in Bronfman
Trust (which is the same in substance as McLachlin J.’s first caveat
in Shell Canada), i.e. losing sight of the fact that an appreciation of
the context of legislation is helpful “provided it is consistent with the text
. . . of the taxation statute” (p. 53). If we begin by considering
the purposes of the statute we run the risk of obscuring the meaning of the
particular statutory language in our enthusiasm to forward the general
statutory purpose. Careful attention must always be taken to give effect to the
particular language Parliament chose to use.
c. The Plain Meaning Approach
65
The reaction to the teleological approach emphasises the particular
statutory language and is often referred to as the “plain meaning” approach.
This Court has not dealt consistently with what, precisely, this approach
entails. Some cases, such as Major J.’s majority decision in Friesen (at
pp. 113-114, citing P. W. Hogg and J. E. Magee, Principles of
Canadian Income Tax Law (1995), section 22.3(c), “Strict and purposive
interpretation”, at pp. 453-54) take a hard line, as follows:
. . . “object and purpose” can play only a limited role in
the interpretation of a statute that is as precise and detailed as the Income
Tax Act . When a provision is couched in specific language that admits of no
doubt or ambiguity in its application to the facts, then the provision must be
applied regardless of its object and purpose.
66
Other cases, such as Cory J.’s majority decision in Alberta (Treasury
Branches) v. M.N.R., [1996] 1 S.C.R. 963, however, have understood
the test differently, so much so that is often difficult to distinguish from
the words-in-total-context approach. In that case, Cory J. held, at para. 15,
that “in order to determine the clear and plain meaning of the statute it is
always appropriate to consider the ‘scheme of the Act , the object of the Act ,
and the intention of Parliament’”.
67
Cory J.’s understanding of the “plain meaning” approach in Alberta
(Treasury Branches) is peculiar but telling. By turning to the total
context of the statute in order to determine the “plain meaning” of statutory
language, he shows that the meaning of statutory language is at times clear
only in a particular context. It is a basic axiom of all textual interpretation
that meaning is context-dependent. Some statutory language might appear
to be obvious in its meaning independent of context. This is not, however,
because context plays no part in interpreting the words used. Rather, it is
simply because the context is so predictable that we need not pay it any
special attention. Nevertheless, it plays a central role in our understanding of
the words used.
68
If the “plain meaning” approach is to make any sense at all, it surely
cannot mean that we are always to ignore context when interpreting statutory
language. Rather, it must be understood to say that although context is always
important, sweeping considerations of general statutory purpose cannot outweigh
the specific statutory language chosen by Parliament. It is an acknowledgement
that Parliament’s purposes can be complex. Rather than finding a single purpose
for the Act as a whole and using it to interpret the clear language of specific
provisions, we should use such broad purposes only as a context to help
elucidate the meaning of the specific statutory language. Understood in this
way, it is not inconsistent with the basic thrust of the words-in-total-context
approach.
5. Application
to the Case at Bar
69
The foregoing discussion, I believe, provides the necessary background
for a proper disposition of this case. Although, as I mentioned above, we need
not review the merits of the trial judge’s analysis of the case (since it turns
on an understanding of the purpose for which the borrowed money was used, which
is substantially a question of fact best left up to him), a careful analysis
reveals that his decision is entirely correct, all the same. In order to show
this, I will apply the principles discussed above to the facts of the case.
a. Economic Realities
70
In Shell Canada, McLachlin J. never excluded the
recharacterization of all legal relationships created by the taxpayer; she only
protected bona fide legal relations. Thus, she invites a normative
inquiry into whether or not such relations are created bona fide in
order to meet the requirements of the statute.
71
Dickson C.J.’s decision in Bronfman Trust makes clear that a
situation such as the one t bar is suspect. Whether or not such a series of
transactions constitutes a sham, they clearly do not constitute a set of bona
fide legal relations. It is an undisputed finding of fact that the
respondent funnelled money through his law firm simply to secure a tax
advantage; his borrowing was not made with the bona fide purpose of
generating income from his business.
b. Section 20(1) (c)(i) in Total Context
72
As mentioned earlier, we must proceed with a contextual reading of s.
20(1) (c)(i). Following Dickson C.J.’s obiter dictum from Bronfman
Trust, I would hold that the legal relations created by the taxpayer have
not been created bona fide.
73
The total context of s. 20(1) (c)(i) includes a number of factors.
First, I would note that this section is an exception to the general rule
(outlined in s. 18(1)(b) (formerly s. 6(1)(b)) as interpreted in Canada
Safeway Ltd. v. Minister of National Revenue, [1957] S.C.R.
717, at pp. 722‑23, per Kerwin C.J., and at p. 727, per
Rand J.) against the deductibility of capital outlays. Although the general
default rule against the taxpayer in exempting provisions is no longer good
law, there is certainly no default in his favour, either.
74
Second, I turn to the purpose of the particular provision. According to Bronfman
Trust, supra, at p. 45, “Parliament created s. 20(1) (c)(i), and made
it operate notwithstanding s. 18(1)(b), in order to encourage the
accumulation of capital which would produce taxable income” (emphasis
added). Thus, insofar as the deduction is being claimed for a use of borrowed
capital that will not lead to the production of income (but, instead will
simply fund the purchase of personal property), I would be disinclined to grant
such a deduction.
75
c. Considering the Transactions Together
The argument was made in this appeal that it was an error of law to
treat the successive transactions as one and that they should be viewed
independently. With respect, I do not agree. As Linden J.A. states, at para.
27, in his dissenting judgment in the Federal Court of Appeal:
There is no rigid rule which demands that complex
transactions be viewed as separate steps or as one transaction. The task at
hand is to discover the economic and commercial reality of the transaction in
order to discover whether the borrowed money was used for the purpose of
earning income.
Whether or not
we consider the two transactions separately or together does not affect the
legal relations created by the taxpayer. Of course, if we examine the two
together, we will discover that the individual transactions were not created bona
fide and that the overt attempt to meet the requirements of s. 20(1) (c)(i)
was legally ineffective. Although the taxpayer did put roughly $300,000 of
borrowed money into his law firm, this does not mean that borrowed money was
used for the purpose of earning income. Rather, understood in context, it was
used to shore up a shortfall incurred as a result of his purchase of a home
with his firm’s funds.
d. Equities
76
The respondent contended that it would be inequitable not to allow a
deduction to the taxpayer in this case because, as my colleague put it, “if a
corporation can refinance equity with debt and deduct the interest on the
associated debt, so too should the respondent be entitled to refinance his
partnership equity with debt and deduct the interest” (para. 37). Major J.
supports this claim by pointing out that fairness requires that no distinction
be made between natural and artificial persons.
77
I do not think it follows that, just because a corporation can refinance
equity with debt and obtain a deduction on the interest, the respondent should
be entitled to refinance his partnership equity with debt and deduct the
interest. Allowing the deduction for the corporation but not for the respondent
does not rest on the difference between natural and artificial persons with
differing treatment giving rise to a claim of unfairness. The point is that
when the corporation borrows money, this is money that will relate to the
business by definition or default, whereas in the case of a person with an
ownership interest in a business (i.e., a partner in a partnership), the
borrowed money may or may not relate to the business. Here it does not. In
other words, if the deduction is denied to the respondent in the circumstances,
it is not denied to him because he is a natural person; rather he is denied the
deduction because, being an individual, the money he borrows may or may not
relate to the business and here the “shuffle of checks” is insufficient to make
it so given the personal use of the borrowed money.
78
Hence, the present situation is not analogous to that of Trans-Prairie
Pipelines Ltd. v. Minister of National Revenue, 70 D.T.C. 6351 (C. de
l’É.). In that case, the shortfall that the taxpayer corporation made up with
borrowed funds was created by an indisputably business-related expense, viz.,
paying off a business debt to preferred shareholders. In the present case, the
taxpayer has no such business purpose. The situation is much closer to that in Sternthal
v. The Queen, 74 D.T.C. 6646 (F.C.T.D.), where the taxpayer had a large
corporate shortfall because he had given large income-free loans to his
children. In that case, the deduction was not allowed.
79
In para. 38, Major J. agrees with Rothstein J.A. that an inconsistency
would arise if the deduction were to be denied to a partner who originally
financed the partnership with his own money, withdraws that money for personal
use and refinances this with debt, whereas a partner whose initial investment
was financed with borrowed funds would get a deduction of interest and any
subsequent refinancing with debt would also have a deductible interest. I think
this comparison is misleading and the unfairness it is meant to point to is
more apparent than real.
80
A partner whose initial investment was financed with borrowed money will
only continue to get the interest deduction on any subsequently borrowed money
if that money is related to the business. He will not get the deduction for
personal spending. Hence, he compares favourably with someone in the
respondent’s position, i.e. a partner who originally finances the partnership
with his own money. Access to the deduction does not turn on whether or not the
initial investment is with borrowed money, but what the borrowed money is used
for – personal use means no deduction regardless of when the borrowing started.
As a consequence, there is no difference or differential treatment giving rise
to potential unfairness. We must view access to the deduction in consideration
of the use of the borrowed funds, as the provision directs us to; there is then
no worry about an inconsistency. Where the borrowed money is used for personal
purchases, there is no deduction in either case. Otherwise, a different kind of
unfairness would be created, namely that partners in partnerships would be
given access to a way to finance the purchase of their homes by virtue of a
shuffle through the capital accounts of their law firms.
81
The unfavourable comparison between a partner who need not borrow money
to invest in the partnership but who does so and as a result benefits from both
the interest deduction and is left with capital that could be used for personal
consumption and a partner who uses his or her own money for investment in the
law firm and as a result does not have that capital available for personal
consumption is a comparison seems too hypothetical to me and requires assuming
that things happened differently than they did in this case. If Singleton had
borrowed rather than used his own money to finance the firm when he first
joined it, theoretically, he could have used that money to buy a house. But
that is not what he did. He used his money to invest in the partnership and the
money he borrowed was used to finance the house, not to finance the partnership
(he only returns it to the partnership because he took it from the
partnership). We cannot attribute to him tax treatment because of something he
could have done. We must look at what he did. As Linden J.A. states, at p. 501,
in his dissent in the Federal Court of Appeal, “[w]e must examine what the
taxpayer actually did, not what he could have or should have done”.
82
There is no inconsistency in saying that if a taxpayer does something
one way, certain tax consequences follow, but things, if done another way,
would be treated differently. He should not get the benefit of an
interpretation which attributes to him the benefits of a possible way to
arrange his affairs; he is to be taxed on how those affairs were actually
arranged. In other words, we cannot say that he should obtain the
deduction because he could have obtained the deduction by another
different arrangement of his affairs. The Act requires that the court consider
the actual purpose for which the borrowed money was used. The question
to be asked in order to ascertain that purpose is rather simple in my view:
what was changed by these transactions? Here it was the acquisition of a house.
The financing of the law firm remained the same.
83
Moreover, the idea that a partner who has originally invested money in a
law firm that he could have used for personal consumption should be given the
same tax benefit as the partner who borrows for that initial investment and
then removes equity from the firm later in order to make a personal purchase
does not result in a standard of “equal treatment” that is practicable. Suppose
the respondent had borrowed in order to buy his part of the partnership,
obtaining as he should deduction on the interest of the debt. Imagine that in
five years he had repaid the borrowed money. Now suppose that the respondent
did what he did here, i.e. took out his equity in the law firm, bought the
house and borrowed to replace the money he took out of the capital account. If the
deduction on the interest of the second loan is allowed, this means that the
fictitious purpose is dominant in all cases as a result, a taxpayer can
effectively continue to obtain deductions for personal consumption at will.
This clearly cannot be what is intended by the legislation, which calls for a
deduction only when the bona fide use of the borrowed funds is to
produce income.
e. “Direct Link” analysis from Shell Canada
84
It was also submitted that there is a direct link between the taxpayer’s
borrowing of the funds in question and an eligible use. According to Shell
Canada, supra, the interest paid on that money should
therefore be deductible. With respect for the opposite view, I do not agree
with this reading of Shell Canada.
85
In Shell Canada, McLachlin J. did, in fact, use the language of
“direct link.” She stated, at para. 32 as follows:
Here, Shell borrowed NZ$150 million from the
foreign lenders and immediately exchanged it for approximately US$100 million
before applying it to its business. This exchange did not after the basic
character of the funds as “borrowed money”. Money is fungible. The US$100
million was simply the NZ$150 million transformed into a different currency
which, although it changed its legal form and its relative value, did not
change its substance. It remained money. [. . .] Viewed thus, it is
apparent that all of the NZ$150 million that Shell borrowed from the foreign
lenders was borrowed money currently and directly used for the purpose of
producing income from Shell’s business. The direct link between the borrowed
money and the activity calculated to produce income can hardly be compared to
the indirect use at issue in Bronfman Trust. . . .
86
From this passage, it appears that McLachlin J. was not dealing with a
situation at all similar to the one at bar. Rather, she was concerned to answer
the argument that because the borrowed money was denominated in New Zealand
dollars, it should not be deductible since it was immediately converted into
U.S. dollars. She points out that money is fungible, however, so the
denominations are immaterial to the analysis. In the present case, we are
concerned with two possible uses of the borrowed funds: one is to invest in the
law firm in order to generate income and the other is to purchase a home. In Shell
Canada, by contrast, all the uses to which the money might be put are
business-related. The only concern is whether a legal formality (that the funds
were borrowed in New Zealand currency but were invested in U.S.currency) should
prevent the taxpayer from being able to deduct interest on borrowed funds that
clearly went toward its business.
87
Reading McLachlin J.’s decision in Shell Canada as a whole leads
to the conclusion that she does not mean to suggest that a taxpayer can deduct
the interest he paid on money he borrowed for a purpose totally unrelated to
his business. Rather, she simply held that bona fide legal relationships
should not be disregarded by the courts in analysing such transactions. Since,
as McLachlin J. points out, money is fungible, the denominations in which it is
calculated are irrelevant to understanding the essence of the transaction.
Since she maintains that it is only bona fide legal relationships that
are to be given deference by the courts, there must be some legal relationships
that courts still consider not to be bona fide. The facts in the present
case surely present as strong a case of legal relations created without bona
fide as one could imagine. A loan was obtained to finance the purchase of a
private home. Interest paid in respect of such a loan should not be claimed as
a deduction from taxable income.
6. Conclusion
88
For the reasons stated above, I would grant the appeal and restore the
judgment of Bowman J.T.C.C.
Appeal dismissed with costs, Bastarache
and LeBel JJ. dissenting.
Solicitor for the appellant: The Deputy Attorney General of
Canada, Department of Justice, Ottawa.
Solicitors for the respondent: Davis & Company, Vancouver.
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