Walton v. MNR, 89 DTC 423, [1989] 2 CTC 2335 (TCC)

Rowe, T.C.J.: —This is the matter of Arthur E. Walton and the Minister of National Revenue.

The appellant appeals from a reassessment of income tax for his 1985 and 1986 taxation years. The appellant, in filing his individual T-1 return for the 1985 taxation year claimed as a deduction superannuation arrears in the amount of $3,082.80 and attached to his return an explanation for claiming the amount rather than the sum of $1,409.10 as shown in Box K on the T-4A slip which he received and attached to his return.

In filing his individual T-1 income tax return for the 1986 taxation year, the appellant claimed as a deduction the amount of $2,466.24 as superannuation arrears and attached a letter indicating that he was claiming the amount of $2,466.24 rather than the sum of $1,127.28 as shown in Box K on the T-4A slip attached to his return.

By notice of reassessment dated October 7, 1987, the Minister reassessed the appellant’s 1985 taxation year so as to disallow a Registered Pension Plan contribution in the amount of $1,674, but did allow the amount of $1,409.10 as shown under Box K of the T-4A 1985 supplementary issued to the appellant by the Superannuation Division.

By notice of assessment dated July 31, 1987, the Minister of National Revenue assessed the appellant's 1986 taxation year as to disallow Registered Pension Plan contributions in the amount of $1,339, but did allow as a Registered Pension Plan contribution the amount of $1,127.28 shown in Box K of the T-4A 1985 supplementary issued to the appellant by the Superannuation Division.

The appellant had been employed by Revenue Canada for 24 years prior to his retirement on October 18, 1984. He had served in the Royal Canadian Air Force between May 20, 1941, and October 1, 1945. He decided to investigate the viability of purchasing his past service pension as permitted by the Public Service Superannuation Act. He ascertained it would cost him $22,544.51 as a cash payment in order to pay for the pension contributions for past service.

He was aware that by borrowing that amount of money and paying the lump sum, any interest charges on the borrowed money would not be deductible by virtue of the operation of subsection 18(11) of the Income Tax Act. The appellant ascertained that he could pay for the past service contributions by making instalment payments. A calculation of those payments was set out in a document which formed part of Exhibit R-1.

The total cost to be paid by him between February 1985 and September 2004 amounted to $49,324.80 payable at the rate of $205.52 per month. On October 2, 1984, he entered into an agreement with the Minister of Supply and Services, said agreement having been filed as Exhibit R-2.

The agreement, under the section entitled "Method of Payment" contained the following words;

I further elect to make my contributions in the following manner.

And then following that, there was an “x” entered into a box indicating the appellant chose to pay a monthly instalment of $205.46.

The appellant submits the respondent is incorrect in not permiting him to deduct the entire amounts paid by him, including the instalments necessary to pay for past service.

Counsel for the respondent submits the payments made by the appellant clearly include interest charges of four per cent per annum, which fact was well known to the appellant prior to signing the agreement.

In fact, counsel argues, the calculation sheet forming part of Exhibit R-1 indicates 54.29 per cent of the total cost of the payment is really attributable to interest. It is conceded by the respondent that a charge of approximately $1,900 relates to an actuarial computation and is not interest per se.

The appellant argues that the plain reading of paragraph 8(1)(m) of the Income Tax Act entitles him to deduct the amount contributed by him to his pension plan, including contributions for past service.

The appellant concedes that there is an interest component included in every monthly instalment, but argues that it still is an amount as contemplated by the section and was not broken down into its component parts for the purpose of the agreement.

Subsection 18(11) of the Act prohibits a taxpayer from deducting financing charges on funds borrowed to contribute to certain deferred, or partially deferred income plans. The financing charges to which the subsection applies are interest deductible under paragraph 20(1)(c), (d), (e) or (k). The financing charges referred to are not deductible when the amount is in respect of indebtedness incurred for the purpose of contributing to certain income plans including the pension plan enjoyed by the appellant.

The relevant portion of paragraph 18(11)(c) of the Act reads as follows:

Notwithstanding any other provisions of this Act, in computing the income of a taxpayer for a taxation year, no amount shall be deducted under Paragraph 20(1)(c), (d), (e) or (k) in respect of indebtedness incurred for the purpose of; (c) making a contribution to a registered pension fund or plan or a deferred profit sharing plan after November 12th, 1981.

Counsel for the respondent argues that the effect of this section is to override paragraph 8(1)(m) and to prohibit the deduction of the appellant's identifiable interest charges which can only be deductible under subsection 20(1) of the Act.

The calculation sheet forming part of Exhibit R-1 and specifically at line 11, refers to "other charges as percentage of total future cost”, which is followed by a computation expressed as 54.29 per cent.

The appellant does not seek to claim a specific deduction for interest, and is not attempting to deduct his contributions under any head, other than as an amount within the meaning of paragraph 8(1)(m) of the Act.

The Minister takes the position that over 50 per cent of each monthly instalment paid by the appellant is tainted by clearly being attributable to interest charges. In my view, the effect of the “notwithstanding” clause in subsection 18(11) is limited by the reference to amounts deducted under paragraph 20(1)(c), (d), (e) or (k) in respect of indebtedness incurred for the purpose specified in paragraph 18(1)(c) of the Act.

Interpretation Bulletin IT-167R5 at paragraph 16, beginning at the second full sentence reads as follows:

Where a past service contribution, including accrued interest is to be paid in instalments it is probable that each instalment will include an interest factor. Prior to the enactment of Subsection 18(11) such instalment interest could also have been regarded as either interest or a registered pension plan contribution as described in (a) and (b) above. A defined benefit plan is one in which benefits to be paid to each member of the plan are defined without regard to the plan's cost or earning experience. As is the case with interest on money borrowed to make a past service contribution Subsection 18(11) now prohibits the deduction under paragraphs 20(1)(c) or (d) of accrued or instalment interest on such contributions after November 12, '81 to a registered pension fund or plan, other than interest on a past service contribution, required to be made pursuant to an obligation entered into before November 13, 1981. Accordingly, accrued and instalment interest paid to a plan on past service contributions, where the obligation to make the past service contributions was entered into after November 12, 1981 will no longer be deductible under Paragraphs 20(1)(c) and (d) of the Act.

The bulletin is interesting in that it contemplated the deduction for interest specifically to fall under paragraph 20(1)(c) or (d) of the Act.

I am satisfied that there is no doubt each instalment payment made by the appellant did, in fact, contain a component of interest in excess of 50 per cent of the total amount of each payment.

I am also satisfied that by paying each monthly instalment he was, in fact, repaying an indebtedness to the Government of Canada to restore past pension contributions.

By choosing to follow the route he did, the appellant increased his total pension by approximately nine per cent.

However, it is not the appellant who chooses to attempt to deduct interest on the indebtedness, rather it is the respondent who isolates that portion of each payment attributable to interest and then places that interest deduction so as to seek its prohibition by virtue of the operation of subsection 18(11) of the Act.

If there is to be no deductibility for the interest component of instalment payments for past pensionable service, one or more things should occur. First, the agreement itself could break down the payment so as to clearly define the interest charges.

Second, in calculating the election available to a taxpayer as to the method of payment as was done on the calculation sheet, instead of a reference to "other charges", the interest component could be clearly specified.

However, since I have already found an interest component existed, those matters do not play a role in my decision. In my opinion, paragraph 8(1)(m) of the Income Tax Act would have to be amended to specifically prohibit deductions of amounts which were attributable to interest. Otherwise, the interest paid is still an amount that is deductible and is not properly prohibited by the operation subsection 18(11). The agreement itself referred to each instalment as a contribution.

It is clear what Parliament intended in enacting subsection 18(11). However, innovative tax planning is an art form. Usually it is the taxpayer who seeks to obtain a deduction notwithstanding he does not fall squarely within a particular section. It is well settled law that the Income Tax Act is to be clearly construed.

As Mr. Justice Pratte of the Federal Court of Appeal stated in the course of delivering judgment for the Court in the case of Produits L.D.G. Products Inc. v. Her Majesty the Queen, [1976] C.T.C. 591; 76 D.T.C. 6344, at page 598 (D.T.C. 6349),

There is nothing reprehensible in seeking to take advantage of a benefit allowed by the law. If a taxpayer has made an expenditure which, according to the Act, he may deduct when calculating his income, I do not see how the reason which prompted him to act can in itself make this expenditure non-deductible.

The appeal is therefore allowed. The respondent is directed to reassess the appellant for his 1985 and 1986 taxation years by allowing him to claim as a deduction the sum of $3,082 for 1985, and the further sum of $2,466.24 for 1986.

Appeal allowed.