Singleton v. R., 99 DTC 5362, [1999] 3 CTC 446 (FCA), aff'd supra.

Rothstein J.A. (McDonald J.A. concurring):

Issue

This is an appeal from the Tax Court of Canada involving the deductibility of interest under paragraph 20(1 )(c) of the Income Tax Act, S.C. 1970-71, c. 63, as amended. Subparagraph 20( I )(c)(i) permits the deduction of

20. (1) (c) an amount paid in the year or payable in respect of the year ..., pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property...

or a reasonable amount in respect thereof, whichever is the lesser;...

20. (1) c) la moins élevée d’une somme payée au cours de l’année ou payable pour l’année ... et d’une somme raisonnable a cet égard, en exécution d’une obligation légale de verser des intérêts sur:

(i) de l’argent emprunté et utilisé en vue de tirer un revenu d’une entreprise ou d’un bien...

The issue is whether money borrowed by the appellant was used for the purpose of earning income from his law firm or whether it was used for the purpose of financing the purchase of a home. If the former, the interest is deductible; if the latter, it is not.

Facts

On October 27, 1988, the appellant was one of two partners in Singleton Urquhart, a law firm with offices in Vancouver and Calgary. In addition to the two partners, the firm employed eleven associate lawyers and various other employees. On October 27, 1988 the amount in the appellant’s capital account at Singleton Urquhart was at least $300,000. On that date, Single- ton Urquhart paid out $300,000 from his capital account to the appellant. The appellant used the $300,000 to assist in the purchase of a home registered in the name of his wife.

Later on October 27, 1988, the appellant borrowed $298,750 from the Bank of British Columbia and together with $1250 of his own money, paid a total of $300,000 back into his capital account at Singleton Urquhart. [1]

The appellant paid interest of $3,688.52 in 1988 and $27,415.46 in 1989 and deducted the interest on his tax returns for those years. The Minister reassessed, denying the interest deduction. The appellant appealed to the Tax Court of Canada.

Essentially, the learned Tax Court Judge found that at the end of October 27, 1988, the appellant had financed the purchase of a home and had become indebted to the Bank of British Columbia. Viewing the matter in this way, he concluded that the funds borrowed by the appellant were used to purchase the home. The following excerpts from his reasons explain his analysis of the facts:

What happened on October 27, 1988 is that money came from the bank, went through the firm and immediately went out to the appellant and was used in the purchase of the house. Without suggesting that there was any sham or dissimulation, that is the reality of the situation.

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.

The true purpose of the use of the borrowed funds subsumed the subordinate and incidental links in the chain. Theoretically one might, in a connected series of events leading to a predetermined conclusion, postulate as the purpose of each event in the sequence the achievement of the result that immediately follows but in determining the “purpose” of the use of borrowed funds within the meaning of paragraph 20(1)(c) the court is faced with practical considerations with which the pure theorist is not concerned.

What the appellant purported to do, he did. I am basing my decision on the fact that, even if one accepts the legal validity of the steps that were taken and also treats the obvious tax motivation 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....

The appeals are dismissed with costs.

Standard of Review

The learned Tax Court Judge used the term “inescapable factual determination” in referring to the “true economic purpose for which the borrowed money was used”. It is a well settled principle of law that, absent a palpable and overriding error affecting the trial judge’s assessment of the facts, an appellate court should not substitute its own findings of fact for those of the trial judge. See R. v. Vanderpeet [2] .

lacobucci J. explained the difference between questions of law, fact and mixed law and fact in Canada (Director of Investigation & Research) v. Southam Inc.?: [3]

Briefly stated, questions of law are questions about what the correct legal test is; questions of fact are questions about what actually took place between the parties; and questions of mixed law and fact are questions about whether the facts satisfy the legal test.

In distinguishing questions of law from questions of mixed law and fact, one of the considerations is whether the point in controversy is one of general principle that might potentially arise in cases in the future. If so, the question is one of law.

In this case, the facts are the transactions that took place on October 27, 1988. There are no issues of credibility. There is no dispute about these facts. What is at issue in this appeal is how the transactions are to be analyzed for purposes of paragraph 20(1)(c). Clearly, if all the appellant’s transactions of October 27, 1988 are treated as one transaction or as a series of connected transactions, the conclusion arrived at by the learned trial judge will be reached. However, if each transaction is treated independently (i.e. withdrawal of funds from the capital account on the one hand and replacement of those funds on the other), the bank borrowings will be found to be used for the purposes of refinancing the appellant’s capital investment in the law firm.

The question of how to treat the transactions for purposes of paragraph 20(1)(c), i.e. independently or as a connected series is, I think, a question of law because it involves the determination of a legal test against which the factual transactions are to be assessed. Because what is at issue is a question of law, it is not inappropriate for this Court to re-examine the conclusion of the learned Tax Court Judge on the question of the purpose for which the appellant borrowed funds.

Analysis

A. Rationale for Treating Transactions Independently

As I have already indicated, what is at issue is whether the transactions in this case are to be treated independently or as a series of connected transactions. I am of the respectful opinion that in this case the transactions must be viewed independently. Only in this way will the reality of the appellant’s circumstances and what he actually did be taken into account. The appellant had his own funds in his capital account in his firm which he withdrew for use in the purchase of a home. He borrowed funds to replenish the funds he withdrew from his capital account. If the purchase of the home and the borrowing of the funds are viewed as one transaction or as transactions in a connected series, these facts are given no meaning. A more detailed consideration of the transactions demonstrates why it would be incorrect not to give meaning to the individual transactions in this case.

At the start of October 27, 1988, the appellant had in excess of $300,000 in his capital account at the firm. From his personal point of view, the capital account was financed with his own funds, that is, not financed by personal borrowing. While it is not possible to specify exactly what the $300,000 was used for by the firm at any given time, it would be generally used to finance assets of the firm such as cash, short-term investments, furniture, fixtures and equipment, accounts receivable and perhaps other assets not financed through liabilities of the firm or the other partner’s capital. When the $300,000 was withdrawn from the firm, the firm’s assets would be reduced, (1.e. probably cash), and the liabilities of the firm would be increased if the firm had to borrow to pay the appellant his $300,000. In order to replace the firm’s reduction of assets or eliminate the firm’s need to incur the increased liability caused by the withdrawal of his capital funds, the appellant borrowed $298,750 from the Bank and together with $1,250 of his own funds, paid $300,000 into the firm. At the end of October 27, 1988, the appellant’s capital account was the same as at the start of the day. However, now it was refinanced with a personal bank loan of the appellant.

There is no suggestion that the firm did not require the funds the appellant paid to the firm in replacement of the funds withdrawn from his capital account. Indeed, it is obvious that the withdrawn funds were required because they were replaced the same day. Nor is there any suggestion that the transactions were not bona fide. i.e. a sham contrived to make it appear that something was taking place that was not, in reality, occurring. [4] The evidence is that the funds paid into the firm on October 27, 1988 were the funds borrowed from the Bank of British Columbia and with respect to which the appellant had a legal obligation to pay interest.

If the transactions are viewed independently, therefore, it is clear that the funds the appellant used for the purpose of assisting in the acquisition of the home were his own funds that he withdrew from the law firm and the funds he used for the purpose of replenishing his capital account at the firm were funds borrowed from the Bank of British Columbia.

If the transactions are not viewed independently, an unexplained inconsistency arises. An initial capital investment by a partner in a law firm can be financed with borrowed funds for which the interest payable is deductible. A subsequent refinancing of that capital investment can also be fi- nanced with borrowed funds for which the interest is deductible, e.g. if the partner changes banks. The Minister has presented no logical reason why, if a partner invests his own funds in his firm, he cannot withdraw those funds for personal use and refinance the investment in the firm with borrowed money in respect of which interest is deductible. Yet that is the result if the transactions are viewed as one or as a series of connected transactions, in which the ineligible use of the withdrawn funds is linked to the refinancing with borrowed funds. The requirement of paragraph 20(1 )(c) is that the borrowed money is used for the purpose of earning income. Its application is not limited to the initial investment made nor to the refinancing of prior borrowed funds. Its application does not exclude refinancing with borrowed funds, a partner’s investment of his own funds in his firm which he withdraws for a non-eligible purpose.

During argument, there was a suggestion by counsel for the Minister that perhaps if there was an interval of time between the withdrawal of the funds from the firm for an ineligible use and the payment into the firm of borrowed replacement funds, that the use of the borrowed funds might be considered to be for the purpose of earning income, i.e. there would be no link between the ineligible use of the withdrawn funds and the borrowed funds. However, I fail to see how an interval of time has any bearing on the issue. Certainly, the interval of time might make the purpose for which the withdrawn funds were used less obvious, but that is hardly a principled basis upon which to find that the funds borrowed to replace the withdrawn funds were or were not used for the purpose of earning income for purposes of paragraph 20(1)(c). Of course, if all transactions occur on the same day, there is a greater risk to the taxpayer that he or she might not structure them so as to ensure that the borrowing comes within the requirements of paragraph 20(1 )(c), e.g. taking shortcuts. However, provided the transactions are properly structured and there is no sham, I see no reason why transactions occurring on the same day should not be treated independently and each be given meaning.

B. Bronfman Trust - Ratio Decidendi

Two requirements for interest deductibility set forth in Bronfman Trust v. R. [5] are relevant in this case. The first is tracing. At page 5064, Dickson C.J.C. states:

The onus is on the taxpayer to trace the borrowed funds to an identifiable use which triggers the deduction.

In the case at bar, the funds borrowed from the Bank of British Columbia can be traced to an identifiable, eligible use, refinancing the appellant’s capital account at his law firm. The funds physically flowed from the Bank of British Columbia to the appellant’s capital account at the firm. Indeed, the Minister has conceded that tracing is not an issue.

The second is consideration of the direct use of the borrowed funds. At page 5065, Dickson C.J.C. states:

In my view, neither the Income Tax Act nor the weight of judicial authority permits the courts to ignore the direct use to which a taxpayer puts borrowed money.

In Bronfman Trust, supra, the borrowed funds were used to make capital allocations to beneficiaries:

There is no dispute concerning the immediate and direct use to which the borrowed funds were put. They were used to make the capital allocations to the beneficiary and not to buy income earning properties.^ [6]

It was argued by the Trust that in borrowing to pay allocations to beneficiaries, the Trust was permitted to retain income producing assets. The result would be the same as if assets were sold to pay the allocations and then borrowed money used to replace them. This argument was rejected on the basis that the direct use was ineligible, even though the indirect use was eligible.

Had the appellant in this case used the borrowed funds directly for the financing of the acquisition of the home and then argued that the result would be the same as if he had used his own funds from the firm for the acquisition and replaced them with borrowed funds, he would be in the same position as the taxpayer in Bronfman Trust, supra, and would not be entitled to interest deductibility. However, that is not what was in fact done.

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.C. in Bronfman Trust, the Court cannot ignore the direct use to which the appellant put the borrowed money.

C. Bronfman Trust - Obiter Dicta

I have also had regard to the obiter dicta in Bronfman Trust [7] :

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. M.N.R., 74 D.T.C. 1121, [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 the 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.

In the case at bar, the Minister does not suggest that what was occurring here was a sham or that there was any concealment.

Nonetheless, a reading of this obiter dicta in isolation and Dickson C.J.C.’s apparent agreement with the result in the Zwaig case, could lead one to conclude that even in the absence of a sham, the appellant in this case should not be allowed to deduct interest payments. This Court and the Supreme Court of Canada have not had occasion to consider the obiter dicta or cases similar to Zwaig since Bronfman Trust was decided. However, there is commentary suggesting that there is difficulty reconciling the Supreme Court’s ratio with the obiter dicta in Bronfman Trust. For example, Brian Felesky and Sandra Jack in their article, “Is There Substance to ‘Substance Over Form’ in Canada?” [8] argue that the obiter dicta in Bronfman Trust is inconsistent with the approach ultimately adopted in that case. They say that the application of the direct use doctrine is inconsistent with the Court’s observation in the obiter dicta that a taxpayer should be denied the deduction where the direct purpose satisfies paragraph 20(1)(c) but the indirect purpose does not. They state,

Indeed, it is interesting, if not perplexing, that after endorsing a broad look into commercial reality, the Supreme Court took a strict approach with respect to paragraph 20(1)(c). Only the direct purpose was ultimately adopted, not the indirect purpose. This is inconsistent with the judgments of the lower courts and many other cases, including those referred to in the obiter dicta. Arguably, it is also inconsistent with the court’s own conclusion as to the result that should follow in different circumstances - that is, when a taxpayer's direct purpose satisfies paragraph 20(1)(c) but the indirect purpose does not.

[emphasis added]

In this appeal, the appellant’s direct purpose satisfies paragraph 20(1 )(c) but his indirect purpose does not. Applying the obiter dicta to the facts of this case fails to recognize the direct use approach actually mandated by the Supreme Court in Bronfman Trust. Further, the application of the obiter dicta to this case would also be inconsistent with more recent pronouncements of the Supreme Court which suggests that in the absence of sham or an artificial transaction, a taxpayer should not be denied the benefit of provisions of the Income Tax Act with which he or she complies, even if the taxpayer’s motivation is solely tax planning. In Continental Bank of Canada v. R., supra, Bastarache J., dissenting in the result but speaking for a unanimous Court on this issue, adopted the approach of Iacobucci J. in Antosko v. Minister of National Revenue?, [9] and outlined three important principles of law which are relevant here. First, a taxpayer who complies with the provisions of the Income Tax Act ought not to 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 an abuse of the provisions of the Act and where the words of the Act are clear, it is not the role of the Court to decide the case based on the Court’s view as to whether the taxpayer is deserving of a deduction. Third, it is an error for the Court to ignore the legal and commercial reality of a transaction.

At pages 328-329 of Continental Bank, Bastarache J. states,

A taxpayer who fully complies with the provisions of the Income Tax Act ough not to be denied the benefit of such provisions simply because the transaction was motivated for tax planning purposes. In Stubart Investments, supra, this Court unanimously rejected the “business purpose test” and affirmed the proposition that it is permissible for a taxpayer to take advantage of the terms of the Income Tax Act by structuring a transaction that is solely motivated by the desire to minimize taxation. Similarly, in Canada v. Antosko, [1994] 2 S.C.R. 312, lacobucci., for a unanimous Court, found at p.328:

In this appeal, despite conceding that these factual elements are present, the respondent is asking the Court to examine and evaluate the transaction in and of itself, and to conclude that the transaction is somehow outside the scope of the section in issue. In the absence of evidence that the transaction was a sham or an abuse of the provisions of the Act, it is not the role of the court to determine whether the transaction in question is one which renders the taxpayer deserving of a deduction. If the terms of the section are met, the taxpayer may rely on it, and it is the option of Parliament specifically to preclude further reliance in such situations.

lacobucci J. went on to say, at p. 330:

This transaction was obviously not a sham. The terms of the section were met in a manner that was not artificial. Where the words of the section are not ambiguous, it is not for this Court to find that the appellants should be disentitled to a deduction because they do not deserve a “windfall”, as the respondent contends. In the absence of a situation of ambiguity, such that the Court must look to the results of the transaction to assist in ascertaining the intent of Parliament, a normative assessment of the consequences of the application of a given provision is within the ambit of the legislature, not the courts.

Having found that the transaction was not a sham, the Court of Appeal should not have found that the parties lacked the requisite intention to form a valid partnership simply because the transaction was motivated by a resulting tax benefit. The Court of appeal proceeded on the basis that the predominance of fiscal motives or the absence of a concurrent business purpose justifies or compels the court to disregard the legal form of the transaction which the parties intended.

The legal and commercial reality in the present case is that Leasing intended and did enter into a partnership with Central within the meaning of s.2 of the Part- nership Act. The Court of Appeal erred by ignoring the substance of a legally effective transaction.

[emphasis added]

On the first point, there is no doubt that what the appellant did in this case was solely for the purpose of reducing his tax liability. The appellant deliberately and without deceit structured his transactions on October 27, 1988, in order to bring his borrowing and legal obligation to pay interest within paragraph 20(1 )(c). His motivation does not deny him the benefit of paragraph 20(1)(c), where he has fully complied with its provisions. As lacobucci J. stated in Neuman v. Minister of National Revenue^, [10] taxpayers are entitled to arrange their affairs, including non-arm’s length transactions, for the sole purpose of achieving a favourable position regarding taxation:

However, as mentioned above, taxpayers are entitled to arrange their affairs for the sole purpose of achieving a favourable position regarding taxation and no distinction is to be made in the application of this principle between arm’s length and non-arm’s length transactions (see Stubart, supra). The ITA has many specific anti-avoidance provisions and rules governing the treatment of non-arm’s length transactions. We should not be quick to embellish the provision at issue here when it is open for the legislator to be precise and specific with respect to any mischief to be avoided.

There is no justification for denying the appellant interest deductibility on this basis.

On the second point, the Minister does not suggest that what was occurring here was a sham or that there was any concealment; nor does he suggest that the words of paragraph 20(1 )(c) are ambiguous. The appellant’s borrowing met the terms of paragraph 20(1 )(c) in a manner that was not artificial. It would be inappropriate for the Court to decide the question of deductibility of interest on the basis of whether, in the Court’s view, the appellant was deserving of interest deductibility.

Finally, the legal and commercial reality of this transaction is that the appellant withdrew his own funds from his law firm to purchase a house. On the same day, he borrowed funds to replace the funds required for his capital account at the firm. In Bronfman Trust, the Court adopted an approach which required the taxpayer to trace the borrowed funds to an identifiable direct use which triggered deductibility of interest under paragraph 20(1)(c). As I have found earlier in these reasons, the appellant has met these requirements. It would be incorrect to ignore the substance of a legally effective borrowing transaction for an income earning purpose in the present appeal.

D. Construction of Paragraph 20(1)(c)

I think there is a further reason for finding that the connected series of transactions approach must be rejected. In The Fundamentals of Canadian Income Tax, supra,\\ [11] Professor Krishna states:

Mark Resources necessarily implies that in multi-step arrangements, the deductibility of interest expense depends upon the real purpose of the “series of transactions” and not the purpose of the immediate and direct use of the funds. There is, however, no authority for importing a series of transactions approach into paragraph 20(1 )(c) of the Act. The phrase “series of transactions”, which appears 41 times in the Act, is not used in paragraph 20(1)(c). Where the Act uses the phrase “series of transactions” the series is deemed to include any related transactions or events completed in contemplation of the series. It is reasonable to infer from the absence of the phrase in paragraph 20(1 )(c) that there is no legislative intention to import the series test into that paragraph.

I agree with the view expressed by Professor Krishna. In the context of the Income Tax Act in which the phrase “series of transactions” appears 41 times, its absence from paragraph 20(1)(c) implies that there is no legislative intent to import the series test into that paragraph or, in other words, to link a series of individual transactions as if they were one transaction as the Minister purports to do in this case.

Disposition

The appeal should be allowed, the judgment of the Tax Court of Canada should be set aside as should the Minister’s reassessment. The Minister should be required to reassess in accordance with these reasons. The appellant should be entitled to costs in this Court and in the Tax Court of Canada.

Linden J.A. (dissenting):

I respectfully disagree with the reasons of my esteemed colleagues.

Introduction

A man takes $300,000 out of his law firm and buys a house. On the same day, he borrows $300,000 from a bank and deposits it with his law firm, replacing what he took out. He seeks to deduct the interest on the borrowed money pursuant to section 20(1 )(c) of the Income Tax Act (“ITA” or the “Act”), which reads:

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) Interest — 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...

or a reasonable amount in respect thereof, whichever is the lesser;

20(1) Malgré les alinéas 18(1)a), b) et h), sont déductibles dans le calcul du revenu tiré par un contribuable d’une entreprise ou d’un bien pour une année d’imposition celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qu’il est raisonnable de considérer comme s’y rapportant:

(c) Intérêts, - la moins élevée d’une somme payée au cours de l’année ou payable pour l’année (suivant la méthode habituellement utilisée par le contribuable dans le calcul de son revenu) et d’une somme raisonnable à cet égard, en exécution d’une obligation légale de verser des intérêts sur:

(i) de l’argent emprunté et utilisé en vue de tirer un revenu d’une entreprise ou d’un bien...

The issue in this case is whether the interest on the loan is deductible. Specifically, the focus of the case is whether the borrowed funds were used for the purpose of earning income.

The facts of the case are adequately summarized by my colleague and by Bowman J.T.C.C. at the Tax Court [12] . Unlike my colleagues, I have come to the conclusion that the Tax Court Judge was correct in deciding these borrowed funds are not properly deductible under section 20(1)(c) of the Act. I have three reasons for my conclusion, which are as follows:

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 the deductibility of interest in transactions such as these.

3. The task of the court under section 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.

Let me expand on each of these points as they relate to this case.

1. The determination of the purpose for which borrowed money was used is primarily a factual determination which should not be interfered with.

Section 20(1 )(c) of the ITA instructs courts to determine whether the amount in question was “borrowed money used for the purpose of earning income.” While the assessment of deductibility under section 20(1)(c) of the Income Tax Act is a question of mixed fact and law, ascertaining the purpose for which borrowed money was used, one of the constituent elements of the larger question of deductibility, is primarily a question of fact. Marceau J.A. came to this very conclusion in the recent case of Ludmer c. Ministre du Revenu national,' [13] where he wrote at paragraph 13 that:

And 1 will say right away that in my view this finding - that the appellants’ true purpose in investing in the two companies as structured was to defer tax and transform the income into capital gains - is a finding of fact.

I agree with Marceau J .A.. Tax Court Judges listen to witnesses, assess their credibility, examine documents, and weigh the evidence before coming to a conclusion. While the conclusion regarding deductibility requires the analysis of facts in light of a legal test, and is therefore more than simply a question of fact, the determination of the facts themselves is the role of the trier of fact. In this case, Bowman J.T.C.C. weighed the evidence before him and concluded that:

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 al- tered by the shuffle of cheques that took place on October 27, 1988. (Emphasis added) [14]

This conclusion is based on the Tax Court Judge’s finding about the purpose of the taxpayer at the time of contracting, which is a finding of fact. [15] The Supreme Court has repeatedly taught us that, barring some palpable or overriding error, it is unwise for Appeal Courts to reverse findings of fact. For example, in R. v. Vanderpeet, Chief Justice Lamer wrote for the Court that:

It is a well-settled principle of law that when an appellate court reviews the decision of a trial judge that court must give considerable deference to the trial judge’s findings of fact, particularly where those findings of fact are based on the trial judge’s assessment of the testimony and credibility of witnesses. In Stein v. The Ship “Kathy K", Ritchie J., speaking for the Court, held at p. 808 that absent a “palpable and overriding error” affecting the trial judge’s assessment of the facts, an appellate court should not substitute its own findings of fact for those of the trial judge:

These authorities are not to be taken as meaning that the findings of fact made at trial are immutable, but rather that they are not to be reversed unless it can be established that the learned trial judge made some palpable and overriding error which affected his assessment of the facts. While the Court of Appeal is seized with the duty of re-examining the evidence in order to be satisfied that no such error occurred, it is not, in my view, a part of its function to substitute its assessment of the balance of probability for the findings of the judge who presided at the trial.

This principle has also been followed in more recent decisions of this Court: Beaudoin-Daigneault v. Richard; Laurent ide Motels Ltd. v. Beauport (City); Hodgkinson v. Simms. In the recently released decision of Schwartz v. Canada, La Forest J. made the following observation at para. 32, with which I agree, regarding appellate court deference to findings of fact:

Unlimited intervention by appellate courts would greatly increase the number and the length of appeals generally. Substantial resources are allocated to trial courts to go through the process of assessing facts. The autonomy and integrity of the trial process must be preserved by exercising deference towards the trial courts’ findings of fact... This explains why the rule applies not only when the credibility of witnesses is at issue, although in such a case it may be more strictly applied, but also to all conclusions of fact made by the trial judge....

I would also note that the principle of appellate court deference has been held to apply equally to findings of fact made on the basis of the trial judge’s assessment of the credibility of the testimony of expert witnesses, N.V. Bocimar S.A. v. Century Insurance Co. of Canada. (Citations omitted) 6 [16]

In this case, the Tax Court Judge heard and weighed the evidence of the parties and made a decisive finding of fact that the borrowed money in this case was used for the purpose of buying a house. In my view, the Tax Court Judge made no palpable or overriding errors in coming to this conclusion, and I would, therefore, not interfere with that finding.

2. Past cases have without exception denied the deductibility of interest in transactions such as these.

Cases which are factually similar to the case at bar have already been decided against the position of the taxpayer. The first case, Robitaille c. R. is factually identical to the case at bar. [17] '7 In that case, the taxpayer withdrew $100,000 from his law firm partnership account on June 12, 1985, purchasing a personal residence with those funds on June 13, 1985. On the same date he took out a $100,000 mortgage on that residence, and on June 14, 1985, he reimbursed his partnership account. The Minister disallowed all mortgage interest deductions claimed by Mr. Robitaille in respect of the mortgages, from which the taxpayer appealed.

Dusseault J.T.C.C., after agreeing with the analysis of Bowman J.T.C.C. in Mark Resources Inc. v. R. [(1993), 93 D.T.C. 1004 (T.C.C.)], based his conclusion primarily on the well-known concluding remarks found in the Bronfman Trust case. He explained:

I consider that essentially the facts in the instant case are sufficiently close to those described by Dickson, C.J. to be bound by his remarks. In each case there was within a short period a reallocation of money originally used to produce income to a personal purpose and then a loan the proceeds of which were immediately returned to the original productive use.

While the binding effect of an obiter stated in the form of a simple observation made in passing may be open to question, it is not so when an opinion supported by reasons is given with respect to specifically described transactions. The binding effect of an obiter becomes clearly more so when such an unambiguous Opinion is stated in a unanimous judgment of the Supreme Court of Canada.^ [18]

My colleague’s reasons in this case suggest that the well-known final paragraphs of Bronfman Trust have no application to the case at bar, as there is no allegation of sham. This ignores the reasoning in Robitaille, supra.. In my view, this is incorrect, because Dickson C.J. mentioned sham as only one of the reasons for which a Court would rightly disallow a transaction such as the one at bar. He wrote that:

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 Reve- nue, 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 N 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 see hav ommercial and practical nature of its transaction: determined by reference to a hypothetical characterization which reflects the epitome of formalism. I cannot accept that it should be allowed to succeed. (Emphasis added) [19] 19

In this passage, the Supreme Court expressly approved of Zwaig v. Minister of National Revenue, [20] the other case denying deductibility which is factually similar to this case.

In Zwaig, the taxpayer sold income-producing securities to a brokerage firm and with the proceeds purchased a life insurance policy of a nominal value of approximately $560,000, for a cash payment of a unique premium of approximately $250,000. After purchasing this non-deductible property he borrowed money from the insurance company, and with this money he repurchased the securities which he had previously sold to the brokerage firm. Thus in Zwaig, the taxpayer liquidated shares and purchased a life insurance policy. He then took money from the bank and repurchased the shares. The similarity to this case is self-evident. [21] The Tax Review Board denied the taxpayer’s attempt to deduct the interest. Zwaig was not adjudicated on the basis of the sham doctrine. The Tax Review Board wrote:

According to the evidence adduced, it appears that Mr. Dunn’s intention was always to keep his securities and by the same token the control of his companies. It also appears that he wanted to purchase a personal asset, namely a life insurance policy and therefore he sold some securities for about $250,000.00....

In the present appeal the borrowed money was not converted into bricks and mortar, part of it was not paid out for inventory and by way of salaries, or used to acquire plant and machinery and to pay running expenses. On the contrary, according to the form of the transaction, it was used to re- purchase the securities that had just been sold and, according to the substance of the transaction, to purchase a life insurance policy....

In the case at bar the proceeds of the sale of the securities was not used to earn income from the business. In Trans-Prairie Pipelines (supra) the preferred shares were used in the business to earn income. So, when Mr. Dunn borrowed monies on his life insurance policy, it was not to fill the hole left by the redemption of preferred shares, as is the case in Trans-Prairie Pipelines. On the contrary, the business was deprived of about $250,000.00 to earn income because the life insurance policy did not contribute in any way whatsoever to increase the power of the business to earn more income....

One must look at the whole picture of the transaction to discover its substance and by the same token to find out if the borrowed money was used to earn income in the business.

It is self-evident that the borrowed money did not go back into the business to earn income but was used to purchase a life insurance policy. Consequently, the appeal is dismissed. (Emphasis added) [22]

In my view, the concluding paragraphs of Bronfman Trust are good law, as are Robitaille, Zwaig. The ultimate task of this Court is to examine the “whole picture”, that 1s, the commercial and economic realities underlying the transaction in order to determine if the borrowed funds were “used for the purpose of earning income.” If there is no purpose to earn income, any approach which seeks to secure the deductibility of otherwise non-deducti- ble interest through transactional form alone is unacceptable.

Thus, in my view, transactions similar to those of the taxpayer in this case were considered and rejected by Bronfman Trust, supra, by Zwaig, supra., and by Robitaille, supra., and the matter of interest deductibility in cases such as this one has been settled.

3. The ultimate task under section 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”.

In a world where transactions regularly occur in multiple steps, it is not feasible for a court analyzing whether borrowed money was “used for the purpose of earning income” to ignore the reality of the transaction by looking only at only one of the steps prior to the use in question. The Supreme Court has twice mandated that, in cases determining compliance with section 20(1 )(c) of the ITA, the task of the courts is to “reflect the economic reality of the situation.” [23] The entire picture must be examined. It is impossible to seek the “commercial and economic realities” [24] or the “bona fide purpose” [25] of a transaction within the confines of any one or more steps of the transaction. Such a view deprives the word “purpose” in ITA section 20(1 )(c) of meaning, and permits sophisticated taxpayers to improperly “manipulate a sequence of events to achieve a patina of compliance with the apparent prerequisites for a tax deduction.” [26]

In order to reduce the possibility of ambiguity, let me be clear about the nature of the task which Parliament has entrusted to the Courts in interpreting section 20(1)(c).

3.1 What do we mean by “purpose ” ?

It is trite to recall that, in absence of section 20(1 )(c), interest on a capital investment would not be deductible at all. The original reasoning prohibiting the deduction of interest was that the accumulation of capital is by definition on capital account, and cannot be deducted against revenue. This proposition stems from an earlier belief that business was to be organized with one’s own capital, and that companies which did not have the money to commence enterprises were not entitled to deductions in order to do so. [27] The deductibility of interest was first permitted in a limited form in 1923, permitting the deduction of borrowed funds which were used to earn income, provided that the stipulated rate was reasonable. [28] The interest deductibility provision was amended in 1948, [29] and the provision which is in force today is substantially similar to the 1948 provision, specifically including the phrase “borrowed money used for the purpose of earning income....”

There have been many adjectives used to describe what is meant by the word “purpose” in section 20(1 )(c) of the ITA. What, exactly, is it that judges are looking for? In this case, the Tax Court Judge referred to the “fundamental” purpose [30] and the “reality of the situation”. [31] The recent case of Ludmer c. Ministre du Revenu national, supra, used numerous ad- jectives to describe what type of purpose is being sought. At paragraph 21, Marceau J.A. wrote that

no one can be in any doubt that what Parliament has in mind is the actual or true, not feigned or merely claimed, intention... (Emphasis added).

At paragraph 36, Desjardins J.A. made a similar observation, noting that

I agree with my colleague Létourneau J.A. that the respondent cannot succeed in her submission that in order for the essential condition of subparagraph 20( 1 )(c)(i) to be met and interest to be deductible, the investor’s dominant purpose must have been to derive income from the borrowed amounts.

Létourneau J.A. disagreed, dissenting on the point. In his view, any income producing purpose is sufficient to ground a finding of deductibility under section 20(1 )(c). At paragraph 75, he wrote:

As I have already mentioned, subparagraph 20( 1 )(c)(i) does not stipulate that the borrowed money has to be used “mainly” for the purpose of earning income from property. The interest deduction is intended to encourage and allow for the acquisition of potentially income-generating capital. That is the conclusion to which the words “used for the purpose of earning income from property" lead us. It is therefore sufficient for the investor to have a reasonable expectation of income when investing borrowed money. It is not necessary for the investor to have an expectation of reasonable income.

Ludmer, supra, turned on the holding that the purpose to be sought in analyzing interest deductibility is the “actual”, “true”, or “dominant” purpose of the transaction. These adjectives reflect the fact that the Courts are seeking to discover the purpose in the light of the commercial and economic reality of the transactions. If the dissent in Ludmer is correct, and any acceptable purpose will satisfy section 20(1)(c) of the ITA, then that section is rendered marcescent. It is hard to conceive of a loan transaction which could not be manipulated in such a way as to be deductible under the minority view in Ludmer. Further, the dissent in Ludmer treats section 20(1 )(c) as if it read “used with a view to earning income.” Such wording would permit ancillary income-earning purposes to satisfy section 20(1 )(c), as is the case with partnership. The section, however, does not use the indefinite article “a”; rather it employs the definitive article “the”; thus, borrowed funds are only deductible under section 20(1 )(c) if they are used for the purpose of earning income.

If borrowed money is divided and used for two purposes, one incomeearning, and one personal, could it be argued that the entire amount could be deducted, since one of the purposes of the use was acceptable? This cannot be. The wording in the section requires that borrowed funds must be used for the purpose of earning income, not a purpose to earn income. If the borrowed money is divided and used for two purposes, a deduction can be taken only to the extent that the money is used to earn income. It is obvious that no deduction is available for the portion of the money used for nonincome earning purposes. Further, if the funds are commingled and used for a variety of purposes there may be no deduction at all allowed. [32]

If courts are to look only at the direct, current use of the borrowed money, then section 20(1 )(c) would permit the deduction of all manner of personal-use borrowing. It is hard to imagine a transaction which could not be manipulated to comply with the words “used for the purpose of earning income” if the direct, current use of the borrowed funds is the only segment to be considered. [33] Such a narrow reading of section 20( I )(c) is untenable.

This discussion is more than one of semantics. The Act says that the borrowed money must be “used for the purpose of earning income.” Parliament thus intended that borrowed money must be used for the purpose of earning income. Courts have not missed this point: the Supreme Court has twice instructed Courts to seek the “commercial and economic reality” of the transaction in order to assess whether the borrowed money was used for the purpose of earning income. It is impossible to seek the commercial and economic realities of a situation by confining the analysis to only the last two steps of any given transaction. Courts must look at the whole transaction and discover the true purpose for which the borrowed money was used.

3.2 There is no rigid rule regarding the separation of the steps in a loan transaction.

Much is made in this case of whether a court searching for “purpose” should view transactions such as this as two separate transactions or as one. A similar problem arose in Shell Canada, a case recently decided by this Court. [34] In that case, the Court took a view of the transaction which adequately and accurately described the economic realities underlying the transaction. In that case, the Court was faced with finding the economic reality underlying a very complex series of transactions by which Shell took loans at a high (foreign) interest rate and purchased currency forwards at the commensurately high (foreign) forward discount. The result was that Shell achieved its borrowing needs at a high interest rate, receiving at the end of the transaction a forward gain equal to the difference between the foreign interest rate and the domestic interest rate at the date of the transaction. The Court chose to describe the economic realities of that transaction by viewing the debt offering and the forward contracts as separate transactions and applying interest rate parity theory to explore the true rate of interest in the transaction. [35]

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 dis- cover the economic and commercial reality of the transaction in order to discover whether the borrowed money was used for the purpose of earning income.

In this case, the economic reality is that the taxpayer’s borrowed money was used for the purpose of buying a house. Not a single new cent in capital investment was created in this personal-use borrowing. As the Tax Court Judge found, the fundamental purpose of the transaction was the purchase of a house. I would not turn ITA section 20(1)(c) into a two-step dance. I prefer instead to watch the entire ballet and come to a more sophisticated and realistic view of the performance. Such a view was taken by the Tax Court Judge in this case, and I would not interfere with his decision.

3.3. We must examine what the taxpayer actually did, not what he could have or should have done.

As with every interest deduction case which comes before this Court, it was argued that the taxpayer could have organized his affairs in such a way as to achieve compliance with the Act, and that he should not be penalized for choosing a different mechanism by which to achieve his goals. It is said that if the appellant had disguised his conduct and waited for a period before buying the house or had varied the amount borrowed or did something else, he might have been allowed the deduction. Dickson C.J. fully answered this argument in Bronfman Trust, noting that it is not what the taxpayer could have done which is before the Court, but what was actually done:

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 a sufficient answer to this submission jo. point to the principle that the courts must deal with what the taxpayer actually did, and not what he might have done..* [36]

In this case, the taxpayer took $300,000 than the bank and put that money into his law firm on the same day that he took $300,000 from his law firm and bought a new home. The Tax Court Judge found that the borrowed money was used for the purpose of buying a home. In my view there is no room to argue that the personal use of the money should be ignored because better tax planning might have yielded an interest deduction that was acceptable under the Act.

3.4. Where the taxpayer's purpose in borrowing the money is at odds with the purpose of Income Tax Act section 20(1 )(c), there can be no bona fide purpose to earn income.

The Supreme Court has twice held that “[t]he purpose of the interest deduction provision is to encourage the accumulation of capital which would produce taxable income.” [37] In this case, no capital was accumulated which will create taxable income. The appellant took money from his law firm and bought a house. The only capital which was accumulated was personal-use capital. The Tax Court Judge made a fact-based finding that the purpose of the transaction was to purchase a house. Given that the taxpayer’s behaviour in this matter contradicts the purpose of the section, it cannot reasonably be said that the taxpayer [has satisfied] the Court that his ... “bona fide purpose in using the funds was to earn income.” [38]

My colleague argues that men and women who own equity in firms or businesses must be able to refinance their equity with debt. I agree. Where we disagree is whether this appellant may refinance his equity stake in this way on these facts and be allowed to deduct the interest on the borrowed funds under section 20(1 )(c) of the Act. In my view, a transaction which has no income-earning purpose will always contradict ITA section 20(1 )(c), because, as Dickson C.J. wrote:

It seems to me that, at the very least, the taxpayer must satisfy the Court that his or her bona fide purpose in using the funds was to earn income (Emphasis added). ^ [39]

Dickson C.J. fully answers my colleague’s point. The taxpayer in this transaction cannot satisfy the Court that his or her bona fide purpose in using the funds was to earn income.

My colleague’s point that refinancing must be permitted is also answered by the reasoning of Dickson C.J. regarding the legislative history of the provision. Dickson C.J. noted that deductibility results from only one of the possible uses of borrowed funds:

I agree with Marceau J. as to the purpose of the interest deduction provision. Parliament created s. 20(l)(c)(i), and made it operate notwithstanding s. 18( 1 )(b), in order to encourage the accumulation of capital which would produce taxable income. Not all borrowing expenses are deductible. Interest on borrowed money used to produce tax exempt income is not deductible. Interest on borrowed money used to I life insurance policies is not deductible. Interest on borrowings used for non-income earning purposes, such as personal consumption or the making of capital gains is similarly not deductible. The statutory deduction thus requires a characterization of the use of borrowed money as between the eligible use of earning non-exempt income from a business or property and a variety of possible ineligible uses. The onus is on the taxpayer to trace the borrowed funds to an identifiable use which triggers the deduction. Therefore, if the taxpayer commingles funds used for a variety of purposes only some of which are eligible he or she may be unable to claim the deduction.... (Emphasis added, citations omitted)^ [40]

The Act and the jurisprudence teach us that recapitalization is only deductible when the use of the borrowed funds has an income earning purpose. The refinancing of equity with debt is perfectly permissible, but the interest on that debt may only be deducted if the borrowed funds are “used for the purpose of earning income.” There is nothing ambiguous about Parliament’s statement. Section 20(1 )(c) of the Act was not designed to promote debt refinancing. It was designed to encourage the accumulation of capital, hence the requirement that borrowed money must be “used for the purpose of earning income.” In this case not one cent of new capital was accumulated. The appellant’s borrowing in this case was personal-use borrowing. Mr. Singleton took $300,000 from his law firm and bought a house on the same day that he took $300,000 from the bank to reimburse his law firm. Interest on borrowing used to buy a house is not deductible.

Disposition

For all the foregoing reasons, I would dismiss the appeal, with costs to the respondent.

Appeal allowed.