The Queen v. Malik, 89 DTC 5141, [1989] 1 CTC 316 (FCTD)

Reed, J.:—The facts in this case are not in dispute. The defendant taxpayer purchased a thirty unit apartment building in 1975 for the purpose of obtaining income therefrom. The building was in bad repair. The defendant borrowed funds both to purchase the building and to make repairs thereto. The endeavour was not a financial success. The defendant sold the building in 1977 at a loss. The capital loss which he suffered was allowed in the computation of his income for tax purposes. Because the building was sold for less than had been paid for it the defendant was left with loans outstanding. It is the interest paid on those loans subsequent to the disposition of the building which are in issue. The defendant sought to claim the interest as an expense during the 1978 and 1979 income taxation years. In the Tax Court the defendant was successful. The Minister appeals that decision by way of appeal (trial de novo) before this Court.

The defendant was during the relevant time a life insurance salesman employed by Sun Life of Canada; he was remunerated by way of commissions. During the years in question he earned $45,123.91 and $60,536.57, respectively, from this source. He also earned small amounts of commission income from self-employment during the years in question ($797.42 and $806.41 respectively). He did not have any income from a business or property source during those years. Both in the Tax Court and in this Court it was argued that interest cannot be deducted as an expense when the source of income to which it relates no longer exists. The Tax Court agreed with that proposition of law. It cited Paul-Emile Deschenes v. M.N.R., [1979] C.T.C. 2690; 79 D.T.C. 461 (Tax Review Bd.), and Peter G. Alexander and Shirley Alexander v. M.N.R., [1983] C.T.C. 2516; 83 D.T.C. 459 (Tax Review Bd.), and concluded that since the original source of income for which the loans had been made had disappeared, the interest paid in 1978 and 1979 could not be charged as an expense for those years.

There is no dispute that the source of income, in relation to which the funds were originally borrowed, ceased to exist in 1977. With respect to the applicable law I might add, to the jurisprudence cited by the Tax Court, the decision in Emerson v. The Queen, [1986] 1 C.T.C. 422; 86 D.T.C. 6184 (F.C.A.), affirming 85 D.T.C. 5236 (F.C.T.D.). This case was decided after the Tax Court decision in the present case. It firmly establishes the rule which the Tax Court applied. The Federal Court of Appeal, in the Emerson case, stated at page 423 (D.T.C. 6185):

. . . We are all of the view that the learned trial judge . . . correctly applied the provisions of subsection 20(1)(c) of the Income Tax Act to the facts of this case. We share his view that an essential requirement for interest deductions thereunder is the continued existence of the source to which the interest expense relates. We also agree that where, as in this case, the source has been terminated, the interest expense is no longer deductible.

The Tax Court in the present case, however, found in favour of the defendant, on the basis of a second argument: the payment of the interest by the defendant was necessary to enable him to earn his life insurance commission income and therefore was properly deductible as an expense during 1978 and 1979, pursuant to paragraph 8(1)(f) of the Income Tax Act:

8. (1) In computing a taxpayer's income for a taxation year from an office or employment, 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: .. . .

(f) where the taxpayer was employed in the year in connection with the selling of property or negotiating of contracts for his employer, and

(i) under the contract of employment was required to pay his own expenses,

(ii) was ordinarily required to carry on the duties of his employment away from his employer's place of business,

(iii) was remunerated in whole or part by commissions or other similar amounts fixed by reference to the volume of the sales made or the contracts negotiated, and

(iv) was not in receipt of an allowance for travelling expenses in respect of the taxation year that was, by virtue of subparagraph 6(1)(b)(v), not included in computing his income,

amounts expended by him in the year for the purpose of earning the income from the employment (not exceeding the commissions or other similar amounts fixed as aforesaid received by him in the year) to the extent that such amounts were not

(v) outlays, losses or replacements of capital or payments on account of capital, except as described in paragraph (j), or

(vi) outlays or expenses that would, by virtue of paragraph 18(1)(I), not be deductible in computing the taxpayer's income for the year if the employment were a business carried on by him.

[Emphasis added.]

The facts which underlie the Tax Court's conclusion are not in dispute in this case. In order to earn commission income as a life insurance salesman the defendant must sign each year an affidavit attesting to the fact that he is in good financial standing. He must be bonded. If he were to file for personal bankruptcy he would lose his licence to sell life insurance. Secondly, the Tax Court found: "One could even say that the commission income went directly to servicing these loans, as a priority obligation”. I did not understand counsel for the plaintiff to challenge any of these findings of fact but consider them to be admitted for the purpose of this case. The issue is whether, on the basis of these facts the interest expense incurred by the defendant falls within paragraph 8(1)(f).

Counsel for the plaintiff argues that: (1) to determine to what source of income an interest expense relates, one must look at the use which was made of the money which was borrowed; in this case the money was used to purchase a property for the purpose of earning income; it was not used for any purpose related to the earning of the defendant's employment commission income; (2) once the source of income disappears, the interest expense cannot be “magically transferred" to a second source; (3) the interest expense in this case is in the nature of a personal expense in so far as the earning of the commission income is concerned. In regard to this last point, counsel argues that the defendant is required to keep the payments on the mortgage of his home in good standing, and not to let them fall into arrears but that the interest payments on that mortgage to not qualify as paragraph 8(1)(f) expenses merely because a failure to pay would put the defendant's life insurance licence in jeopardy.

In my view counsel's argument must prevail. Paragraph 8(1)(f) contemplates expenses which are in some substantial way connected to the earning of the employment commission income and such connection simply does not exist in the present case. Amounts paid with respect to debts unconnected to the employment, to enable a person to remain solvent and thereby retain a licence which allows him or her to engage in a profession or calling, are not closely enough connected to the earnings of the employment income to fall under paragraph 8(1)(f). There must be some closer connection than possible insolvency simpliciter, to qualify as an expense under paragraph 8(1)(f).

Counsel for the plaintiff also argued that the interest payments were amounts paid on account of capital and therefore not deductible: The Queen v. Bronfman Trust, [1987] 1 C.T.C. 117; 87 D.T.C. 5059 (S.C.C.); Canada Safeway Limited v. M.N.R., [1957] C.T.C. 335; 57 D.T.C. 1239 (S.C.C.). Since I have concluded as set out above, I do not need to consider this aspect of counsel's argument.

The defendant argues: that he is not a Bronfman; that he does not fall within the exact fact situation of any of the cases cited by counsel; that he is in a unique position as a life insurance salesman being required to keep himself in good financial standing, as he has done; that his position is unique because a good financial standing is required to allow him to continue to work as a life insurance salesman. The defendant is correct none of the cases cited are identical to the fact situation of his case. Also, there is no doubt that he found himself after the 1975 purchase of the property in a very unenviable financial position. Nevertheless he is not unique in being required to keep himself in a sound financial position in order to retain a licence and to be bonded. Many individuals are in a similar situation; many require a sound financial status in order to retain their professional or employment qualifications.

Every case which comes before a Court is on its particular facts unique. Legal rules and principles which arise from the relevant legislation, in this case the Income Tax Act, and the past jurisprudence are applied to the particular facts of a case. In this case, the unique facts of the defendant's case are not such as to bring the defendant within the applicable legal rules and principles; the defendant's fact situation does not fall within the parameters of paragraph 8(1)(f).

For the reasons given the plaintiff's appeal (claim) is allowed.

Appeal allowed.