[OFFICIAL ENGLISH TRANSLATION]
Date:
20021009
Docket:
2001-3871(IT)I
BETWEEN:
FRANÇOISE
DESLAURIERS,
Appellant,
and
HER
MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre, J.T.C.C.
[1] These
are appeals under the informal procedure from assessments made by the Minister
of National Revenue ("Minister") disallowing the appellant an
interest expense deduction in computing her income for the 1997, 1998 and 1999 taxation
year under paragraph 20(1)(c) of the Income Tax Act ("Act").
[2] Specifically,
the deduction of the amounts of $9,718, $8,770 and $8,374 claimed by the
appellant for those years respectively was disallowed. Those amounts
corresponded to interest paid on a $125,000 loan taken out at the Caisse
populaire Desjardins (Jean-Talon) in May 1994. The proceeds of that loan were
used to repay debts that the appellant owed to her brother, Réjean DesLauriers
($56,000), and to another Caisse populaire Desjardins (St‑Léopold) in the
amount of $65,000 and to pay notary's fees ($4,000).
[3] The
chronology of events is as follows. In 1987, the appellant and her spouse,
Pierre Trudeau, still owed $27,000 on a mortgage on their residence
(appellant's testimony). They renewed that mortgage in the amount of $70,000
(Exhibit A‑6). The surplus borrowed was used to invest in an income
property in co‑ownership with other investors (Exhibit A‑5).
[4] On
March 31, 1988, the business corporation 2550‑7724 Québec Inc.
("corporation"), of which the appellant owned 50 percent of the
shares, the other 50 percent belonging to Francine Trudeau, acquired
the convenience store called "Bidule" for $115,000 (Exhibit A‑1).
To make that acquisition, the two shareholders borrowed $55,000 personally and
on behalf of the corporation from Edouard Beaudouin,
Francine Trudeau's husband. That amount was used to pay a portion of an
initial downpayment of $65,000. The vendor moreover kept an outstanding balance
of $50,000 on the sale price (Exhibit A‑4).
[5] In
1991, Francine Trudeau separated from Mr. Beaudouin, and
Mr. Beaudouin demanded payment of his loan by the corporation that owned
the Bidule convenience store. Since Francine Trudeau had declared personal
bankruptcy at the time, the appellant personally had to repay the residual
balance of the loan granted by Mr. Beaudouin.
[6] To
do that, on June 6, 1991, the appellant personally borrowed the sum of
$52,000 plus interest (Exhibit I‑4) from her brother,
Réjean DesLauriers, and repaid Mr. Beaudouin.
[7] On
January 6, 1992, the appellant acquired all the shares that
Francine Trudeau held in the corporation (subparagraph 7(b)(v) of the
Reply to the Notice of Appeal, admitted by the appellant).
[8] On
June 2, 1992, the income property jointly owned by Pierre Trudeau and
the appellant was sold (Exhibit A‑3), and they obtained an amount of
$30,000 (appellant's testimony).
[9] On
July 7, 1992, the appellant repaid the balance of the selling price of the
Bidule convenience store (Exhibit A‑2). To do that, she used the
$30,000 received at the time of the sale of the income property and once again
borrowed from her brother. Instead of granting her a second loan, the brother
gave the appellant a discharge from the first loan of $52,000 (Exhibit I‑3)
and executed a new loan for a total amount of $59,620, without interest
(Exhibit I‑2). Those two documents were signed on July 7, 1992.
[10] The appellant then repaid the balance of the selling price of the
Bidule convenience store. At that point, the appellant no longer owed money to
anyone except to her brother, Réjean DesLauriers.
[11] On November 17, 1993, the corporation, of which the appellant was
now the sole shareholder, sold the Bidule convenience store at a loss to
another corporation for $34,285 in an arm's length transaction (Exhibit I‑1).
[12] On June 6, 1994, the appellant and her spouse renewed the
expiring mortgage on their house with the Caisse populaire Desjardins
(Jean-Talon) for an amount of $125,000 (Exhibit I‑6).
[13] The proceeds of that loan were used to repay the balance of $65,000 of
the mortgage with the first Caisse populaire Desjardins (St‑Léopold),
$56,000 to the appellant's brother and $4,000 in notary's fees. It is the interest
on this $125,000 loan that is in dispute (Reply to the Notice of Appeal,
subparagraph 7(b)(x), admitted by the appellant).
[14] On June 14, 1994, Réjean DesLauriers gave the appellant a
discharge (Reply to the Notice of Appeal, subparagraph 7(b)(xi), admitted
by the appellant).
[15] At the corporation's fiscal year end on November 30, 1994, the
financial statements showed an amount of $109,221 "owed to the
director" (Exhibit I‑5) and, for 1994, the director was
allocated a business investment loss a portion of which she was able to carry
over to 1992 and 1993 (Reply to the Notice of Appeal,
subparagraphs 7(b)(xiii) and (xiv), admitted by the appellant).
[16] On May 24, 1995, the corporation was dissolved (Reply to the
Notice of Appeal, subparagraph 7(b)(xv), admitted by the appellant).
[17] The respondent contends that the corporation was no longer carrying on
an active business after its fiscal year ended on November 30, 1993.
[18] Counsel for the respondent considers that the amount of $125,000
borrowed in 1994 was not used for the purpose of
earning income from a business or property within the meaning of
paragraph 20(1)(c) of the Act.
[19] In her view, if the business was no longer operated at the time of the
loan, the interest on that loan was no longer deductible since the use of that
loan did not constitute an eligible purpose. The borrowed money was not used to
earn income (see Bronfman Trust v. Canada, [1987] 1 S.C.R.
32).
[20] The appellant considers that the loan was used to repay a debt
incurred for the purpose of enabling her to earn income. In her view, although
the income-bearing property no longer exists, the debt incurred in order to
invest in that property still exists. She therefore believes that the interest
should be deductible.
[21] Interest on borrowed money may be deducted in computing a taxpayer's
income under subparagraph 20(1)(c)(i) of the Act, which
reads as follows:
SECTION 20: Deductions
permitted in computing income from business or property.
(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 (other than
borrowed money used to acquire property the income from which would be exempt
or to acquire a life insurance policy).
[22] Four elements must be met for interest to be deductible under
subparagraph 20(1)(c)(i). The Supreme Court of Canada referred to
them in Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, as
follows at paragraph 28:
... The provision has four elements: (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.
[23] Only the third condition is in dispute here. The issue thus concerns
only the question as to whether the borrowed amount of $125,000, for which an
interest expense was claimed, was used for the purpose of earning non-exempt
income from a business or property.
[24] As Iacobucci J. stated in Ludco Enterprises Ltd. v.
Canada, [2001] 2 S.C.R. 1082, at paragraph 44, Dickson C.J.
of the Supreme Court of Canada, as he then was, closely analyzed the third
element of interest deductibility in Bronfman Trust, supra. He
classified the various possible uses of borrowed money as: eligible and
ineligible, original and current, direct and indirect. Dickson C.J.
outlined the inquiry into the third element at pp. 45‑46:
... 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 buy 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 ... .
The interest deduction
provision requires not only a characterization of the use of borrowed funds,
but also a characterization of "purpose". Eligibility for the
deduction is contingent on the use of borrowed money for the purpose of earning
income. It is well-established in the jurisprudence, however, that it is not
the purpose of the borrowing itself which is relevant. What is relevant,
rather, is the taxpayer's purpose in using the borrowed money in a
particular manner: Auld v. Minister of National Revenue,
62 D.T.C. 27 (T.A.B.). Consequently, the focus of the inquiry must be
centered on the use to which the taxpayer put the borrowed funds. [Emphasis in original.]
[25] Thus, in analyzing the use made of borrowed money, Dickson C.J.
endorsed the proposition that it is the current use rather than the original
use of borrowed funds by the taxpayer which is relevant in assessing
deductibility of interest payments. Dickson C.J. wrote as follows in
paragraphs 23, 25 and 34 in Bronfman Trust, supra:
¶ 23 ... A taxpayer cannot continue to deduct interest
payments merely because the original use of borrowed money was to purchase
income-bearing assets, after he or she has sold those assets and put the
proceeds of sale to an ineligible use.
...
¶ 25 ... A continuing obligation to make interest
payments to the creditor therefore does not conclusively demonstrate that the
borrowed money has a continuing use for the taxpayer.
...
¶ 34 ... As stated previously, however, the fact that
the taxpayer continues to pay interest does not inevitably lead to the
conclusion that the borrowed money is still being used by the taxpayer, let
alone being used for an income-earning purpose. For example, an asset purchased
with borrowed money may have been disposed of, while the debt incurred in its
purchase remains unpaid.
[26] This is based on the principle that the deduction of interest
payments, which would normally be prevented by paragraph 18(1)(b)
of the Act, is permitted by paragraph 20(1)(c) in order to
encourage the accumulation of taxable income-producing assets. (See Tennant v.
Canada, [1996] 1 S.C.R. 305, at paragraph 16, which also refers
to Bronfman Trust, supra.)
[27] Thus, if the taxable income-bearing asset is no longer owned by the
taxpayer or has not been replaced by another taxable income-bearing asset,
there is no longer any reason for the interest on a loan that was used to repay
the initial loan (which was originally used for an eligible purpose) to be
deductible.
[28] Iacobucci J. summed up the situation as follows in Tennant,
supra, at paragraph 20:
To repeat, it is
implicit in the principles outlined in Bronfman Trust that the ability
to deduct interest is not lost simply because the taxpayer sells the
income-producing property, as long as the taxpayer reinvests in an eligible use
property.
[29] In Emerson v. Canada, [1985] F.C.J. No. 320 (Q.L.),
affirmed by [1986] F.C.J. No. 160 (Q.L.), the taxpayer had borrowed a sum
of money to repay an eligible initial bank loan, which had been used to
purchase shares in business corporations. The second loan was taken out after
the taxpayer had disposed of his shares. The proceeds of disposition of the
shares were not reinvested in other eligible use property. Cullen J. of the
Federal Court Trial Division refused to allow the deductibility of the interest
on the second loan since the source of income from a business or property had
disappeared. He wrote as follows at page 3:
An essential
requirement, therefore, of any deduction on account of interest pursuant to
20(1)(c) is the existence of the source to which the expense relates and
if the source has been terminated, as is the case here, the interest expense is
no longer deductible. The continuing obligation to meet the interest costs of
an outstanding loan, after, the source has been extinguished, is not relevant.
...
To sum up, as the Defendant does,
In the case at bar, the interest
expense in question, in the amount of $3,737.32, was charged on borrowed money
used to replace a previous loan which had been used to finance the purchase of
shares. However, at the time that the interest costs of $3,737.32 (interest
being the cost of using someone else's money over time) were incurred by the
Plaintiff, the shares were no longer owned by the Plaintiff. The shares used to
be the source of income against which the interest expense on the original loan
was deductible in the computation of income from that source. Upon the
disposition of the shares, there no longer was a source of income, nor a
computation of income, in which that interest on the original loan, had it not
been repaid, and the interest on the replacement loan, in fact used to repay
the original loan, would be deductible outlays. The only purpose of the
refinancing was to repay the money previously borrowed which was a debt owing
by the Plaintiff and there is no ground for finding that the borrowed money to
which the $3,737.32 interest related, was used for the purpose of earning
income from a property.
[30] In Tennant, Iacobucci J.¾even though he distinguished the situation in Emerson
from the situation in Tennant¾implicitly
approved of the Federal Court Trial Division's finding, which was affirmed by
the Federal Court of Appeal in Emerson. Iacobucci J. wrote as
follows at paragraphs 21 and 23:
¶ 21 ... In my view, the Emerson
case is not of any application to these facts. Emerson is
distinguishable as the proceeds of disposition in that case were not reinvested
into a second eligible use property, unlike the case at hand.
...
¶ 23 ... As long as the replacement
property can be traced to the entire amount of the loan, then the entire amount
of the interest payment may be deducted. If the replacement property can be
traced to only a portion of the loan, then only a proportionate amount of the
interest may be deducted.
[31] If all these comments are applied to the instant case, it becomes
clear that, in computing her income, the appellant could not deduct the
interest paid on the $125,000 loan contracted with the Caisse populaire
Desjardins (Jean-Talon) in 1994. At the time the money was borrowed, the source
of income had disappeared since the Bidule convenience store, which constituted
the corporation's sole source of income, had been sold in November 1993. The
proceeds of disposition of the Bidule convenience store were not reinvested in
income-bearing replacement property. The $125,000 loan was used solely to repay
the initial loans, and the conclusion cannot be made that the purpose of that
loan, to which the interest was related, was to earn income from a property or
business.
[32] In the instant case, the interest that was paid on the $125,000 loan,
and which is at issue here, could not be deducted by the appellant in computing
her income for the 1997, 1998 and 1999 taxation years under
paragraph 20(1)(c) of the Act.
[33] The appeals are therefore dismissed.
Signed at Ottawa, Canada, this 9th day of
October 2002.
J.T.C.C.
Translation certified true
on this 23rd day of December 2003.
Sophie Debbané, Revisor
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