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Citation: 2003TCC303
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Date: 20030430
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Docket: 2002-3770(IT)I
2002-3773(IT)I
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BETWEEN:
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SOLOMON ISAAC and ALINA ISAAC,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Sarchuk J.
[1] These are appeals by Solomon Isaac
and his wife, Alina Isaac, from assessments of tax with respect
to their 1998, 1999 and 2000 taxation years. In computing income
for those years, the Appellants claimed mortgage interest
expenses in the amounts of $6,409.51, $6,409.51 and $6,409.51,
respectively.[1] In
reassessing the taxation years in issue, the Minister of National
Revenue disallowed mortgage interest expenses in the amounts of
$1,598, $1,816 and $2,630, respectively.
[2] The basic facts are not in
dispute. In 1991, the Appellants took out a mortgage with the
Royal Bank of Canada in the amount of $200,000 on their personal
residence located at 7 Esther Crescent ("Esther") to enable them
to finance the purchase of shares in Connectric Systems Inc. From
1991 to 1996, the principal was paid down to a balance of
$162,487.66. In that year, the Appellants sold Esther and
purchased a new residence at 63 Flamingo Road. The
outstanding principal balance of the Esther mortgage was $162,488
when the mortgage was discharged on May 29, 1996. To finance the
acquisition of the new residence on May 28, 1996, the Appellants
took out a new mortgage with the Royal Bank in the amount of
$300,000. It is not disputed that this mortgage represented the
amount of $137,512.34 required to complete the acquisition of the
new home and $162,487.66 being the remaining balance due and
owing to the Royal Bank with respect to the Esther mortgage.
[3] The Appellant Solomon Isaac
testified that notwithstanding the existence of one mortgage,
there were in fact two loans in existence, the first in the
amount of $162,487.66 which represented funds borrowed for the
purpose of earning income and the second in the amount of
$137,512.34 to acquire the new home at 63 Flamingo Road. On
this basis, subsequent to May 28, 1996, the Appellants say they
made principal payments only against what they refer to as the
"personal loan" of $137,512 and that no amounts were paid against
the "loan" of $162,488, being the balance due and owing
on what they referred to as the "share purchase loan".
Furthermore, Isaac said it was intended that no payments would be
made on the "share purchase loan" until such time as
the "personal debt" was paid in full. On this basis,
the Appellants calculated the amount of interest deductible on
the "share purchase loan" as being 7.3% of $162,488 i.e.
$11,861.62, 50% of which was deducted by each Appellant. Isaac
also noted that since this interest charge did not change from
1998 to 2000 as no principal reduction of the "share purchase
loan" had taken place, the same amount was deducted in all years
in issue.
Appellants' Position
[4] The Appellants contend that two
entirely distinct and separate loans exist, the share purchase
loan and the home purchase loan. They argue that the only common
factor between these two "loans" is that they were both
secured under one mortgage held by the Royal Bank. It is the
Appellants' position that the fact that both
"loans" were secured under one mortgage does not negate
the fact that these are two entirely distinct loans advanced at
different times and for different purposes. Accordingly, the
Appellants contend that the allocation of the payments made to
the Royal Bank in respect of the principal balances can be
structured by them as they choose. Accordingly, they chose to pay
down the "personal" portion of the principal first, thus reducing
the interest relating to the "personal" portion only. Once their
"personal" debt was paid off, all subsequent principal payments
would be deducted from their "investment loan balance". They
further contend that because the interest is paid every month, no
compounding of interest upon the "share purchase loan" occurs.
Therefore, the business portion of the mortgage has a constant
interest expense of 7.3% annually until such time as the personal
portion was paid off at which time the business principal would
start to decrease. On this basis, the annual deduction of
$5,930.80 for the taxation years in issue was correct and ought
not to have been subject of a reassessment by the Minister.
Conclusion
[5] I am satisfied that there is no
rational basis for the Appellants' proposition that because
the "mortgage loan" was obtained for two different
purposes, it may be considered by the borrowers for tax purposes
as two separate loans. There is in this case but one
"loan" agreement between the Bank and the Appellants
and both the payments made by the Appellants and the interest
incurred in each taxation year were in respect of this single
loan.
[6] Subparagraph 20(1)(c)(i) of
the Act 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:
(a)
...
(c) an amount paid
in the year or payable in respect of the year (depending on the
method regularly followed by the taxpayer in computing the
taxpayer's income), pursuant to a legal obligation to pay
interest on
(i) borrowed
money used for the purpose of earning income from a business or
property ...
or a reasonable amount in respect thereof, whichever is the
lesser.
[7] It is an accepted fact, as was
noted in Tonn v. The Queen:[2]
Subparagraph 20(1)(c)(i), it can be seen, sets out yet
another business purpose test, albeit of a rather narrow
application, but in other respects much like the tests
contemplated by subsection 9(1) and paragraph 18(1)(a). In
certain circumstances, and in view of the requirements set out in
the Bronfman decision, any given interest expense may have
to be allocated ratably between eligible and non-eligible uses to
the extent reasonably practical. Such allocation is contemplated
by the statutory provision and is not unusual in the case
law.
[8] Since there is but one loan, I
have concluded that an allocation of interest expenses must be
made in each taxation year if the taxpayers are to comply with
the provisions of paragraph 20(1)(c) of the Act. In
Friedberg v. The Queen,[3] Linden J. made the following comments:
In tax law, form matters. A mere subjective intention, here as
elsewhere in the tax field, is not by itself sufficient to alter
the characterization of a transaction for tax purposes. If a
taxpayer arranges his affairs in certain formal ways, enormous
tax advantages can be obtained, even though the main reason for
these arrangements may be to save tax (see The Queen v. Irving
Oil 91 DTC 5106, per Mahoney, J.A.). If a taxpayer fails to
take the correct formal steps, however, tax may have to be paid.
If this were not so, Revenue Canada and the courts would be
engaged in endless exercises to determine the true intentions
behind certain transactions. Taxpayers and the Crown would seek
to restructure dealings after the fact so as to take advantage of
the tax law or to make taxpayers pay tax that they might
otherwise not have to pay. While evidence of intention may be
used by the Courts on occasion to clarify dealings, it is rarely
determinative. In sum, evidence of subjective intention cannot be
used to "correct" documents which clearly point in a
particular direction.
[9] The appeals are dismissed.
Signed at Ottawa, Canada, this 30th day of April, 2003.
J.T.C.C.
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