Dan Krall v. Her Majesty the Queen (Informal Procedure), [1995] 1 CTC 2570, 95 DTC 411

Mogan J.T.C.C.:-The issue in this case, heard under the informal procedure, is whether the appellant received a taxable employee benefit when his employer asked him to move and then contributed a portion of the interest payable on the appellant’s increased house mortgage.

The appellant is a professional engineer employed by Petro-Canada Inc. In 1991, the appellant was transferred by Petro-Canada from Calgary, Alberta to Burlington, Ontario. The cost of housing in Burlington was approximately 50 per cent higher than the cost of comparable housing in Calgary. The appellant sold his house in Calgary for $118,000 and purchased a comparable house in Burlington for $182,500. The mortgage on the appellant’s house in Calgary at the time of sale was $70,000 leaving the appellant with an equity of $48,000. The appellant used all of the net proceeds from the sale of his Calgary house as a down payment on his Burlington house; and he placed a fresh mortgage of $133,981 on his Burlington house. The increase ($63,981) in the amount of his Burlington mortgage over the amount of his Calgary mortgage was almost the same as the excess cost of his Burlington house ($64,500) over the sale price of his Calgary house.

The appellant transferred his work location from Alberta to Ontario on June 10, 1991 and acquired possession of his Burlington house on August 15, 1991. Petro-Canada had a policy which assisted an employee with respect to mortgage interest payments if the employee was asked by PetroCanada to move to a municipality where the cost of housing was higher than in the employee’s place of residence before the move. Following this policy, Petro-Canada contributed approximately $7,000 in 1992 toward the interest which the appellant was required to pay in 1992 for the mortgage on his Burlington house. The Minister of National Revenue included the amount of $5,362.16 in the appellant’s 1992 income as an "employee benefit" under the provisions of subsections 80.4(1) and 6(9) of the Income Tax Act, 1985 (5th Supp.), c. 1 (the "Act"). The appellant claims that the amount of $5,362.16 should not be included in his income because it is a subsidy for only part of his mortgage interest.

Exhibit A-l is a statement of the Petro-Canada policy concerning assistance for mortgage interest payments. The relevant parts of Exhibit A-l may be summarized as follows.

1. Utilizing average sales data for detached two-storey four bedroom houses of approximately 2,000 square feet, Petro-Canada determines the relationship between the value of houses in two municipalities. This establishes the market diffeiential. When an employee’s house is sold, the market differential is multiplied by the sale price. This establishes the comparable price.

2. The difference between the sale price of the employee’s house and the comparable price of a house in the new municipality is the maximum amount which Petro-Canada will "subsidize".

3 An employee must use all proceeds from the sale of the original house in the purchase of the new house. The actual amount which is subsidized is the difference between the sale price of the employee’s original house and the purchase price of the house in the new location, subject to the “maximum amount" referred to in item 2 above.

4. The mortgage interest assistance program was only available through Confederation Life. An employee applied directly to Confederation Life and was required to meet its normal lending criteria.

5. Once the loan was approved, Confederation Life billed Petro- Canada directly for interest costs equal to the actual mortgage interest on the original differential (on a declining balance) or on the balance of the mortgage, whichever was lesser.

6. Petro-Canada did not make payments which reduced the principal balance of the mortgage.

7. The mortgage subsidy continued for only ten years on a declining balance of the original differential in accordance with the following table:

Year of New	Percentage of Original
Mortgage	Differential Subsidized
Year one	100%
Year two	97%
Year three	94%
Year four	90%
Year five	85%
Year six	80%
Year seven	75%
Year eight	10%
Year nine	60%
Year ten	50%

The rate of interest on the appellant’s Burlington mortgage was 10... per cent per annum which was 0.75 per cent higher than the rate of interest on the Calgary mortgage. During the first year of the Burlington mortgage, Petro-Canada paid directly to Confederation Life interest on 100 per cent of the original differential which appears to have been $63,981; and the appellant paid interest on the remaining principal amount which would have started at $70,000 and presumably declined with each payment if the mortgage loan was amortized. The appellant also paid any amounts of principal required in accordance with the amortization of the mortgage. Following the table set out above, during the second year of the mortgage, Petro-Canada would have paid directly to Confederation Life interest on 97 per cent of the original differential with the appellant paying the balance required by the amortization schedule. And so on, until the 11th year of the Burlington mortgage when the appellant would have been the only person making payments to Confederation Life.

There are two recent decisions of the Federal Court which deal with payments by an employer to an employee with respect to housing costs when the employee is asked to move to a new work location. In Splane v. The Queen, [1990] 2 C.T.C. 199, 90 D.T.C. 6442 (F.C.T.D.), an employee was asked to move from Ottawa to Edmonton and, according to the policy described in the employer’s "relocation directive", the employee received the amounts of $1,124, $856 and $546 in the years 1985, 1986 and 1987 respectively, as a "mortgage interest differential payment". The mortgage on the house in Edmonton was at a higher rate of interest than the mortgage on the house in Ottawa. Cullen J. allowed Splane’s appeal and held that the three amounts in question were a reimbursement of mortgage expenses and not a taxable benefit or allowance. The decision of Cullen J. was upheld by the Federal Court of Appeal, [1991] C.T.C. 224, 92 D.T.C. 6021. In Phillips v. M.N.R., [1994] I C.T.C. 383, 94 D.T.C. 6177 (F.C.A.), an employee who worked in Moncton, N.B. was required to move to Winnipeg, Manitoba where the cost of a house comparable to his Moncton house was approximately $30,000 higher. To each employee who sold a house in Moncton and purchased a house in Winnipeg in order to relocate his employment, the employer paid a lump sum of $10,000 with respect to the differential in house values. The Federal Court of Appeal held that the $10,000 payment was a taxable benefit under paragraph 6(1 )(a) of the Income Tax Act.

It seems to me that the issue in this case is whether the portion of the mortgage interest contributed by Petro-Canada is a non- taxable subsidy for certain expenses under the Splane umbrella or a taxable benefit under the Phillips umbrella. In Phillips, Robertson J.A. (with Stone J.A. concurring) stated at page 392 (D.T.C. 6184):

It is apparent on the facts before us that the respondent’s net worth qua employee increased. Even if the $10,000 payment is taxable, he gains considerable disposable income. The compensatory payment effectively represents a temporary wage increase not available to all employees. Second, he gains an advantage over fellow employees resident in the community with higher housing costs. I find it difficult to accept that the respondent has a valid claim to a $10,000 tax-free benefit which can be used in the purchase of a house, while other Winnipeg employees are forced to expend after-tax dollars in order to gain entry into the housing market.

There is no doubt that the $10,000 payment received by Phillips (even if taxable) increased his net worth qua employee. Also, the after-tax portion of the $10,000 was a significant contribution to the cost of his more valuable Winnipeg house. In my view, however, those statements would not apply to the appellant herein. Although the appellant was required to pay $64,500 more in Burlington to purchase a house comparable to his Calgary house, Petro-Canada made no contribution to that greater cost. Also, the mortgage interest subsidy paid by Petro-Canada did not give the appellant more disposable income because the subsidy was restricted to that portion ($63,981) of the Burlington mortgage which was related directly to the greater cost ($64,500) of the Burlington house.

Although the circumstances in Phillips are very different from the facts in this appeal, both appellate court judges who wrote reasons in Phillips anticipated a fact situation like the one herein. Robertson J.A. stated at pages 388-89 (D.T.C. 6181):

Two kinds of losses can arise upon the sale of an employee’s house: a capital loss and a loss associated with the discharge of a mortgage with an interest rate lower than prevailing market rates. It is necessary to distinguish these losses from the expenses occasioned by a new mortgage with both a higher interest rate and a principal amount which reflects the higher housing prices at the new work location.

For example, if an employee had a $50,000 outstanding mortgage at 10 per cent and relocated to purchase a house requiring a $70,000 mortgage at 15 per cent, only the five per cent differential on the $50,000 can truly be considered a loss. Assuming that the $20,000 difference in principal is attributable solely to higher housing costs at the new work location (a task which itself is fraught with uncertainty), interest rate compensation with respect to that amount must be classified as reimbursement for an expense incurred in the purchase of a replacement house.

The tax treatment of compensation directed only to the loss of a favourable mortgage rate on the sale of a house is, in my view, governed by Splane. Unfortunately, the trial judge’s recital of the facts in that case is not comprehensive. This Court affirmed the trial judge’s decision with brief oral reasons.

We do know that in Splane, the taxpayer sold his Ottawa house for $63,000 and purchased one in Edmonton for $65,000. We also know that his employer reimbursed him for the costs of the 1.75 per cent higher mortgage rate on the replacement house. The facts, however, do not disclose whether the principal amount of the new mortgage loan exceeded that owing under the original mortgage.

And Linden J.A. when writing his concurring reasons in Phillips stated at page 394 (D.T.C. 6185):

Here we are dealing with a cash payment upon relocation of $10,000 used in the purchase of a house, whereas in Splane the issue revolved around the reimbursement of additional interest payments necessitated because of relocation. It is not necessary, in deciding this case, to opine that there should be a difference in treatment between additional interest payment because of an increase in interest rate and additional interest payments because of an increase in the principal amount of the mortgage. That issue was not before this Court, nor was it before the Court in Splane. Because that precise question may well come before this Court in the future, I believe it is inadvisable to try to decide that issue prematurely in this case, where it is not before the Court for decision.

Although the majority of the Court in Phillips concluded (in obiter dicta) that the tax treatment of compensation directed only to the loss of a favourable mortgage rate on the sale of a house is governed by Splane, that is not the question in this appeal. The question here is the tax treatment of payments from Petro-Canada which compensated the appellant only for mortgage interest payable with respect to that portion of the principal amount of the Burlington mortgage which was directly related to the higher cost of the Burlington house.

Having regard to the relocation of an employee from one city to another and his or her need to purchase a comparable house at a higher cost, there are different ways in which the employer may offer assistance. If the employee suffered a loss on the sale of the first house, the employer may compensate for that loss as in Ransom v. M.N.R., [1967] C.T.C. 346, 67 D.T.C. 5235 (Ex. Ct.). If the cost of the second house was significantly higher than the sale price of the first house, the employer may contribute toward that higher cost as in Phillips. If the employee transfers a mortgage on the first house at a low rate of interest and places a mortgage on the second house at a higher rate, the employer may pay the differential on the mortgage interest which appears to have been the case in Splane. And then there is a scenario like this appeal in which the employer starts by paying in the first year all of the interest on the portion of the new mortgage which represents the higher cost of the new comparable house; and then the employer phases out the mortgage interest subsidy over the nine succeeding years on a declining scale.

In my opinion, this case is closer to Splane than to Phillips for the following reasons. Firstly, the mortgage interest subsidy was limited to only that portion of the principal amount of the mortgage which represented the higher cost of the comparable house (1.e., the market differential). In other words, the subsidy did not increase the appellant’s net worth qua employee like the $10,000 payment in Phillips. Secondly, the mortgage interest subsidy will be phased out over ten years. Although it begins as compensation for mortgage interest on the full market differential, in each successive year the subsidy applies to a lower percentage of the market differential until the end of the tenth year when the subsidy disappears completely. Having regard to the fact that almost all residential mortgages are amortized over a term of 20, 25 or 30 years, the PetroCanada mortgage interest subsidy is progressively reduced and phased out within a reasonable period of time. It is not a permanent subsidy to the transferred employee. And thirdly, the subsidy was directed at only a portion of the mortgage interest which is a revenue type of expense. The subsidy was not directed at any part of the cost of the Burlington house which is a capital outlay. In that sense, the subsidy is more like a reimbursement of expenses incidental to the move.

The appeal is allowed with costs.

Appeal allowed with costs.