Adolph Tonn v. Minister of National Revenue, [1991] 2 CTC 2338, 91 DTC 1132

Garon, T.C.J.: —These are appeals from reassessments with respect to the taxation years 1982, 1983 and 1984. By his reassessments the Minister of National Revenue disallowed the deduction of the following amounts of interest in respect of the years mentioned: $16,339.55 for 1982; $10,349.08 for 1983; $7,087.08 for 1984.

At the hearing of these appeals counsel for the Minister of National Revenue admitted that the disallowance of interest for the 1984 taxation year should not have been $7,087.08, but rather $6,986.38.

The essential facts were not disputed. The appellant purchased a house on August 17, 1981. This house was and still is his principal residence. This purchase was financed by the appellant granting a one-year mortgage in the amount of $110,000. The appellant sold another house that he had owned for some time for $132,000 on September 30, 1981. Out of the proceeds of this sale the appellant took out two term deposits in the amounts of $120,000 and $7,000. On April 13, 1982 the $120,000 term deposit was reduced to $20,000 and the balance in the amount of $100,000 was loaned to Empire Heavy Equipment (Northlands Investments) Ltd. "Northlands" with a promise to repay the amount in question by the renewal date of the mortgage on the appellant's house, which date was August 17, 1982.

The appellant stated that prior to the renewal date of the mortgage he was informed that Northlands was experiencing severe financial difficulties and was unable to repay the loan to the appellant by the renewal date of August 17, 1982. Then the appellant applied all available funds including the term deposits to reduce his mortgage on his residence to $70,000, again for one year. This reduction of the mortgage to $70,000 from $110,000 definitely indicated that the appellant's intention was to pay off the mortgage on his house as soon as possible. In actual fact the $70,000 mortgage was paid off on September 17, 1984.

It is also in evidence that during the five-year period beginning with the year 1982 and terminating with the end of the year 1986 the appellant included in his income as interest a total amount of $64,071, while during the same period he paid out as interest $33,775.71.

The issue in this case has to do with the disallowance of the interest payments made by the appellant during the years 1982, 1983 and 1984 in respect of the mortgage that he had on his house.

The appellant submitted that the substantial amounts of interest income that were generated during the three-year period by the loans he made out of the proceeds of the sale of his house in September 1981 could not have been made if he had not mortgaged the house he acquired in August 1981. The appellant's agent indicated to the Court that the appellant was forced into renewing the mortgage for an amount of $70,000 by the inability of Northlands to meet its obligation and repay the loan to the appellant by the due date, which was August 17, 1982. It is clear that if the appellant had not made the above-mentioned loan to Northlands or if the loan in question had been repaid on time, the appellant could have used part of these moneys to pay off in full the mortgage on his residence.

The matter of the deductibility of interest is governed by the provisions of paragraph 20(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), which provides as follows:

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 upon the method regularly followed by the taxpayer in computing his 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),

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy), or, . . .

The scope of this provision respecting the range of deductibility of interest has given rise to much litigation and has, therefore, been considered by the courts on many occasions. The leading case in the matter is the decision of the Supreme Court of Canada in the matter of The Queen v. Phyllis Barbara Bronfman, [1987] 1 S.C.R. 32; [1987] 1 C.T.C. 117; 87 D.T.C. 5059. The then Chief Justice of Canada, speaking for a unanimous Court, said this at page 126 (D.T.C. 5065; S.C.R. 48):

“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."

Later on at page 127 (D.T.C. 5066; S.C.R. 50) the Chief Justice added the following observations:

In a similar vein, it has been held repeatedly that an individual cannot deduct interest paid on the mortgage of a personal residence even though he or she claims that the borrowing avoided the need to sell income-producing investments."

The principles laid down in the decision of the Supreme Court of Canada have since been followed in many subsequent court decisions. One of them is the decision of the Federal Court of Appeal in the case Said Mohammad Attaie v. Canada, [1990] 2 C.T.C. 157; 90 D.T.C. 6413. In that case it was held that once the taxpayer has ceased using his house to generate rental income, interest paid on the mortgage thereon was no longer deductible. The fact that the taxpayer in that case chose to invest the funds from Iran in order to generate income rather than using a portion thereof to pay off the mortgage did not change this.

There is an interesting passage in the judgment in that case at page 162 (D.T.C. 6417). Madam Justice Desjardins expressed herself as follows:

The taxpayer, in the case at bar, is far from meeting the special circumstances of Trans-Prairie Pipelines. What was said by Dickson, C.J. in the extract cited above was that ‘’. . . the taxpayer must satisfy the Court that his or her bona fide purpose in using the funds was to earn income”. The borrowed moneys were not used by the taxpayer to earn income from business or property like they were under the business arrangement described in Trans-Prairie. They were used to finance the personal residence of the respondent.

From these decisions it is clear that in order to be entitled to a deduction of interest a taxpayer must directly and not indirectly use the borrowed moneys or the amounts payable by him, as the case may be, for the purpose of earning income. The indirect use of moneys for an earning income purpose was not accepted by the Supreme Court of Canada in the Bronfman Trust case, supra.

In the present case the moneys borrowed by the appellant, secured by mortgage on his residence, were originally used by the appellant for the direct purpose of acquiring his residence. Subsequently in August 1982, when a new mortgage in the amount of $70,000 affecting the subject residence was entered into by the appellant and his mortgagee in substitution for the previous mortgage in the amount of $110,000, it is apparent that the moneys secured by the new mortgage were used by the appellant for the direct purpose of preserving the appellant's rights and interest in the residence in question. This property was not in the years in issue an income-producing asset. Therefore, the direct use to which the borrowed moneys were put by the appellant was not for the purpose of earning income from the subject property. It is only indirectly that, as a result of the new mortgage, moneys that would not have been available otherwise could be used to earn income. This result may appear to be overly technical, but the courts cannot rewrite legislation enacted by Parliament. As has been said many times, the role of courts is to interpret and apply legislation as it is found in the statute books.

It therefore follows that the appellant is not entitled to the deduction of interest claimed for the years 1982, 1983 and 1984. In the case of the year 1984, however, a slight correction must be made to the reassessment along the lines I have indicated earlier.

Therefore, the appeals for the 1982 and 1983 taxation years are dismissed. In the case of the year 1984 the appeal is allowed in order to enable the Minister of National Revenue to make the correction set out earlier at the beginning of these Reasons but, in other respects, the appeal for that year is dismissed.

Appeal dismissed in the main.