Brulé,
T.C.J.:
—This
is
an
appeal
from
assessments
of
income
tax
against
the
appellant
for
its
1981
and
1982
taxation
years.
In
1981
the
appellant
claimed
deductions
amounting
to
$4,632,416
which
were
disallowed
and
as
a
result
in
1982
a
claim
for
non-capital
losses
was
not
available
according
to
the
respondent.
Facts
The
appellant
owned
a
large
building
in
Hamilton,
Ontario,
on
which
there
were
three
substantial
mortgages.
In
1974
the
building
was
sold
but
the
proposed
purchaser
failed
to
complete
the
sale
and
litigation
ensued.
By
September
30,
1980,
the
mortgages
outstanding
were:
first
mortgage
—
$8,803,863;
second
mortgage—$6,168,116;
third
mortgage—$662,154
for
a
total
of
$15,634,133.
At
about
the
same
time
there
was
also
owed
about
$1,000,000
to
lien
claimants
and
unsecured
creditors.
In
1976
the
first
mortgagee
had
commenced
foreclosure
proceedings
and
the
Court
appointed
an
interim
receiver
thus
preventing
the
appellant
from
collecting
revenues
and
paying
property
taxes
and
making
mortgage
payments.
Following
these
proceedings
the
Supreme
Court
of
Ontario
ordered
the
sale
of
the
property
but
despite
two
public
auctions
the
property
was
not
sold.
In
June
of
1980
the
appellant
was
awarded
almost
$5
million
in
respect
of
the
action
commenced
with
regard
to
the
frustrated
sale
of
the
property
in
1974.
In
February
of
1981
the
appellant
agreed
to
pay
the
second
mortgagee
$2
million
and
the
third
mortgagee
$300,000
in
respect
to
their
claims.
Such
was
to
be
done
by
the
assignment
of
the
respective
mortgages.
Following
the
damage
award
mentioned
above,
the
appellant
had
the
funds
to
retire
these
mortgages
but
chose
instead
to
lend
$2.3
million
to
an
associated
corporation,
Frisina
Construction
Company
Limited
("Frisina")
by
way
of
an
interest-free
loan.
Frisina
then
used
the
funds
to
acquire
the
second
and
third
mortgages
by
way
of
assignment.
This
method
of
dealing
with
the
problem
and
the
reasons
therefor
are
dealt
with
below.
In
May
of
1981
the
Court
made
a
final
order
of
foreclosure
with
respect
to
the
property
with
the
result
that
there
was
a
disposition
of
the
property
by
the
appellant
and
the
second
and
third
mortgages
held
by
Frisina
became
unsecured,
interest-bearing
loans
of
the
appellant.
After
these
events
the
appellant,
in
computing
its
income
for
the
taxation
year
ended
September
30,
1981,
deducted
as
an
expense
for
interest
and
property
taxes
in
respect
of
the
former
second
and
third
mortgages,
the
sum
of
$3,922,824
and
also
interest
expense
subsequent
to
the
assignment
of
the
mortgages
in
February
of
1981
of
$709,592
for
a
total
of
$4,632,416
which
sum
was
disallowed
by
the
respondent.
For
1982
the
respondent
reassessed
the
appellant
on
the
basis
that
no
non-capital
losses
existed
for
the
1981
taxation
year
that
could
be
used
to
reduce
the
taxable
income
of
the
appellant
in
1982.
Minister's
Position
As
of
February
18,
1981,
when
the
second
and
third
mortgages
were
assigned
the
respondent
claimed
that
these
liabilities
ceased
to
exist
on
the
payment
of
$2.3
million
even
though
some
$7,225,964
was
by
then
still
owing
on
these
liabilities.
The
amount
of
$709,592
claimed
by
the
appellant
as
an
interest
deduction
after
this
date
could
not
be
claimed
as
the
second
and
third
mortgage
liabilities
were
extinguished
by
virtue
of
their
settlement
with
Central
Trust
Company
who
owned
both
of
them.
The
respondent
claimed
that
the
interposition
of
Frisina
by
the
appellant
had
no
bona
fide
business
purpose
and
had
primarily
the
purpose
of
reducing
tax.
As
a
result
of
the
alleged
extinguished
liabilities
of
the
appellant,
the
respondent
said
that
no
deduction
could
be
allowed
under
paragraph
20(1)(c)
of
the
Income
Tax
Act
(the
'Act").
Further,
it
was
said,
that
no
deduction
of
interest
expense
could
be
allowed
in
computing
the
appellant's
1981
income
because
if
allowed,
this
expense
would
unduly
or
artificially
reduce
the
appellant’s
income
contrary
to
subsection
245(1)
of
the
Act.
Taxpayer's
Position
It
was
submitted
that
the
events
which
took
place
were
in
accordance
with
accepted
business
practices
and
that
no
tax
reasons
were
ever
considered.
The
assignment
of
the
second
and
third
mortgages
directly
from
third
parties
to
Frisina
rather
than
to
the
appellant
enabled
it
to
preserve
a
part
of
the
damages
award
received
in
respect
to
the
litigation
over
the
frustrated
1974
sale.
This
put
the
appellant
in
a
better
bargaining
position
with
its
remaining
outside
creditors.
Had
this
sequence
of
transfers
not
taken
place
and
the
second
and
third
mortgages
had
been
transferred
to
the
appellant
they
would
have
been
extinguished
by
operation
of
land
law.
The
appellant
did
not
want
to
eliminate
these
mortgages
from
its
balance
sheet
as
such
elimination
would
not
fairly
represent
the
facts
and
would
eliminate
the
benefits
referred
to
above.
The
deductions
claimed
were
said
to
be
proper
in
the
circumstances
and
that
subsection
245(1)
of
the
Act
had
no
application.
Analysis
Both
the
appellant's
and
respondent's
counsel
directed
the
Court
to
several
authorities
dealing
with
subsection
245(1)
of
the
Act.
I
do
not
consider
it
necessary
to
review
these
in
detail.
That
particular
subsection
reads
as
follows:
In
computing
income
for
the
purposes
of
this
Act,
no
deduction
may
be
made
in
respect
of
a
disbursement
or
expense
made
or
incurred
in
respect
of
a
transaction
or
operation
that,
if
allowed,
would
unduly
or
artificially
reduce
the
income.
This
subsection
(formerly
subsection
137(1))
was
succinctly
dealt
with
by
Collier,
J.
in
the
case
of
Sigma
Explorations
Ltd.
v.
The
Queen,
[1975]
C.T.C.
215;
75
D.T.C.
5121
wherein
he
said
at
page
221
(D.T.C.
5125):
Parliament
has
not
defined
the
meaning
of
the
phrase
“unduly
or
artificially
reduce
the
income”.
The
taxpayer,
in
the
carrying
on
of
his
business
affairs,
is
left
to
speculate
on
the
arcane
intention
of
the
legislators,
and
the
perhaps
unpredictable
attitude
or
opinion
of
the
Minister
in
each
individual
case.
.
.
.
The
test
in
deciding
whether
a
deduction
is
prohibited
by
subsection
137(1)
must,
as
I
see
it,
be
an
objective
one.
The
main
source
of
the
evidence
relating
to
it
is
commonly
the
taxpayer.
The
evidence
is
therefore
often
subjective
in
nature.
An
assessment
of
its
weight
and
reliability
is
of
necessity
required,
but
in
the
final
analysis
the
overall
finding
of
undueness
or
artificiality
(or
not)
is
a
value
judgment
based
on
all
the
facts
and
factors.
Undoubtedly,
many
expenditures
arithmetically
reduce
a
taxpayer's
income.
.
.
.
If,
however,
the
expenditure
is
a
reasonable
one
for
legitimate
income-earning
and
business
purposes,
and
not
in
its
true
light
a
vehicle
primarily
to
minimize
tax,
then
no
matter
how
drastically
income
may
be
diminished,
I
do
not
think
the
transaction
can,
or
ought
to
be,
at
the
same
time
characterized
as
an
unreasonable
reduction
of
income,
or
an
unreal
or
unnatural
reduction.
Collier,
J.
was
referring
to
the
judgment
of
Ritchie,
D.J.
of
the
Exchequer
Court
in
Shulman
v.
M.N.R.,
[1961]
C.T.C.
385;
61
D.T.C.
1213,
which
case
was
affirmed
by
the
Supreme
Court
of
Canada
without
reasons
at
62
D.T.C.
1166.
In
the
present
case
when
all
the
facts
are
considered
and
looked
at
both
realistically
and
objectively,
it
cannot
be
concluded
that
what
transpired
unduly
or
artificially
reduced
the
appellant's
income.
The
testimony
of
Garth
Manning,
Q.C.
who
was
accepted
to
give
expert
testimony
said
in
an
affidavit
filed
with
the
Court:
In
my
opinion,
a
prudent
solicitor
in
these
circumstances
would
have
sought
to
ensure
that
the
second
and
third
mortgages
remained
outstanding
and
were
not
discharged
as
a
result
of
any
settlement
and
payment
to
those
mortgagees,
so
that
the
debt
evidenced
by
those
mortgages
would
rank
with
all
other
debts
owing
by
the
Appellant.
If
the
Appellant
has
discharged
the
second
and
third
mortgages,
or
had
taken
an
assignment
of
those
mortgages,
the
mortgages
would
cease
to
have
existed
or
would
have
merged
in
the
equity
of
redemption.
In
my
opinion,
it
was
prudent
for
the
Appellant
to
loan
funds
to
Frisina
Construction
Limited
in
order
that
Frisina
Construction
Limited
could
take
an
assignment
of
the
second
and
third
mortgages
in
order
to
preserve
those
mortgages
so
that
they
would
constitute
a
debt
to
be
ranked
with
the
other
debts
of
the
Appellant
and
thereby
encourage
the
other
creditors
to
settle
their
claims
on
reasonable
terms,
and
to
prevent
those
mortgages
from
merging
in
the
equity
of
redemption.
In
my
opinion,
any
prudent
solicitor
would
have
structured
the
transaction
in
this
fashion
for
business
and
legal
reasons.
In
my
opinion,
the
second
and
third
mortgages,
and
the
debts
represented
thereby,
did
not
cease
to
exist
upon
their
assignment
to
Frisina
Construction
Limited
and
were
enforceable
according
to
their
terms
and
the
general
law.
This
adequately
summarizes
the
reasons
for
the
appellant's
actions
and
in
no
way
were
tax
savings
considered
although
such
enured
to
the
appellant.
The
result
therefore
is
that
this
appeal
is
allowed
and
the
matter
referred
back
to
the
respondent
for
reconsideration
and
reassessment.
The
appellant
is
entitled
to
his
costs
on
a
party-and-party
basis.
Appeal
allowed
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