Donald M Lyons v. Minister of National Revenue, [1984] CTC 2690, 84 DTC 1633

Christie, CJTC:—The issue to be decided is whether the appellant is entitled to deduct interest in the amounts of $2,201 and $6,413.27 in relation to his 1978 and 1979 taxation years respectively. The determination of this question turns on the meaning to be attributed to subparagraph 20(l)(c)(i) of the Income Tax Act, RSC 1952, c 148, (“the Act”), the relevant provisions of which, for the purposes of this appeal, provide that in computing a taxpayer’s income for a taxation year from property, there may be deducted such of the following amount as is wholly applicable to that source, namely, an amount paid in the year or payable in respect of the year (depending upon whether the taxpayer is on a cash or an accrual basis), pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from property.

Subparagraphs 3(a) to (d) of the respondent’s reply to notice of appeal read:

3. In reassessing the Appellant as he did, the Respondent relied, inter alia, upon the following assumptions of fact:

(a) that in September of 1974, the Appellant purchased 10,000 units of securities in Blue Vista Enterprises Limited (‘‘the Company”) for a total consideration of $50,000.00;

(b) that in financing the purchase of securities from the Company the Appellant

obtained loans in September of 1974 from the Toronto-Dominion Bank;

(c) that the Appellant was one of the original incorporators of the Company, incorporated on June 5, 1974 under the laws of the Province of Ontario;

(d) that the Company ceased carrying on operations less than one year after its incorporation;

The only evidence adduced at the hearing was the testimony of the appellant. His evidence corroborated the substance of what I have cited from the reply to notice of appeal.

Blue Vista Enterprises Limited (“the Company”) was incorporated on June 5, 1974 as a public company under the laws of Ontario. The appellant said he was a director of the Company. Each of the 10,000 units he purchased consisted of one preferred share, one common share and a share warrant for a common share. The Company was involved in the tourist business and owned subsidiaries which had hotels in Nassau, in the Bahamas, and in Jamaica. The appellant said that the Company paid dividends on the preferred shares in respect of the last quarter of 1974. There was some suggestion by him that another dividend was paid in respect of preferred shares soon after they were issued, but his evidence in this regard was doubtful. The Company was in serious financial difficulties at an early stage and the hotels were taken over by banks in the Bahamas and Jamaica. Trading in its shares was prohibited by provincial authorities and the ban has never been rescinded. In the course of cross-examination, it was suggested that about a year after the Company’s securities had been issued, it “went into liquidation”. The appellant’s reply was that there had been no “liquidation”, but that the Company “went into bankruptcy”. He was then confronted with a letter he had written in December 1981 to an official of National Revenue which reads, in part as follows: “However, about a year after issue, the Company got into difficulty and went into liquidation”. Thereupon, the appellant confirmed what the letter said. Subsequently, his testimony was that there had been no proceedings in bankruptcy. He added that he did not think the Company’s charter had ever been surrendered. I do not believe that the appellant was being devious in testifying. My impression was that he is simply not well informed concerning the history of the Company after it failed. When this occurred, one of its principal promoters “fled the country, went back to England, and was untraceable”. The appellant’s loss of interest in the Company after it went under is understandable even though he continues to be saddled with the debt which he finally repaid in full in 1981.

Whatever eventually happened to the Company, it is clear on the evidence that by March 1975 it had “effectively ceased to operate as a viable business enterprise”. Even if the Company was not dissolved or wound up prior to 1978, there was no suggestion at the hearing that after March 1975 it was anything other than a worthless economic shell without hope of resuscitation. In the circumstances, the appellant was not entitled to the claimed deductions of interest in 1978 and 1979. At that time, a “source” of the kind envisaged in subparagraph 20(l)(a)(i) of the Act did not exist. I believe that this conclusion is consistent with and supported by Deschenes v MNR, [1979] CTC 2690; 79 DTC 461; Alexander et al v MNR, [1983] CTC 2516; 83 DTC 459, and the authorities referred to therein. While these cases relate to the other use in respect of which interest on borrowed money may be deducted pursuant to subparagraph 20(l)(a)(i), ie an amount paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business, I regard the result of those appeals as applicable to this litigation.

In Deschenes the appellant had, in 1970, borrowed money to purchase a hairdressing business. He sought to deduct the interest on the loan in his 1973 and 1974 taxation years, but by that time the business was bankrupt and “‘no longer existed”. It was held that the deductions were not permissible. In Alexander the appellants borrowed $25,000 from a bank in 1977 to be used for the purpose of earning income from a business which they operated in partnership. On August 31, 1978, the partnership was dissolved and as of that time the operations of the business ceased. The appellants sought to deduct interest in respect of their 1979 taxation year. The respondent, the Minister of National Revenue, disallowed the claim. Taylor, TCJ said at 2517 [461]:

The position of the respondent is correct. For the taxation year under appeal, the appellants have not shown that there remained a “source” (section 20(1)) from which the interest payment at issue could be deducted. The business, as indicated, had been terminated and the carrying charges from the financial obligations incurred in connection therewith, could not be redirected and deducted from other income, such as employment income.

The appeal is dismissed.

Appeal dismissed.