Rosemarie and Dieter Evertz v. Minister of National Revenue, [1997] 1 CTC 2088, 97 DTC 672

Sobier J.T.C.C.: — The Court is now prepared to give Reasons for Judgment in the appeal between Rosemarie Evertz and Her Majesty the Queen, 94-979(IT)G, and Dieter Evertz and Her Majesty the Queen, 94-980(IT)G. These appeals were heard on common evidence under the General Procedure of this court.

The Appellants appeal for the assessments by the Minister of National Revenue for their 1990 and 1991 taxation years whereby the Minister denied their claims for interest deductions in the amount of $53,408 in 1990 and $67,413 in 1991. These amounts with respect to both Appellants were in the aggregate.

In 1986 the Appellants agreed to purchase a condominium at 401 Queens Quay West Toronto, Ontario (the “condominium”). Although the Agreement of Purchase and Sale was executed in 1986, the closing did not take place until September 12, 1989. However, the Appellants occupied the condominium since June 30th, 1987 paying a monthly occupancy fee. The condominium was purchased for cash and was free from encumbrances at the time of closing. The purchase price was $417,000 subject to adjustments. In 1989 the Appellants agreed to purchase a home at 115 Appleby Place, (the “home”) in Burlington, Ontario. The purchase price was $950,000 all cash. The purchase of the home was completed on March 30th, 1990.

On March 29, 1990, the Appellants borrowed $600,000 from CIBC Mortgage Corporation, (“CIBC”), on the security of the condominium. The mortgage bore interest at 13.75% per annum and was for a term of one year. The mortgage appeared to have been renewed during the relevant periods and interest was payable at the a similar rate.

In examination of statements of adjustments and other documents shows that the proceeds of the mortgage loan went into a solicitor’s particular account and those same proceeds came out of that account and were paid to the vendor of the home. From the evidence of Mrs. Evertz there is no doubt that the proceeds of the loan secured by the mortgage on the condominium were used as part of the purchase price of the home.

The Appellants moved out of the condominium in September 1990. At that time, they attempted to rent it. They were unsuccessful in 1990. Therefore, there was no rental income for 1990. However, in 1991 it was rented to a Swiss banker for a gross rental of $21,285. Rental expenses in 1990 were claimed at about $32,000 of which approximately $27,000 was claimed to be interest expense. In 1991, rental expense of approximately $84,000 was claimed of which approximately $67,000 was claimed to be interest expense.

In the fullness of time, the Appellants were reassessed and the interest expenses were disallowed. The reason given for the disallowance was that the deduction was not one permitted under subparagraph 20( 1 )(c)(i) of The Income Tax Act. That subparagraph states as follows, and I quote:

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.

And paragraph (c) reads:

An amount paid in the year or payable in respect of the year (depending on the method regularly followed by the Appellant in computing the taxpayer’s income), pursuant to a legal obligation to pay interest on (i) money borrowed for the purpose of earning income from a business or a property.

The issue, therefore, simply stated is whether the $600,000 borrowed by the Appellants from CIBC and secured by the mortgage on the condominium and used to aid in the purchase of the home was money borrowed for the purpose of earning income from a business or property and in particular the condominium.

The Appellants claim, among other things, that having converted the condominium to a rental property, they are entitled to deduct the mortgage interest payable on the loan secured by the mortgage of the condominium.

A leading case in the deductibility of interest is Bronfman Trust v. R., (sub nom. Bronfman Trust v. The Queen) [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059 (S.C.C.), a decision of the Supreme Court of Canada. In analyzing the history of deductibility of interest, Chief Justice Dickson pointed out that without the existence of a provision such as paragraph 20(1)(c), no deduction for interest would be possible generally.

He goes on to say at pages 124-25 (D.T.C. 5064):

The statutory deduction thus requires a characterization of the use of borrowed money as between the eligible use of earning non-exempt income from a business or property in a variety of possible ineligible uses. The onus is on the taxpayer to trace the borrowed funds to an identifiable use which triggers the deduction. Therefore, if the taxpayer commingles funds used for a variety of purposes only some of which are eligible, he or she may be unable to claim the deduction. See, for example, Mills v. Minister of National Revenue 85 D.T.C. 632 (T.C.C.), No. 616 v. Minister of National Revenue 59 D.T.C. 247 (T.A.B.). The interest deduction provisions requires not only a characterization of the used of borrowed funds, but also a characterization of purpose. Eligibility for deduction is contingent on the use of borrowed money for the purpose of earning income. It is well established in the jurisprudence, however, that it is not the purpose of the borrowing itself which is relevant. What is relevant, rather, is the taxpayer’s purpose in using the borrowed money in a particular manner. Auld v. Minister of National Revenue 62 D.T.C. 27 (T.A.B.). Consequently, the focus of the inquiry must be centered on the use to which the taxpayer put the borrowed funds.

The Appellants here urged the Court to look at direct or indirect use of those monies. However, at page 126 (D.T.C. 5065) of Bronfman Trust, the Chief Justice goes on to say, and I quote:

In my view, neither The Income Tax Act or the weight of judicial authority permits the courts to ignore the direct use to which a taxpayer puts borrowed money. One need only contemplate the consequences of the interpretation sought by the Trust in order to reach the conclusion that it cannot have been intended by Parliament. In order for the Trust to succeed, subparagraph 20( 1 )(c)(i) would have to be interpreted so that a deduction would be permitted for borrowings by any taxpayer who owned income producing assets. Such a taxpayer could, on this view, apply the proceeds of a loan to purchase a life insurance policy, to take a vacation, to buy speculative properties, or to engage in any other non-income-earning or ineligible activity. Nevertheless, the interest would be deductible. A less wealthy taxpayer, with no income earning assets, would not be able able to deduct interest payments on loans used in the identical fashion. Such an interpretation would be unfair as between taxpayers and would make a mockery of the statutory requirement that, for interest payments to be deductible, borrowed money must be used for circumscribed income-earning purposes.

And further on that page he says, at page 127 (D.T.C. 5065):

It is not surprising, therefore, that cases interpreting 20(l)(c)(i) and it’s predecessor provisions have not favoured the view that a direct ineligible use of borrowed money ought to be overlooked whenever an indirect eligible use of founds can be found.

The actual use of the borrowed monies was to purchase the home, not to earn income from the condominium. The condominium was merely used as security given by the Appellants to secure a loan of $6000 which enabled them to purchase the home. Here we have an attempt to deduct interest on a loan for a principal residence in the guise of a business venture. Accordingly, I find that the interest paid on the $600,000 borrowed and secured by the mortgage on the condominium was not interest paid for the purpose of earning income from that property. For these reasons, the appeals are dismissed with costs.

Appeal dismissed.