Lars Eric Larsson v. Her Majesty the Queen, [1996] 3 CTC 2430, [1998] DTC 2213 (Informal Procedure)

O’Connor J.T.C.C.: — These appeals were‘heard in Penticton, British Columbia on June 12, 1996. The Appellant acted on his own behalf, gave evidence and presented exhibits.

Issue

The sole issue is whether the Appellant, in the taxation years 1990 through 1992, was entitled to deduct as alimony or other allowance or as maintenance certain amounts paid to the mortgage creditor holding the mortgage on the former matrimonial home in which the Appellant’s separated spouse lived with the children of their marriage.

Facts

In computing his income for the 1990, 1991 and 1992 taxation years, the Appellant deducted $16,116.00, $7,764.68 and $9,979.86 respectively, claiming same as alimony or maintenance payments to his separated spouse. The Minister of National Revenue (“Minister”) assessed the Appellant to allow certain amounts with respect to child support included in the above totals but to disallow the third party mortgage payments in the amounts of $9,516.00 in 1990, $1,372.32 in 1991 and $3,979.86 in 1992.

An Order of the Supreme Court of British Columbia (“Supreme Court”) dated November 14, 1989 (the “First Order”) awarded custody of the children of the marriage to the Appellant’s separated spouse, Kathleen Anne Larsson, and provided as follows:

THIS COURT FURTHER ORDERS that the Defendant do pay interim spousal maintenance for the support of the Plaintiff in the form of monthly mortgage payments on the former matrimonial home commencing with a payment for the month of November, 1989...;

THIS COURT FURTHER ORDERS that the Defendant do pay to the Plaintiff interim child maintenance for the support of the aforesaid children of the marriage in the sum of $275.00 being payable on the 1st and 15th days of each and every month and commencing on the 15th day of November, 1989:

A further Order of the Supreme Court dated September 27, 1991 (the “Second Order”) provided, inter alia, that the former matrimonial home be listed for sale with the proviso that the closing or completion date could be no sooner than four months from the date of the offer to purchase with the net sale proceeds to be divided equally between the Appellant and his spouse. The Second Order provided further as follows:

THIS COURT FURTHER ORDERS that the Defendant shall pay to the Plaintiff as lump sum spousal maintenance the sum of EIGHT THOUSAND ($8,000.00) DOLLARS, together with 60 per cent of all arrears of spousal maintenance which have accumulated under the Order ... made the 14th day of November, 1989, being $3,979.86, and that these amounts shall be deducted from the Defendant’s share of the net sale proceeds of the former matrimonial home and paid to the Plaintiff, and that these monies shall represent full and final satisfaction of any spousal maintenance payable by the Defendant to the Plaintiff;

THIS COURT FURTHER ORDERS that the Defendant shall continue to pay to the Plaintiff for the support of the infant children ... the sum of TWO HUNDRED and FIFTY ($250.00) DOLLARS per month per child commencing on the 1st day of October, 1991, and continuing thereafter on the 1st day of each and every month until such time as that said child shall attain the age of nineteen (19) years of age;

THIS COURT FURTHER ORDERS that any and all spousal and child support payments made by the Defendant to the Plaintiff in 1989 by way of mortgage payment on the former matrimonial property, are to be deemed periodic maintenance payments pursuant to the Income Tax Act (Canada), R.S.C.B. 1979, Chapter 190, and amending Acts thereto;

THIS COURT FURTHER ORDERS that in the event that the Plaintiff is reassessed for her 1989 Income Tax taxes, the Defendant shall pay any reassessment out of his share of the net sale proceeds of the former matrimonial residence;

A further Order of the Supreme Court dated November 4, 1993 obtained on an ex parte application by the Appellant (the “Third Order”) provided as follows:

THIS COURT ORDERS that the Order ... pronounced the 27th day of September, 1991, be amended to include all mortgage payments made between the years 1989 and 1990 be deemed periodic maintenance payments, pursuant to the Income Tax Act (Canada), ... and amending Acts thereto

A further Order of the Supreme Court dated March 3, 1994 also obtained on an ex parte application by the Appellant (the “Fourth Order”) provided as follows:

THIS COURT ORDERS that the Order ... pronounced November 14, 1989, be and is hereby amended on Page 2, Paragraph 1, to read as follows:

THIS COURT FURTHER ORDERS that the Defendant do pay interim spousal maintenance for the support of the Plaintiff in the form of monthly mortgage payments on the former matrimonial home commencing with a payment for the month of November, 1989, and such payments are to be deemed periodic maintenance payments pursuant to the Income Tax Act ( Canada ).... Subsection 60.1(2) and 56.1(2), and amending Acts thereto.

The matrimonial home was sold, the closing date being January 31, 1992 and the closing documentation (Exhibit R-2) indicates that the Appellant did pay his spouse out of the proceeds the sums of $8,000.00 and $3,979.86 referred to in the Second Order.

Submissions of the Appellant

The Appellant submits that all of the third party mortgage payments should have been deductible and that it was only because of technical omissions in the First and Second Orders that the Minister denied deductibility. He adds that any doubt in the matter should be removed by the amendments effected by the Third Order and Fourth Order. He points to Rule 41(23) of the Rules of the Supreme Court which gives that Court the authority to amend an order to provide for any matter which should have been but was not adjudicated upon. He referred to a judgment of the Court of Appeal of British Columbia which, in effect, enforced the Rule in question. He argues that the amendments are to be considered effective as of the dates of the First Order and Second Order.

With respect to the amount of $3,979.86 in the 1992 year, which comprised arrears of mortgage payments, the Appellant submits that it should be considered as regular maintenance. He points out that the reason the amount was only paid in 1992 was his generous concern for his wife which resulted in his agreeing that the closing date could not take place until four months after the offer to purchase. In other words, if the payment had been made in 1991 when the offer was received, as opposed to 1992, it would have qualified.

Submissions of the Respondent

Counsel for the Respondent submits that only the First Order and Second Order are to be considered. The Third Order and Fourth Order cannot have retroactive effect so as to amend the First Order and Second Order with effect as of their previous dates. Counsel further submits that since the Appellant’s wife had no discretion as to the use of the monies, paragraph 56(12) of the Income Tax Act (“Act”) must govern so as to deny the Appellant the deductions claimed. She adds that the effective Orders, namely the First Order and Second Order contain no reference to subsections 56.1(2) and 60.1(2) of the Act and consequently the Appellant cannot deduct the amounts claimed notwithstanding the wording of the Fourth Order which again counsel maintains cannot be retroactive. She points out that the whole concept of timing is important. In other words, if the subsequent Orders amended the earlier Orders, the Minister must have time to go back and reassess the returns of the Appellant’s spouse, i.e. not be time barred from so doing. Counsel points out because of paragraphs 56(3) and 60.1(3) of the Act the amending orders could only affect the year in which they were rendered or the immediately preceding year.

With respect to the figure of $3,979.86 in 1992, counsel for the Respondent maintains that this is capital in nature as the payment of said sum plus another amount terminated the Appellant’s obligation to make any further payments to his spouse.

Analysis

The relevant provisions of the Act, so far as material, are:

56(1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year,

(b) any amount received by the taxpayer in the year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, as alimony or other allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage, if the recipient was living apart from, and was separated pursuant to a divorce, judicial separation or written separation agreement from, the spouse or former spouse required to make the payment at the time the payment was received and throughout the remainder of the year;

(c) any amount received by the taxpayer in the year, pursuant to an order of a competent tribunal, as an allowance payable on a periodic basis for the maintenance of the taxpayer, children of the taxpayer, or both the taxpayer and children of the taxpayer if, at the time the payment was received and throughout the remainder of the year, the taxpayer was living apart from his spouse who was required to make the payment;

56(12) Subject to subsections 56.1(2) and 60.1(2), for the purposes of paragraphs (l)(b), (c) and ... (hereinafter in this subsection referred to as the “former paragraphs”) and 60(b), (c) and ... (hereinafter in this subsection referred to as the “latter paragraphs”), “allowance” does not include any amount that is received by a person, referred to in the former paragraphs as “the taxpayer” and in the latter paragraphs as “the recipient”, unless that person has discretion as to the use of the amount.

56.1(1) Where, after May 6, 1974, a decree, order, judgment or written agreement described in paragraph 56(1 )(b), (c) or ..., or any variation thereof, has been made providing for the periodic payment of an amount

(a) to a taxpayer by a person who is

(i) the taxpayer’s spouse or former spouse, or ...

(b) for the benefit of the taxpayer, children in the custody of the taxpayer or both the taxpayer and those children,

the amount or any part thereof, when paid, shall be deemed, for the purposes of paragraphs 56(l)(b), (c) and ... to have been paid to and received by the taxpayer.

(2) For the purposes of paragraphs 56(1 )(b), (c) and ... the amount, if any, by which

(a) the aggregate of all amounts each of which is an amount (other than an amount to which paragraph 56(1 )(b), (c) or ... otherwise applies) paid by a person in a taxation year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, in respect of an expense ... incurred in the year or the immediately preceding taxation year for maintenance of a taxpayer who is

(i) that person’s spouse or former spouse, or

or for the maintenance of children in the taxpayer’s custody or both the taxpayer and those children if, at the time the expense was incurred and throughout the remainder of the year, the taxpayer was living apart from that person

exceeds

[a formula follows]

shall, where the decree, order, judgment or written agreement, as the case may be, provides that this subsection and subsection 60.1(2) shall apply to any payment made pursuant thereto, be deemed to be an amount paid by that person and received by the taxpayer as an allowance payable on a periodic basis.

(3) For the purposes of this section and section 56, where a decree, order or judgment of a competent tribunal or a written agreement made at any time in a taxation year provides that an amount received before that time and in the year or the immediately preceding taxation year is to be considered as having been paid and received pursuant thereto, the following rules apply:

(a) the amount shall be deemed to have been received pursuant thereto; and

(b) the person who made the payment shall be deemed to have been separated pursuant to a divorce, judicial separation or written separation agreement from his spouse or former spouse at the time the payment was made and throughout the remainder of the year.

60 There may be deducted in computing a taxpayer’s income for a taxation year such of the following amounts as are applicable:

(b) an amount paid by the taxpayer in the year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, as alimony or other allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage, if he was living apart from, and was separated pursuant to a divorce, judicial separation or written separation agreement from, his spouse or former spouse to whom he was required to make the payment at the time the payment was made and throughout the remainder of the year;

(c) an amount paid by the taxpayer in the year, pursuant to an order of a competent tribunal, as an allowance payable on a periodic basis for the maintenance of the recipient thereof, children of the marriage, or both the recipient and children of the marriage, if he was living apart from his spouse to whom he was required to make the payment at the time the payment was made and throughout the remainder of the year;

60.1(1) Where, after May 6, 1974, a decree, order, judgment or written agreement described in paragraph 60(b), (c) or or any variation thereof, has been made providing for the periodic payment of an amount by a taxpayer

(a) to a person who is

(i) the taxpayer’s spouse or former spouse, or

(b) for the benefit of the person or children in the custody of the person, or both the person and those children,

the amount or any part thereof, when paid, shall be deemed, for the purposes of paragraphs 60(b), (c) and ... to have been paid to and received by that person.

(2) For the purposes of paragraphs 60(b), (c) and ... the amount, if any, by which

(a) the aggregate of all amounts each of which is an amount (other than an amount to which paragraphs 60(b), (c) or ... otherwise applies) paid by a taxpayer in a taxation year, pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written agreement, in respect of an expense ... incurred in the year or the immediately preceding taxation year for maintenance of a person who is

(i) the taxpayer’s spouse or former spouse, or

or for the maintenance of children in the person’s custody or both the person and those children if, at the time the expense was incurred and throughout the remainder of the year, the taxpayer was living apart from that person

exceeds

[a formula follows]

shall, where the decree, order, judgment or written agreement, as the case may be, provides that this subsection and subsection 56.1(2) shall apply to any payment made pursuant thereto, be deemed to be an amount paid by the taxpayer and received by that person as an allowance payable on a periodic basis.

(3) For the purposes of this section and section 60, where a decree, order or judgment of a competent tribunal or a written agreement made at any time in a taxation year provides that an amount paid before that time and in the year or the immediately preceding taxation year is to be considered as having been paid and received pursuant thereto the following rules apply:

(a) the amount shall be deemed to have been paid pursuant thereto; and

(b) the person who made the payment shall be deemed to have been separated pursuant to a divorce, judicial separation or written separation agreement from his spouse or former spouse at the time the payment was made and throughout the remainder of the year.

At the outset, although some of the Orders refer to 1989, that year is not before the Court in these appeals.

Secondly, as to the 1992 taxation year, I am satisfied that the position of the Minister is correct. The amount in question, namely $3,979.86, represented a lump sum payment representing 60 per cent of mortgage arrears and combined with the $8,000 payment resulted in the Appellant being totally discharged of any further maintenance obligations towards his former spouse. Consequently the amount is capital in nature and not deductible.

Thirdly, subsections 56.1 and 60.1 of the Act provide for an income inclusion and corresponding deduction from income for certain payments of an alimony or maintenance nature which are made to third parties rather than to the spouse or child or children who obtain the benefit of the payments. These payments are common in separation and divorce situations and often take the form of direct payments of items such as rent, mortgage payments, medical expenses, etc. These subsections do not provide for the inclusion/deduction but simply state the payments are deemed for purposes of paragraphs 56(1 )(b) and (c) and 60(b) and (c) to have been paid to the recipient by the payor. The courts therefore have decided that the definition of “allowance” in subsection 56(12) of the Act applies to these payments. Further difficulties arise from the wording of subsections 56.1(2) and 60.1(2) which allow the deductibility of certain amounts if specific mention of the said subsections is made in the order or written agreement.

This whole area as to whether certain amounts are includable and deductible under the above provisions has led to controversy and confusion. To discern this one need only examine the article of John W. Durnford and Stephen J. Toope entitled “Spousal Support in Family Law and Alimony in the Law of Taxation”, 1994 Canadian Tax Journal, page 1. Much of the confusion has been caused by the drafting of the provisions, the lack of definitions of “alimony”, “maintenance” and “periodic”, the constant references back and forth to the various provisions and the numerous deeming provisos.

There is little, if any, dispute that the provisions are ambiguous. I believe therefore that in interpreting them one is entitled to examine the purpose of the legislation. The main purpose was to attempt to mitigate the increased financial burden that arises when one household ceases and two begin. Our legislators wished to reduce the overall tax burden of the family. This was accomplished by allowing the higher income earner to deduct alimony payments thereby reducing his tax and taxing those payments in the hands of the lower income earner. The amounts would thus be taxed at a lower rate. For many reasons the good intentions of the legislators did not, in many cases, produce the desired result. However the purpose was there and the provisions should be interpreted with that purpose in mind. I should think that if that were done, a court in an ambiguous or doubtful case would tend to favour the income inclusion/deduction process. Notwithstanding the foregoing I realize I am bound by decisions of the Federal Court of Appeal unless they are distinguishable on the facts of these appeals.

This case is distinguishable from that decided by the Federal Court of Appeal in Armstrong v. R. (sub nom. Minister of National Revenue v. Armstrong), [1996] 2 C.T.C. 266, 197 N.R. 262 (F.C.A.), and other similar decisions of the Federal Court of Appeal.

I consider the following aspects important.

1. I do not believe subsections 56.1(2) and 60.1(2) are applicable to cases where one finds that the payments meet the tests in 56(1 )(b) or (c) and 60(b) or (c). This is clear from the words in 56.1(2) and 60.1(2) indicating they are addressing amounts “other than those contemplated in 56(1 )(b) or (c) and 60(b) and (c).”

2. Subsection 56(12) of the Act was enacted essentially to overrule the interpretation given to the word “allowance” by the Supreme Court of Canada in Gagnon v. R. (sub nom. Gagnon v. The Queen), [1986] 1 S.C.R. 264, [1986] 1 C.T.C. 410, 86 D.T.C. 6179. The key words in subsection 56(12) are “allowance does not include any amount that is received by a person referred to in the former paragraphs as ‘the taxpayer’ and in the latter paragraphs as ‘the recipient’ unless that person has discretion as to the use of the amount”. The subsection does not state “any amount that is received or deemed to be received by a person”. I realize there are some authorities to the effect that the addition of the words “deemed to have been received” may not be essential in certain cases. However in a situation such as the present, where we have convoluted provisions which refer back and forth to each other and since one must attempt to give effect to subsection 56(12) and section 60.1 I believe it essential to examine the precise words used. Moreover the word “deemed” is used at least eight times in the provisions quoted above, but does not appear in subsection 56(12). In my view, therefore the only logical interpretation of subsection 56(12) when dealing with third party payments contemplated in section 60.1 is that the payments contemplated in subsection 56(12) are those actually received by a spouse but earmarked for payment to third parties and not those paid, with the consent of the spouse, to a mortgage creditor on the matrimonial home occupied by her. I am comforted in this conclusion when it is realized that subsection 56(12) was enacted specifically in reaction to the Gagnon decision, and that case involved payments to the spouse earmarked for payment to a mortgage creditor and not payments made directly to a mortgage creditor with the consent of the spouse.

3. If my analysis in paragraph 2 is not correct, in the present case the Appellant’s spouse agreed or acquiesced in the payments being made direct to the mortgage creditor as evidenced by the First Order and Second Order. It is arguable therefore that at a point in time she had discretion as to the use of the amounts and she exercised that discretion by agreeing they be paid directly to the mortgage creditor.

4. The present appeals are distinguishable on the facts from the Armstrong decision above. The First Order ordered the Appellant to pay “interim spousal maintenance for the support ... in the form of monthly mortgage payments on the former matrimonial home”.

Also, the Second Order refers to the mortgage arrears as “spousal maintenance” and “all spousal support ... payments made by the Defendant ... by way of mortgage payments on the former matrimonial property ...”. In other words, both these orders contemplated that the mortgage payments actually comprised the maintenance and support payments. This concept is dealt with in paragraph 16 of Interpretation Bulletin IT-118R3. It reads:

As noted in 15 above, even though subsection 60.1(1) deems the payment to be paid to and received by the recipient, the payment must still be an “allowance” in order to be deductible. Third party payments, made in compliance with a court order or separation agreement, for specific living expenses of the recipient (or the children in the recipient’s custody) such as medical, rent or mortgage expenses will not be deductible to the payer if the payments are in addition to any maintenance allowance specified in the order or agreement. This is because the recipient does not have discretion as to the use of the amount (see note below). Such third party payments would only be deductible if the amount is deducted from the maintenance otherwise payable with the express or implied concurrence of the recipient...

The mortgage payments in question comprised the entire amount of maintenance the Appellant was obliged to pay. They were not “in addition to” any other spousal maintenance.

For the above reasons I have concluded that the deductions denied to the Appellant by the Minister in the 1990 and 1991 taxation years are to be allowed as deductions in those years but that the deduction disallowed in the 1992 taxation year, being capital in nature, was correctly disallowed.

Consequently the appeals are allowed on this basis, without costs, and the assessments for 1990 and 1991 are referred back to the Minister for reconsideration and reassessment accordingly.

Appeal allowed.