Gregory E. Levi v. Her Majesty the Queen, [1996] 3 CTC 2445 (Informal Procedure)

Taylor J.T.C.C.: — These are appeals heard in Toronto, Ontario on June 17, 1996 using the Informal Procedure, against assessments under the Income Tax Act (“Act”) for the years 1990, 1991, 1992 and 1993, in which the Respondent had disallowed claims for interest deductions. The Notice of Appeal read:

Facts:

Notices of Objection were filed with respect to income tax assessments for the 1990, 1991, 1992 and 1993 taxation years. The Minister of National Revenue rejected the Notices of Objection and confirmed the assessments on September 18, 1995 as follows:

Interest expenses to the extent of $8,941.00 in 1990, $10,948.00 in 1991, $9,113.00 in 1992 and $6,519.00 in 1993 claimed as deductions from income were denied as they were not considered to be outlays or expenses incurred by me for the purpose of gaining or producing income within the meaning of Paragraph 18(l)(a) of the Act but were personal or living expenses within the meaning of paragraph 18(l)(h) and subsection 248(1) of the Act.

Reasons for appeal:

The interest expense in question was incurred on monies borrowed to invest in a company through the purchase of common shares. The interest expense is, therefore, deductible pursuant to both section 18(l)(a) (the general limitations) and more specifically pursuant to section 20(1 )(c) of the Act regarding the deductibility of interest expense.

For the Respondent in the Reply to the Notice of Appeal the situation was:

3. In computing income for the 1990, 1991, 1992 and 1993 taxation years, the Appellant deducted the amounts of $13,945.22, $17,107.60, $9,301.98 and $6,,519.67 respectively as carrying charges and interest expenses.

4. The Minister of National Revenue (the “Minister”) assessed the Appellant for the 1990, 1991, 1992 and 1993 taxation years by Notices of Assessment mailed on December 6, 1991, September 14, 1992, December 15, 1993 and June 16, 1994 respectively.

5. On October 20, 1994, the Appellant filed with the Minister a waiver in prescribed form in respect of the 1990 taxation year.

6. In reassessing the Appellant for the 1990, 1991, 1992 and 1993 taxation years, by concurrent Notices of Reassessment mailed on March 27, 1995, the Minister disallowed the deduction of the carrying charges and interest expenses to the extent of $8,941.00, $10,948.00, $9,113.00 and $6,519.00 respectively ( the “Amounts”).

7. In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) in 1986, the Appellant borrowed $70,000.00 from a bank to partly finance his purchase of 2,800 common shares of Neighbourhood Dental Services Ltd. (the “Company”);

(b) the Company was incorporated in May, 1984;

(c) in 1989 the Company’s assets were liquidated and the Company ceased operations;

(d) the Amounts disallowed as carrying charges and interest expenses were in respect of the funds borrowed by the Appellant to purchase common shares of the Company;

(e) no source of dividend or other income was derived by the Appellant from the Company common shares which he purchased;

(f) during the 1990, 1991, 1992 and 1993 taxation years there were no reasonable prospects of the Appellant deriving income from his purchase of the Company’s common shares;

(g) the Appellant did not pay the Amounts of interest in the 1990, 1991, 1992 and 1993 taxation years pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property;

(h) interest expenses to the extent of the Amounts were not made or incurred for the purpose of gaining or producing income from a business or property but were personal or living expenses of the Appellant.

B. Issues to be decided

8. The issue to be decided is:

- whether the Appellant paid the Amounts of interest in the 1990, 1991, 1992 and 1993 taxation years pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.

C. Statutory provisions, grounds relied on and relief sought

9. He relies on sections 3 and 9, subsection 248(1) and on paragraphs 18(1 )(a), 18(1 )(h) and 20(1 )(c) of the Income Tax Act (the “Act”) as amended for the 1990, 1991, 1992 and 1993 taxation years.

10. He submits that the Appellant did not pay the Amounts of interest in the 1990, 1991, 1992 and 1993 taxation years pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property and that the Appellant was properly assessed in accordance with paragraphs 18(1 )(a) and 20(1 )(c) of the Act.

11. He requests that the appeal be dismissed.

From the above I have calculated the following:

No reference to the amounts “allowed” above was made at the trial, and perhaps none was needed. However, the amount of $188. (1992) does appear on the income tax return as relating to some deductible interest items, apparently other than any arising from the $70,000.00 loan above. Nothing like that appears obvious in the returns for the years 1990 and 1991. I assume that the amounts remaining at issue for this trial (above) represent the interest claimed for such amounts paid by the Appellant with respect only to the $70,000.00 loan noted above and perhaps the allowed amounts above also do.

The testimony and documentary evidence presented by the Appellant was interesting and informative - indeed in some ways tragic and distressful particularly to him, but in my view irrelevant as far as the essential point to be addressed at this trial. In essence, Mr. Levi as a minority shareholder, in fact the only remaining minority shareholder, has been totally unable to advance his cause - whether financially or otherwise with the majority shareholder - a major life insurance company. The crux of the matter however, is Mr. Levi still owed the $70,000 borrowed; he still retained the shares purchased with those funds; the shares had been acquired for the purpose of gaining or producing income; and he has not disposed of the shares even up until today. There was no dispute, as I understood it, from either party regarding those fundamental facts.

The Respondent’s main point is contained in the Reply to the Notice of appeal - “in 1989 the company assets were liquidated and the company ceased operations”.

Mr. Levi agreed that the company assets (as he put it the “hard assets”) had been disposed of, and that there was no evidence of current business activity in the company. But I heard no evidence that the company had “ceased operations” to the extent implied by the Respondent in striking the assessments at issue - such that in this appeal, it should be treated as if the company had been wound up, and the charter surrendered. That did not happen. I agree with Mr. Levi — that the company could restart operations tomorrow, in which case potentially he would have an income earning asset - his shares again. But whether he has an income earning asset now or ever is not the point at this hearing, he still has the shares.

In the words of counsel for the Respondent:

Perhaps, originally, when Mr. Levi...purchased the shares in NDS shares for $70,000.00, perhaps, at that time, the business was functioning and the interest paid for that borrowed money could have been deductible, but there is no tracing of that original investment of $70,000.00 from an eligible use in NDS to perhaps another eligible — another use that could be used to earn income from the business or property. The $70,000.00 borrowed funds were used to purchase NDS shares and...the money is still tied up in the ownership of NDS shares, but the income earning potential of those shares has disappeared....

I simply do not agree that comment to be a proper basis for the assessments at issue. Mr. Levi’s position was put forward in the following terms by a friend, a Chartered Accountant who addressed the Court:

You can look at it from the standpoint that the use is changed inasmuch as the company is not active, but if Mr. Levi is successful as a businessman in negotiating something with London Life, then he is able to create a source of income for him and in which case the interest expenses would be deductible....

…I don’t know what the answer to this is, but what happens if London Life does turn around and say, okay, we are going to do an IPO and we are going to bring in however many millions of dollars — Mr. Levi, all of a sudden, is sitting there with shares of a public company that trades and presumably becomes active again and earns income.

These expressions on behalf of the Appellant are closer to the reality, but they still miss the point. For the deductibility of these claims for interest, there is no reason to wait for any activity by the majority shareholder in this company - that should not be even under discussion here. There never has been a question that the funds from the loan of $70,000.00 involved went to the purchase of an income earning investment, the shares of the company - at least the investment clearly had that potential at the outset. I might add at this point, that Mr. Levi, as far as I can see, has not filed a claim for an allowable business loss, or an investment or capital loss of any kind. Even if he had done so and been so awarded, it should not affect the merit of these appeals. The issue in these appeals is not the current value of the investment in shares. The real question relates to the ownership of the shares and the use of the funds provided by the loan. That has remained undisturbed throughout, perhaps more by fickle fortune than by Mr. Levi’s desire, but that does not matter here. The issue comes down to the continued obligation for the $70,000.00 loan and the interest thereon. I am unaware of any contemporary jurisprudence which would deny him that benefit from an income tax viewpoint. A proper reading of the signal case of Tennant v. R., [1996] 1 C.T.C. 290, 96 D.T.C. 6121 (S.C.C.), which was referenced as support by Counsel for the Respondent would assist materially in reaching that conclusion, as I see it.

The appeals are allowed, with costs if applicable, and the entire matter referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons.

Appeal allowed.