Paul-Emile Deschenes v. Minister of National Revenue, [1979] CTC 2690, 79 DTC 461

Guy Tremblay [TRANSLATION]:—This case was heard in Quebec City on March 20, 1978.

1. Point at Issue

The question here is whether, in computing his income, the appellant was entitled to deduct

(a) as interest, the sum of $2,182.91 and $2,134.69 respectively for the 1973 and 1974 taxation years;

(b) as insurance premiums, the sum of $614 for each of the 1973 and 1974 taxation years.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

3.1 In June 1970 the appellant, who is agency manager for an insurance company, purchased a hairdressing and hairweaving business for the sum of $15,000 borrowed from a banking institution. The amount was paid in full to the vendor.

3.2 During the next three months the appellant borrowed additional sums of money totalling $7,000 from the same institution, with a view to continuing the business.

3.3 On September 1970, finding that he could not operate the business at a profit, he sold the business back to the person he had purchased it from three months earlier.

3.4 The selling price was also $15,000, payable in monthly instalments. In fact, the appellant recovered very little of his money because shortly after the business went bankrupt.

3.5 In 1970, the appellant suffered a loss which he claimed as reduction of income from other sources. He was assessed by the respondent accordingly.

3.6 In May 1971, the appellant borrowed from his employer, inter alia, the sum of $14,876.58, which he used to reduce his debt to the banking institution.

3.7 According to documents from the banking institution making the loan (Exhibit 1-1), the balance owed by the appellant stood as follows on December 31 for each of the years mentioned below:

3.8 In 1971 and 1972, the respondent allowed the interest paid in 1971 and 1972 as expenses in the appellant’s income calculation, but disallowed that paid in 1973 and 1974. The interest paid amounted to the following:

3.10 To guarantee the amounts borrowed both with the banking institution and his employer, the insurance company, the appellant assigned as collateral two insurance policies which had been taken out well before 1970 and which listed the legal heirs as beneficiaries.

3.11 At the time of the loan in 1970, he wanted to obtain special life insurance in order to guarantee the contracting debt directly. However, as he had already suffered a heart attack, the cost of the premium was excessive, as he was asked to pay three to four times the cost of an ordinary premium.

3.12 The respondent disallowed the appellant’s deduction of the amount of $614, paid in premiums for the policies taken out before 1970, for both 1973 and 1974.

3.13 The appellant filed his objection with the Minister on October 28,1976 for the assessments issued on August 12, 1976 for the years concerned.

3.14 Following the Minister’s reply on March 17, 1977, allowing the first assessment in part and disallowing, inter alia, the interest and insurance premium expenses described above, an appeal was lodged with the Tax Review Board on June 5, 1977.

4. Act, Case Law and Comments

4.1 Act

The following sections of the new Act concern the problems at issue:

20. Deductions permitted in computing income from business or property.

(1) 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:

(c) Interest.—an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy), or

(iii) an amount paid to the taxpayer under

(A) an Appropriation Act and on terms and conditions approved by the Treasury Board for the purpose of advancing or sustaining the technological capability of Canadian manufacturing or other industry, or

(B) the Northern Mineral Exploration Assistance Regulations made under an Appropriation Act that provides for payments in respect of the Northern Mineral Grants Program,

or a reasonable amount in respect thereof, whichever is the lesser:

(e) Expense of issuing shares or borrowing money.—an expense incurred in the year,

(i) in the course of issuing or selling shares of the capital stock of the taxpayer, or

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt),

but not including any amount in respect of

(iii) a commission or bonus paid or payable to a person to whom the shares were issued or sold or from whom the money was borrowed, or for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course of issuing or selling the shares or borrowing the money, or

(iv) an amount paid or payable as or on account of the principal amount of the indebtedness incurred in the course of borrowing the money, or as or on account of interest.

4.2 According to the appellant, after having allowed the expenses in 1971 and 1972 the respondent disallowed them without a valid reason in 1973 and 1974. All the information required by the respondent’s employees was provided.

4.3 Interest

Counsel for the appellant cited the following cases:

-Trans-Prairie Pipelines Ltd v MNR, [1970] CTC 537; 70 DTC 6351;

— Lakeview Gardens Corporation v MNR, [1973] CTC 586; 73 DTC 5437;

— MNR v Mid-West Abrasive Company of Canada Ltd, [1973] CTC 548; 73 DTC 5429;

—Lyle A Meredith v Her Majesty the Queen, [1975] CTC 570; 75 DTC 5412.

These precedents clearly establish—in the application of paragraph 20(1)(c)—that the interest expenses which can be allowed as a deduction are those deducted from the source of income of the business or property for which the money was borrowed, and not those deducted from other sources of income. The courts rely on the introductory paragraph of subsection 20(1).

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:

(Emphasis added by the Board)

In this case, according to the established facts, the money was borrowed for the purpose of the hairweaving and hairdressing salon and in order to defray the expenses of the said salon. However, in 1973 and 1974 the said salon no longer existed. The interest paid in these years cannot therefore be included in the calculation of the salon’s source of income and cannot be deducted from any other income.

In Trans-Prairie Pipelines Ltd v MNR, Jackett, P of the former Exchequer Court stated the following, at page 541 [6354]:

Surely, what must have been intended by Section 11(1)(c) (20(1)(c) of the new Act) was that the interest should be deductible for the years in which the borrowed capital was employed in the business rather than it should be deductible for the life of a loan as long as its first use was in the business.

It is evident therefore that once the business no longer exists, or at least ceases to function, the interest paid can no longer be deducted.

4.4 Insurance Premiums

According to the appellant, the insurance premiums should be allowed in the calculation of his income under paragraph 20(1)(e).

The same introductory paragraph of subsection 20(1) cited above therefore applies.

Consequently, the expense can only be allowed against the source of income constituted by the hairdressing and hairweaving salon. However, in 1973 and 1974 the said salon no longer existed for the appellant. He therefore cannot apply it against other sources of income.

4.5 The fact that the respondent allowed the interest and premiums paid in 1971 and 1972 as deductions against other sources of income, when the appellant no longer owned the hairdressing and hairweaving salon, does not bind the respondent for the subsequent years. The appellant should simply be thankful that owing to the inadvertence or administrative negligence of the respondent, he was able to pay less tax.

5. Conclusion

The appeal is dismissed in accordance with the above reasons for judgment.

Appeal dismissed.