Eric J Dorman v. Minister of National Revenue, [1977] CTC 2355, 77 DTC 251

Delmer E Taylor:—This is an appeal against a reassessment of income tax in which the Minister of National Revenue disallowed as interest expenses the amounts of $843.17, $824.36 and $804.39 for the years 1972, 1973 and 1974 respectively. The respondent relied, inter alia, upon paragraphs 18(1 )(h) and 20(1)(c) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Facts

The appellant during the times material was a senior manager with the Royal Trust Company (hereinafter referred to as the “Company”). In 1965, while living in Calgary, Alberta, he borrowed a sum of money as a “staff loan” from his employer and purchased investments in stocks and bonds with it. He gave back as security for the staff loan a mortgage on his private residence. In filing his income tax returns for the ensuing years, he deducted from his investment income (earned from the stocks and bonds) the interest paid to the Company on this Staff loan. This met with no objection from the Department of National Revenue since, in the view of that Department, the purpose for which the staff loan had been made was for investment, and not to aid in the purchase of a private residence, even though the security which rested with the Company was a mortgage on the private home of the appellant. In 1969 the appellant was transferred to Regina, Saskatchewan and, during the late summer of that year, sold his home in Calgary and purchased another one in Regina. The terms of the staff loan borrowed in Calgary from the Company required that it be repaid before he could sell his home. To accommodate his move to Regina, the appellant obtained a new and separate short-term loan of $10,500, took out a further $15,000 staff mortgage on his new home, both from the Company, thereby allowing him to pay $25,500 for the residence in Regina. During the same general period of time he sold his Calgary home for $28,000 cash, paid off the existing Company staff loan on that home, repaid the short-term accommodation loan from the Company to purchase his Regina home, and received the balance of the proceeds. There was some uncertainty with respect to exact dates in 1969 for the above purchase and sale, and the amount of the original Company staff loan in Calgary was not shown. From 1969 on the appellant deducted the aforementioned interest payments on the mortgage on his Regina residence from the investment income from the same stocks and bonds he continued to hold.

Contentions

The appellant asserted that the money borrowed in 1969 ($15,000 for the mortgage on the Regina residence) was money borrowed for the purpose of repaying an existing loan, the interest on which was deductible, and accordingly the interest on the 1969 loan was also deductible.

The respondent submitted that the interest claimed as a deduction in computing the income in the years under appeal was not interest on borrowed money used for the purpose of earning income from business or property within the meaning of paragraph 20(1)(c) of the Income Tax Act and that the said interest expense was a personal or living expense and accordingly not deductible in computing income in accordance with the provisions of paragraph 18(1)(h) of the Act.

Evidence

Neither the appellant nor counsel for the respondent submitted evidence of any material nature.

Argument

The appellant reiterated his position that there was really only one transaction involved in the buying and selling of the houses and that he had merely substituted one form of security (the mortgage on the Regina residence) for another (the mortgage on the Calgary residence), and therefore all matters rested the same, including the deductibility of the interest payments.

Counsel for the respondent argued that the essence of the matter was the purpose for which the borrowed funds had been used on the two occasions—first to purchase investments in Calgary, and second to purchase a private residence in Regina—and that indeed there were also two separate and unrelated transactions which occurred in 1969, ie the selling of the Calgary residence and the purchasing of the Regina residence and that, therefore, no mere “substitution” of funds and security had happened. Cases to which the Board was referred by counsel included: Flora Edina Carswell v MNR, 5 Tax ABC 194; 51 DTC 414; Omer Couture v MNR, [1971] Tax ABC 1156; 72 DTC 1013; C A Auld v MNR, 28 Tax ABC 236; 62 DTC 27.

Findings

During the course of the hearing the appellant noted that apparently the Minister had accepted the deduction of similar amounts from his income tax returns for the years 1969, 1970 and 1971, only commencing the reassessment in 1972. This Board does not require explanations from the Minister for assessments which might appear to a taxpayer to be inconsistencies, but neither does any such apparent variation alter or diminish the responsibility of the Board to review matters on their own merits for whatever taxation years are brought before it.

Reviewing first the cases cited by counsel for the respondent, the Board notes that the Au/d matter (supra) does not appear to be relevant. In that situation the security for the loans was the incomeproducing investment, whereas in the instant appeal the incomeproducing investments were never the security for the loans. The Couture matter (supra) (at page 1156 [1014]), however, contains a significant comment:

Whatever reason appellant may have had for borrowing money and giving a mortgage on his home to secure the loan, it is irrelevant, because this loan was obtained to pay for personal expenses, and such expenses may not be deducted under Section 12(1 )(h) mentioned above.

Such is also the situation in the Carswell matter (supra) (at page 195 [415]), and I quote:

It appears to me that the voluntary and personal nature of the appellant’s purchase rendered it entirely different from the transaction dealt with in the Begg case which, in any event, of course, would not be binding in Canada.

The critical words in that case appear to me to be “voluntary and personal nature of the appellant’s purchase”.

It is of some interest to me in deciding this appeal that the Minister of National Revenue apparently accepted that the use of the proceeds of the original staff loan to the appellant in 1965 provided a basis for the income tax deductibility of the interest charges associated with that loan. This should mean that the said original borrowing came squarely within paragraph 11 (1)(c) of the Act as it then read:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(c) 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

(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 a reasonable amount in respect thereof, whichever is the lesser;

Such a borrowing did not meet the condition explicit in subparagraph 11(1)(c)(i) since, in my opinion, the borrowed money was not used for the purpose of earning income from a business or property. The appellant was clearly not in a business, and there is no evidence that before the borrowing he owned a property from which it was his intention, by the use of the borrowed funds, to earn income. The appellant used the proceeds to purchase investments from which he then earned income. This is quite different than the direct application of the funds received, to the mechanics of gaining or producing (perhaps increasing) income from a property. It may be assumed, therefore, that the deduction was permitted under subparagraph 11 (1)(c)(ii):

(c) . . . pursuant to a legal obligation to pay interest on

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom .. . .

The Board is not seized with matters arising out of the appellant’s income tax returns for these earlier years from 1965 through 1969, and indeed up to and including 1971, and accepts that such a “legal obligation’’ for ‘‘an amount payable for property acquired . . .’’ was evidenced to the satisfaction of the Minister for those periods. However, for the period under review in this appeal, there has been no evidence that there was any amount “payable for property acquired”. There was apparently no legal obligation of any kind which would directly connect the “property acquired” (the investments purchased in 1965) and the real estate mortgage on the residence purchased in Regina in 1969. The “property acquired” in 1965 was fully paid, there was no amount yet “payable”; it was owned outright by the appellant, and had been so held for several years. The claim by the appellant that the mortgage taken out as collateral in 1969 was only in substitution for the earlier mortgage used as collateral in 1965, even when the allowance of the interest deduction for several years by the Minister is taken into account, does not change the essence of the matter before the Board. The critical point is whether the interest paid on a mortgage taken out on a personal residence is deductible from the income earned from investments, even accepting that the proceeds of such a mortgage were used to purchase the income-producing investments. A “legal obligation to pay interest on . . . an amount payable for property acquired’’, in my opinion, could only exist when all or part of the purchase price for the investments had not been paid at acquisition and some formal arrangement to complete the payment (a legal obligation), including interest, had been made between the parties involved related to that specific indebtedness. I am unable to conclude that once having fully paid for the investments acquired, the interest payable under some separate financial arrangement by which the funds to do so had been raised, would meet the criteria for deductibility outlined in this section of the Act. In my opinion the “legal obligation” must relate directly to “an amount payable for property acquired”. Only after that need consideration be given to whether the acquisition had been “for the purpose of gaining or producing income therefrom . . 9)

This leads me to believe that where such direct and conclusive connection between the legal obligation and a relevant amount payable is not evident, the responsibility for the taxpayer to establish such a connection may well extend considerably beyond the mere indication of the apparent use made of the borrowed funds. This is certainly the case in this matter where the only known “legal obligation” is a real property mortgage on a personal residence, the proceeds from which, by the appellant’s own evidence, went directly to the vendor from whom he purchased the Regina property. Further, at the time the appellant’s Calgary residence was sold and the real estate mortgage on it discharged, the “legal obligation” was extinguished, no matter how tenuously it had been related to the “property acquired”.

Decision

The interest charges alleged by the appellant to have been incurred for the purpose of gaining or producing income are personal or living expenses and do not qualify as deductible expenses under the Income Tax Act. The appeal is dismissed.

Appeal dismissed.