Andrew Kiss v. Minister of National Revenue, [1976] CTC 2112, 76 DTC 1093

The Chairman:—This is the appeal of Andrew Kiss from income assessments in respect of the 1970, 1971 and 1972 taxation years.

By notices of reassessment dated November 29, 1974, the Minister disallowed as deductions on account of interest expense the amounts of $811, $357, and $1,525 respectively in each of the years pertinent to this appeal. These amounts were disallowed on the ground that they were not paid as interest on borrowed money used for the purpose of earning income, but on borrowed money used to finance the appellant’s cost of living.

The appellant, on the other hand, contends that, in each of tne pertinent taxation years, all the money borrowed was used for the purpose of providing working capital for his practice and, in particular, ‘+o finance the holding of his professional accounts receivable and the generating of professional work in progress”.

The facts are that the appellant hired a management company to manage his billings, banking and other transactions related to his practice. In addition, a firm of chartered accountants prepared the appellant’s financial statemenis.

However, in each of the years 1970, 1971 and 1972 the appellant’s drawings were greater than his net income, and the Minister concluded that a portion of the bank loans negotiated by the appellant in the pertinent years were for the purpose of financing his drawings and his cost of living expenses, and that, consequently, some portions of the interest payments were not amounts of interest paid on money borrowed for the purpose of earning income from the appellant’s practice.

The portion of interest expense disallowed by the Minister for each of the taxation years in question was calculated in the following manner, if one uses 1970 as an example:

The amounts of $357 and $1,525 disallowed for the 1971 and 1972 taxation years were calculated on the same basis.

The appellant’s witness, Mr Irvin W Harendorf, a chartered accountant, testified that, according to him, the method of calculation used by the assessor was wrong, because it did not take into account the flow of working capital throughout a taxation year, and that there could have been periods in which the bank interest was high because the receivables were not collected quickly enough. This, according to the witness, would not necessarily mean that the appellant withdrew more money for personal expenses than his earnings justified.

Even though Mr Harendorf’s opinion could be partly justified, the onus of proving that the Minister’s calculations are wrong is incumbent on the appellant and, in my opinion, he has not discharged that onus. In the absence of any further evidence, or any suggestion on the part of the appellant as to an alternative method of making the necessary calculations, I can only conclude that the Minister’s assumptions are correct and his method of calculating the allowable portion of the appellant’s interest payments is logical and reasonable, based as it is on the difference between the appellant’s drawings and his net professional income as disclosed on a cash basis in the financial statements submitted by the appellant with his income tax returns.

I do not see how the Exchequer Court decision in Trans-Prairie Pipelines Ltd v MNR, [1970] CTC 537; 70 DTC 6351, cited by counsel for the appellant in support of his contention, can have any bearing on the facts of the appeal presently before the Board. Mr Justice Jackett, the President of the Exchequer Court of Canada, at page 541 [6354], stated:

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

In the case of Sternthal v Her Majesty the Queen, [1974] CTC 851; 74 DTC 6646, Kerr, J, in referring to the decision in Trans-Prairie Pipelines Ltd (supra), said, at page 856 [6649]:

. . . There Is in the rationale of that decision the rule that the borrowed money must be used for the purpose of earning income from the business, and the President’s appreciation of the matter in the Trans-Prairie case was that the appellant was using the borrowed money in its business to earn Income. I do not think it follows from anything said in that judgment that on the facts in the present appeal it should be found that the borrowed money was either borrowed or was being used by the plaintiff to earn money from his business or property.

It seems clear from the above decisions of what is now the Federal Court of Canada that interest expenses for loans are deductible only for the period of time during which the borrowed money is used to earn income, and, in my opinion, a logical corollary of that principle is that only the interest paid on that portion of the amount borrowed that is used to earn income can be deductible pursuant to paragraph 11(1)(c) of the Income Tax Act as it applied to the years 1970 and 1971 under appeal or pursuant to paragraph 20(1)(c) of the amended Act applicable to the 1972 taxation year.

In this instance, the Board, on the basis of the evidence adduced, is justified in assuming that the appellant, having borrowed money for the alleged purpose of earning money from his practice, withdrew from his business some portion of that borrowed money for personal living expenses. The problem is to determine what portions of the appellant’s loans were used to earn income and what portions were used for personal living expenses, so that the non-deductible portions of the interest payments on the loans can be determined.

In my opinion, the Minister’s approach to the problem is reasonable and logical. The appellant did not convince the Board that the Minister’s method of calculating the non-deductible portion of the appellant's interest expenses was wrong and he failed to prove that he was wrongly assessed in the 1970, 1971 and 1972 taxation years.

For these reasons therefore, the appeal is dismissed.

Appeal dismissed.