Estate of W C Cochrane v. Minister of National Revenue, [1976] CTC 2215

A W Prociuk (orally: April 28, 1976):—The executors of the estate of W C Cochrane, the appellants herein, appeal from the respondent’s assessment of the income of the estate for the taxation year 1972, wherein the sum of $14,663.31, claimed as a deduction in respect of interest paid on a short-term loan was disallowed on the ground that the said interest was paid with respect to money borrowed to pay estate tax and provincial succession duties, and it was not paid in the year, or payable in respect of the year, pursuant to a legal obligation to pay interest on either (1) borrowed money used for the purpose of earning income from a business or property or (2) 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 within the meaning of paragraphs 18(1)(a) and 20(1)(c) of the Income Tax Act, which paragraphs read as follows:

18. (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

20. (1) . . .

(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 to acquire a life insurance policy),

(il) 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 a reasonable amount in respect thereof, whichever is the lesser:

At the commencement of the hearing of this appeal, the parties filed an Agreed Statement of Facts, which reads as follows:

AGREED STATEMENT OF FACTS

ESTATE OF W C COCHRANE

1. Francis Cochrane, A E Barron, Gordon Cardy and Dorothy B Cochrane were, by Letters Probate dated the 9th day of February, 1972, appointed the Executors (called the ‘‘Executors’’) of the Estate of the late W C Cochrane, who died on the 24th day of November, 1971.

2. The aggregate value of the property passing on the death of W C Cochrane was approximately $3,740,000.00, and in respect thereof there was approximately:

(a) $750,000 in federal estate taxes payable on or before the 24th day of May, 1972; and

(b) $807,650 in provincial succession duty payable on or before the 24th day of May, 1972 (collectively called the Death Taxes).

3. The assets of the estate after the payment of all obligations including Death Taxes were to be distributed as follows:

(a) An amount equivalent [to] $200,000.00 was to be set aside in trust with the income payable during her lifetime to Dorothy B Cochrane and on her death the capital was to be divided equally between Francis Cochrane and Alice E Cardy, the children of W C Cochrane and Dorothy B Cochrane;

(b) The residue of the estate was to be distributed in equal shares to Francis Cochrane and Alice E Cardy.

4. The major assets of the estate were; a) shares of Cochrane Dunlop Hardware Limited valued at $1,925,000; b) a $1,400,000 Royal Bank of Canada two year term deposit taken out on July 17. 1970, maturing on July 18, 1972 and bearing interest at 7% % per annum (called the Term Deposit); c) a note receivable from Francis Cochrane in the amount of $135,000, payable on demand with interest at the rate of 1% per annum; and d) sundry shares and securities in other corporations which in the aggregate were valued at less than $300,000.

5. At the time the only asset of sufficient value which could be realized upon in time to pay the Death Taxes was the Term Deposit.

6. The Term Deposit provided for redemption in a minimum amount of $100,000.00 or any multiple of $100,000.00 before the maturity date but such early redemption was subject to an interest reduction penalty as follows:

(a) if the deposit was redeemed within the first 30 days, no interest at all would be paid;

(b) if the deposit was redeemed after the expiration of the initial 30 day period but before maturity, interest would be paid at the rate of 63% per annum; and

(c) if held to maturity, the full amount of interest at 734% would be paid.

7. Interest was paid on the Term Deposit as follows:

			Accumulated
	Recipient of	Amount of	Interest to
Interest Period	Interest	Interest	Date
July 17, 1970 to	W C Cochrane	$31,806.85	$31,806.85
Oct. 31, 1970
(107 days)
Nov. 1 1970 to	W C Cochrane	53,804.11	85,610.96
Apr. 30, 1971
(181 days)
May 1, 1971 to	W C Cochrane	54,695.89	140,306.85
Oct. 31, 1971
(184 days)
Nov. 1, 1971 to	W C Cochrane	7,134.25	147,441.11
Nov. 24, 1971
(24 days)
(W C Cochrane died November 24, 1971)
Nov. 25, 1971 to	Executors	46,967.12	194,408.22
Apr. 30, 1972
(158 days)
May 1, 1972 to	Executors	7,134.25	201,542.47
May 24, 1972
(24 days)
	(Death Taxes payable May 24, 1972)
May 25, 1972 to	Executors	16,646.58	218,189.05
July 18, 1972.
(56 days)

8. If the Term Deposit had been redeemed on May 24, 1972 to pay ihe Death Taxes, the interest penalty would have been approximately $25,852 calculated as follows:

By perpetuating the investment in the Term Deposit to the date of maturity, interest income in the amount of $25,852.00 earned or accrued to May 24, 1972 was preserved by the Executors.

9. In order to earn additional interest income for the estate and avoid the interest income penalty. The Term Deposit was not redeemed prior to maturity and the Executors in order to fund the payment of Death Taxes negotiated a demand loan with the Royal Bank of Canada, Main Branch. The principal amount of the loan was $1,513,000 and interest thereon was payable at the rate of 6% per annum. The Executors pledged as the security for the repayment of the loan, effected to avoid the interest income penalty and to maintain the Term Deposit as an interest income Producing asset, the Term Deposit as well as shares in Cochrane Dunlop Hardware Limited held by the Estate.

10. The Executors made the following payments to the Royal Bank in respect of the liability on the demand loan.

Date	Amount of Principal		Source of Funds
May 25, 1972	$	5,007.88	Proceeds of a a term
			deposit held by Estate
June 6, 1972		407.77	Proceeds of Sale of
			New Insco Shares
July 18, 1972	1,423,084.35		Principal and Interest
			on matured Term
			Deposit
July 26, 1972		50,000.00	Part payment by
			Francis Cochrane on
			demand note
August 16, 1972		1,100.00	Dividends received
November 16, 1972		1,100.00
			Dividends received
November 27, 1972		32,300.00	Part payment by
			Francis Cochrane on
			demand note

11. The excess of interest income earned by retaining the Term Deposit for the 56 day period from May 24, 1972 to maturity over the interest expense incurred in respect of the demand loan was $1,983, computed as follows:

Interest income earned on Term Deposit	$16,646
Interest expense on demand loan	14,663
Excess Earned interest Income	$ 1,983

in addition, by arranging the loan which enabled the Executors to retain the Term Deposit until maturity $25,582 was added to the amount of interest income earned, during the period that the Term Deposit was held.

12. The full aggregate amount of additional interest income earned and interest Income penalty avoided in the amount of $42,228.00 was included in the income of either W C Cochrane during his lifetime or by the Estate after his death.

13. In filing the tax return for the estate for the 1972 taxation year, the Executors reported the sum of $71,975.74 as interest income. The interest income received on the Term Deposit represented at least $70,600.00 of the interest income reported. The Executors claimed as a deduction from income the sum of $14,663.31 described on the return as “interest paid to have income earning term deposit to maturity”.

14. By Notice of Reassessment dated April 3, 1975, the Minister of National Revenue disallowed the interest expense deduction of $14,663.31 claimed.

15. The Estate in its Notice of Objection dated May 27, 1975 requested under the provisions of Section 165 an immediate hearing of the appeal by the Tax Review Board and the Minister of National Revenue consented to such request on the 2nd day of September, 1975.

it will be observed that the executors had the option of cashing the term deposit before it matured and paying the said estate tax and succession duties. By proceeding in this manner, the estate would have lost the contingently accrued interest of some $25,852 as well as the net gain of interest in the sum of $1,983, for a total of $27,835.

Counsel for the respondent argued that the ultimate use of borrowed funds was to pay a a debt, and therefore no interest paid in respect of the said loan could properly be deducted.

In my view, if this had been the only use and purpose of the loan, I don’t think there would be any dispute with the respondent’s position. Jurisprudence on this proposition is well established. However, the executors took into account the fact that there was a sum of $25,852 of accrued interest, an asset which they, as executors and trustees, were under an obligation to protect, and also the fact that the net interest to be earned for the short period of the loan was additional Income of $1,983.

Viewed in this light, it becomes obvious that the prime purpose and use of the loan was to protect and gain income in the sum of the said $27,835, which, of course, was taxable in the hands of the executors.

In the case of Her Majesty the Queen v F H Jones Tobacco Sales Company Limited, [1973] CTC 784; 73 DTC 5577, Associate Justice Noel, at page 790 [5581] states as follows:

For some years, however, our courts have been inclined to accept certain expenses or losses as deductible, considering not so much the legal aspect of the transaction, but rather the practical and commercial aspects.

The learned Justice continues with the following paragraph which I wish to quote and which is taken from the dictum of Lord Pearce in B P Australia Ltd v Commissioner of Taxation of Australia, [1966] AC 224 at 264:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances, some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all guiding features which must provide the ultimate answer.

It was in Halstroms Pty Ltd v FTC (8 ATD 190), however, that the Court held, at p 196, that a realistic attitude must be adopted towards deduction of expenses or losses. Indeed, it stated that in such cases the solution depends on what the expense is calculated to effect from a practical and business point of view, rather than upon a juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

Surely if the executors were only concerned about the estate tax owing, they would have proceeded to deal with it by liquidating the major asset immediately (that is, the said term certificate) and by paying the taxes at that time. They could have ignored the practical and the commercial realities of the situation, including their duty to prudently and diligently administer the estate and render an account of their stewardship to the beneficiaries thereof.

in the circumstances of this case, I can come to no other conclusion but that, by arranging for a loan as set out in the Agreed Statement of Facts, the appellant used this method to preserve and to gain income from the property, that is, from the term deposit cerificate, for the benefit of the estate.

The appeal accordingly is allowed.

Appeal allowed.