Hyman Max Swartz v. Minister of National Revenue, [1974] CTC 2337

Judge K A Flanigan (orally: May 2, 1974):—This is an appeal by Hyman Max Swartz against reassessments of the Minister of National Revenue for the years 1967, 1968, 1969 and 1970. The reassessments resulted in the disallowance by the Minister of certain sums of money claimed by the taxpayer as expenses under paragraph 11 (1)(c) of the old Act, in respect of interest on borrowed money used for the purpose of earning income from a business or property.

Briefly, the facts are that Mr Swartz is a barrister and solicitor who has been practising law since 1931 and has concentrated his efforts mainly in the real estate field. In the years in question he had pretty well limited his legal practice to serving old clients—! use the term “old” in terms of their years as a client, and not in terms of their age as individuals—and to handling his own investments of which he had many. He had over the course of the years purchased several properties in the vicinity of Wellington and Church Streets in the City of Toronto in what is commonly known as “the Old St Lawrence Market area”, and most, if not all, of these properties had been warehouse properties which were purchased with substantial first mortgages back, reasonably low down-payments and upon which renovations had been undertaken to make them revenue-producing. He had in two of these properties (one at 81-83 Front Street, which he acquired in 1952, and the other at 8-10 Market Street, which he acquired I believe in 1961) some 26 or 27 thousand square feet. He also had over the course of the years incorporated certain companies which have been referred to in the evidence and in the exhibits, including Rialto Investments Limited, Tom Taylor Company Limited, Dunbay Securities Limited and Mypaul Investments Limited, I think it was. These properties in the area that I have mentioned were held by these various companies, the Dunbay company being primarily a mortgage company with, as near as I can ascertain or infer from the evidence, only one main mortgage with which it was concerned. The appellant was the principal shareholder of all these companies, the other shareholders being his two sons and his wife, and there is no question in this appeal as to whether or not these companies were related or associated, because unquestionably they were.

What happened over the course of the years in appeal before me was that Mr Swartz would borrow money in arm’s length transactions from institutions or personal friends, sometimes on the strength of mortgage securities and at other times on notes, and would place this money in a special account which he kept in his law office and which he did not mingle with the moneys of his law practice clients, although he did deposit his own earnings from his legal practice in that same account.

Over the years there has been refinancing and improvement in each and every one of the properties, and the evidence is that, although in the years in question all the companies were at best breaking even and some were perhaps in a losing position financially, today they are all doing well, This is as a result of the sale of. some properties, the taking over of a building on which default occurred on the first mortgage, and like transactions, as well as a result of the general inflationary values of real estate in this and most areas of the country.

What the appellant did, as and when a company of which he was the major shareholder required money for refinancing or renovations or was short of capital, was borrow from his various contacts (all of these transactions being at arm’s length), deposit the money in his special account, and then transfer it to whichever company required it, at no interest. There was a great series of these transactions, and in the years in question the principal amount owing to the appellant between 1967 and 1970 ran between $123,000 and $182,000.

The appellant also had other properties in which he had interests: one in Whitby in a syndicate in which I think he had a 25% interest, and one or two on Yonge Street in which I believe he had about a one-third interest; and it is clear on the evidence that the interest that was disallowed in these four years amounted to, roughly, about 50 to 60% of what was claimed in each of the first three years and, in the year 1970, about 75% of the interest claimed was disallowed. I surmise that the part that was allowed was interest on his borrowings in connection with properties in which he himself owned a part interest or the properties that he had in his own name, or some other business or property that the Minister felt was one to which subparagraph 11 (1 )(c)(i) of the former Act could properly apply.

The appellant’s argument is three-pronged, two aspects of which were not pressed with any great fervour, but with logic. One is that the amounts disallowed should be in the ratio borne by the amounts owing by the companies to the appellant at the end of a given year in comparison with the principal amount outstanding; and/or, secondly, that one should take a look and see what percentage these sums are of the appellant’s overall assets. By acting upon this latter suggestion, one would find that, in 1967, this would amount to 4.9 per cent of his assets, and this percentage varies over the years, being in some years greater, but I don’t think in any years less. I really cannot find in the evidence any support for this approach that would assist the taxpayer.

The third and, of course, the real basis of the appeal, in my view at least, is that the money borrowed by the appellant taxpayer in these arm’s length transactions, and transferred to the aforesaid companies interest-free, was money borrowed and used for the purpose of earning income from a business or property.

It is freely admitted, since the money was used by the limited companies and the limited companies are the operators of the business, that the appellant cannot fall into the saving provision of earning income from a business. The earnings were clearly those of the limited company. The main thrust of the argument is that the borrowed money was used for the purpose of earning income from a property of the taxpayer, the property being his controlling interest in each of the companies, such controlling interest being by way of shareholding.

Many cases have been cited, almost all of which are contrary to the assertions put forward on behalf of the taxpayer.

I say again, as I have said before, that all cases of this type must be looked at on their own facts, and after considering all the surrounding transactions and circumstances, I do not find the majority of the cases cited very helpful in arriving at a decision in this case.

Learned counsel for the Minister relies mainly on the case of DWS Corporation v MNR, [1968] CTC 65; 68 DTC 5045; [1968] 2 Ex CR 44, in which Mr Justice Thurlow held that the property was not the shares held in the corporation by the taxpayer but was rather the note that was received in return for the interest-free loan. It would appear, at page 73 [5050], that the comments dealing with property were obiter dicta, being merely an expression of opinion after he had already reached his decision, except that he does say, and I quote:

The submission was, however, made that the borrowed money was used for the purpose of earning income from the appellant’s property, that is to say, the demand note given by World T and I Corporation or the property right which it evidenced.

He then goes on to quote the late Mr Justice Rand in Canada Safeway Limited v MNR, [1957] SCR 717; [1957] CTC 335, where, at page 728 [345], Mr Justice Rand said as follows:

The word “property” is introduced in paras (i) and (ii) [of section 11, and those are my words] but I cannot see that it can help the appellant; the language “borrowed money used for the purpose of earning income from . . . property (other than property the income from which is exempt)” in (i) means the income produced by the exploitation of the property itself. There is nothing in this language to extend the application to an acquisition of “power” annexed to stock, and to the indirect and remote effects upon the company of action taken in the course of business of the subsidiary.

Mr Justice Thurlow then goes on to say:

Though in the present case there was no use of the borrowed money to purchase stock to obtain “power” or control over World T and I Corporation I think that the possibility of increased dividends by lending to World T and I Corporation must be taken to be too remote to characterize the lending of the borrowed money to it without interest as use for the purpose of earning income from the property represented by the loan. It is the loan itself rather than the shares that I think Rand, J, refers to when he says the statute means “the income produced by the exploitation of the property itself”.

On appeal, this decision was unanimously upheld by the Supreme Court of Canada without written reasons. Learned counsel for the appellant in the course of his argument has used the term “running together” or “blurring of” the two separate items of business and property dealt with in the Act. In this particular case, there was no need for the appellant to acquire any shares with the borrowed money because he already controlled all the companies to which he was lending money.

I realize that I am bound by the decisions of higher courts, and particularly of the highest court in the land, in matters such as this, and it is for that reason and for that reason only that ! must dismiss the appellant’s appeal in this matter.

I cannot agree entirely with the DWS Corporation v MNR case, but I cannot find enough evidence in this instance to allow me to distinguish it from those very plain words of Mr Justice Thurlow and the quotation of Mr Justice Rand. Therefore on all the evidence I cannot find that the appellant has discharged the onus and the appeal will therefore be dismissed.

Appeal dismissed.