Dussault T.C.J.:
1 These appeals were heard under the informal procedure. They are appeals from assessments for the appellant's 1991, 1992 and 1993 taxation years.
2 In assessing the appellant for those years the Minister of National Revenue (“the Minister”) disallowed the deduction of interest paid on money borrowed in 1985 and 1988, the repayment of which was secured in each case by a mortgage on his home.
3 The facts assumed by the Minister in making these assessments are set out in subparagraphs (a) to (k) of Paragraph 13 of the Reply to the Notice of Appeal. They read:
[TRANSLATION]a) During those years at issue, the appellant was working as a lawyer in a general partnership whose firm name was “Kronström Desjardins”;
b) on June 12, 1985, the appellant withdrew a sum of $100,000 from his “Partners' equity” account with “Kronström Desjardins”;
c) on June 13, 1985, the appellant purchased a private residence at the price of $113,500 in cash;
d) on June 13, 1985, the appellant mortgaged his new residence with the Caisse populaire de Lévis for the amount of $100,000;
e) on June 14, 1985, the appellant used the proceeds of the loan to pay back the amount of $100 000withdrawn two days earlier into his “Partners' equity” account with “Kronström Desjardins”;
f) on January 25, 1988, the appellant mortgaged the said residence, with the Caisse populaire de Lévis, for an additional amount of $25,000;
g) on January 28, 1998, the appellant deposited $25,000 in trust, with notary Roch Godbout;
h) on January 31, 1988, the appellant withdrew an amount of $25,000 from his “Partners' equity” account with “Kronström Desjardins” in view of making renovations to his private residence;
i) on January 31, 1988, notary Roch Godbout invested an amount of $25,000 in the firm “Kronström Desjardins” for the benefit of the appellant in respect of an alleged contribution;
j) the appellant claimed the deduction of the interest on the mortgage loan in his 1991, 1992 and 1993 tax returns;
k) the Minister considers that the interest accrued on the mortgage loans with the Caisse populaire de Lévis were not deductible interest for the appellant as the funds from said loans had been used to reimburse temporary loans granted by the firm Kronström Desjardins, the funds of which had been used for personal reasons.
4 On May 27, 1997 the parties submitted an agreement on admissions accompanied by relevant documents. That agreement reads:
[TRANSLATION]
1. Kronström Turmel Desjardins Villeneuve, Kronström McMicoll Desjardins Parent et Villeneuve, Lafleur Brown de Grandpré Kronström et Kronström et associés (hereafter called “Kronström”) is a law firm established in 1936 which Mr. Alain Robitaille joined as a salaried lawyer in 1973;
2. Mr. Alain Robitaille was admitted in Kronström in 1978 and has retained his status as a partner since that date;
3. Kronström established the internal rules of the partnership provided for in a contract of partnership to which Mr. Robitaille adhered in June 1978;
4. the decisional structure of Kronström comprises a board of directors who execute the firm's orientation decisions dictated from time to time by the partners. A managing partner in charge of the administration of current operations is designated by the board of directors;
5. the contract of partnership of Kronström has been revised and amended from time to time by the partners. The February 1, 1985 version of the contract of partnership concerns the period covered by the objection;
DOCUMENT 1
6. the contract of partnership of February 1, 1985 has been replaced by the contract of February 1, 1987, which incorporates some of the appendices of the 1985 contract;
DOCUMENT 2
7. section 21 of the contract of partnership of February 1, 1985 included a clause which provided for the partners' capital to bear interest;
8. section 21 of the contract of partnership of February 1, 1987 makes no provision for interest on the partner's capital;
9. the Kronström partners' capital account represents their invested capital accumulated from their annual revenues which have not been withdrawn as years went by. The capital account includes also the allocated portion of the work in progress;
10. the Kronström partners' capital account is completely exempted from income taxes, with the exception of the portion representing the part allocated to each partner in the firm's work in progress;
11. the firm's guideline is to fund its short term operations without bank loan; the maintenance of a minimum funding level deemed necessary for this purpose is determined by the board of directors;
12. in June 1985, the Kronström partners' capital was distributed as shown in the firm's financial statements.
DOCUMENT 3
13. on January 31, 1985, the balance in Mr. Alain Robitaille's capital account was $171,809;
14. on June 12, 1985, Mr. Alain Robitaille made an authorized withdrawal in the amount of $100,000;
15. before the end of the financial year ending on January 31, 1986, Mr. Alain Robitaille deposited, by way of a cheque payable to Kronström, an amount of $100,000 in its capital account; this transaction appears in the financial statement of Kronström for the year concerned and in the statement of its capital account;
DOCUMENT 4
16. two (2) other partners were authorized by Kronström to make special withdrawals during the financial period ending January 31, 1986;
17. Mr. Alain Robitaille's capital account balance was $184,891 on January 31, 1986;
DOCUMENT 3
18. the deposit of $100,000 by Mr. Alain Robitaille on June 14, 1985 was made from a loan contracted at the Caisse populaire de Lévis;
DOCUMENT 6
19. the loan contracted at the Caisse populaire de Lévis is secured by a mortgage on Mr. Alain Robitaille's principal residence;
20. Mr. Alain Robitaille's withdrawal from the capital account was used to pay the purchase of the principal residence at the price of $113,950 to the Caisse populaire de Lévis and $20,500 to the mortgagee of the second mortgage, Mr. Jean-Pierre Cadorette;
DOCUMENTS 7, 8
21. beginning in the financial year ending on December 31, 1985, Mr. Alain Robitaille deducted from his income the interest expense generated by the loan contracted to make the deposit in his capital account;
22. Kronström had the necessary liquidity in its cash account in June 1985 to authorize the withdrawal of $100,000 from Mr. Alain Robitaille's capital account;
23. on January 28, 1988, Mr. Alain Robitaille withdrew $25,000 from his capital account;
DOCUMENT 9
24. the balance of Mr. Alain Robitaille's capital account on January 31, 1987 was $199,148;
DOCUMENT 10
25. the balance of Mr. Alain Robitaille's capital account on January 31, 1988 was $228,635;
DOCUMENT 10
26. Mr. Alain Robitaille deposited $25,000 in his capital account on January 31, 1988;
DOCUMENT 11
27. the January 31, 1988 deposit by Mr. Alain Robitaille was made from a loan contracted with the Caisse populaire de Lévis for this purpose;
DOCUMENT 12
28. in order to get the best interest rate available, the loan obtained by Mr. Alain Robitaille from the Caisse populaire de Lévis was secured by a second mortgage on his principal residence;
29. beginning in the financial year ending on December 31, 1988, Mr. Alain Robitaille deducted from his income the interest expense generated by the loan contracted to make a $25,000 deposit in his capital account.
5 In his testimony the appellant explained that his firm's capital consisted of loans made by each of the partners from income allocated to each of them each year. No initial contribution was required but the partners had to leave part of their income earned each year in the firm, which made it unnecessary to obtain bank loans to finance current operations. The amount of the withdrawals for each partner (whether weekly or biweekly, depending on the year) was determined at the annual meeting. The same was true for the quarterly withdrawals necessary to make tax instalment payments for each person. The balance of each person's after-tax income was retained by the firm as capital and any other withdrawal was at the discretion of the managing partner. The appellant requested such a withdrawal twice, in the amounts of $100,000 in 1985 and $25,000 in 1988. The two withdrawals were authorized provided the amounts were repaid to the firm before the end of the fiscal year in each case. The appellant stated that such withdrawals were also authorized for other partners. The appellant further mentioned that the capital accumulated by each partner in the firm bore interest in 1985 but not after 1987.
6 Counsel for the appellant referred first to the appellant's testimony and two notarial deeds of obligation signed by the appellant in favour of the Caisse Populaire de Lévis,in which he stated that the loan was obtained for the purpose of investment in the law firm in which he was a partner. In his submission, no evidence was adduced to show that the money borrowed had not in fact been invested in the law firm's capital account. Furthermore, he relied on art. 2819 of the Civil Code of Quebec, which states that a notarial act signed by the parties is authentic and makes proof against all persons not only of the juridical act which it sets out but also of those declarations of the parties which relate directly to the act. As no evidence was adduced to contradict the appellant's statements about the purpose of the loans contained in those deeds, counsel for the appellant accordingly claimed that the statements should be treated as absolute proof in this regard, even against third parties.
7 Furthermore, counsel for the appellant argued that the partnership could have paid all the income to the partners and financed its operations by bank loans. In that case, interest would have been deductible and the partners' income would have been reduced accordingly. Since the partnership chose instead to finance itself with part of the partners' income, he considered that the Minister's position in disallowing deduction of the interest was intended to penalize the appellant, who in any case would have had less income tax to pay if the partnership had financed its operations by loans.
8 Counsel for the appellant also referred to the Exchequer Court's judgment in Trans-Prairie Pipelines,in which the deduction of interest was allowed on a loan for investment purposes even when the proceeds had partly been used to fill the gap resulting from the use of part of the money to redeem preferred shares. Nevertheless, it was held in that case that all the money was used in the business of the appellant and for the purpose of earning income from that business.
9 Counsel for the appellant further relied on judgments in Shore, Tennant and Bronfman Trust and argued that the money was borrowed to invest in the partnership. He argued that it was paid directly into the partnership's capital account and was actually used in order to produce or earn income. In his submission, the direct and actual use of the money borrowed is thus an admissible purpose permitting deduction of the interest. He went on to emphasize that the instant case should be clearly distinguished from Bronfman Trust, supra, in that the argument regarding the preservation of assets in order to earn income to explain the purpose of the loan in that case was not based on any logic, since annual interest of $100,000 would only generate $10,500 income.
10 Finally, counsel for the appellant argued that Singleton is clearly to be distinguished from the instant case, especially as the loan in that case was obtained by the appellant and his wife jointly. In that case, by a series of transactions carried out on the same day the sum of $300,000, which formed part of a loan obtained by a lawyer and his wife jointly and secured by a mortgage, was deposited in the general trust account of a law firm in which he was a senior partner and then transferred to the firm's general account. Next, after being credited to the appellant's capital account, the same amount was paid to him by a cheque which he deposited in his personal account. The lawyer in turn made out a cheque payable to the law firm, which deposited it in a special trust account opened for the investment of money intended to purchase a residence. The law firm then issued on this account (which included an additional amount deposited by the appellant's wife) a cheque payable to the solicitors for the sellers of a house purchased by the appellant's wife. The deduction of interest paid on the amount of $300,000 was disallowed on the ground that the economic purpose for which the proceeds of the loan were used was the purchase of a house, not the enhancement of the law firm's income earning potential by a contribution of capital.
11 Counsel for the respondent referred, first, to facts not disputed by the appellant which were set out in the Reply to the Notice of Appeal. He laid special emphasis on the proximity of the transactions, arguing that their true economic purpose was not investment in the law firm but instead the purchase of the appellant's residence in 1985 and its renovation in 1988. Accordingly, on June 12, 1985 the appellant first withdrew $100,000 from his capital account. On June 13 he purchased his residence and borrowed $100,000 secured by a mortgage upon it. Finally, on June 14 he paid the proceeds of the loan into his capital account. The sequence in 1988 was different. Thus, on January 25 the appellant first borrowed $25,000 secured by a second mortgage on his house and this amount was deposited in his notary's trust account. On January 31 the appellant withdrew $25,000 from his capital account and the same day the notary paid $25,000 into the appellant's capital account in the partnership.
12 Counsel for the respondent admitted that instead of financing partnership operations with an accumulation of undistributed income the partnership could have borrowed to do this and thus deducted the interest paid, which would have had the effect of reducing the partners' income. However, that was not how they decided to proceed and the appellant must bear the consequences of that choice.
13 Counsel for the respondent argued that the use by the appellant of his capital account is not a regular or usual manner of using the account and that he could not withdraw funds permanently from it. Thus, referring to the partnership contracts,counsel for the respondent argued that although the appellant owned the money in his capital account he could not permanently withdraw it unless he withdrew from the partnership, in which case his capital would be paid to him gradually over a three- to five-year period.In fact, according to the appellant's own testimony, under the policy on discretionary withdrawals adopted by the partnership the money withdrawn by the appellant had to be reimbursed before the end of its financial year.
14 Counsel for the respondent argued that the appellant had to present evidence of a bona fide intent to use the money borrowed to earn income, and that in this connection the Court must look at the ultimate purpose of the transactions. In his submission, no such evidence was presented in the circumstances since the appellant only engaged in the transactions on his capital account in order to be able to deduct interest on a loan for the purchase of his residence, which is not permitted since in that case it is a personal expense. In support of his arguments, counsel for the respondent referred to the decisions in Bronfman Trust, supra, Mark Resources, Zwaig and Singleton, supra, which in his submission applied the same principle to different situations.
15 Counsel for the respondent noted in particular the obiter dictum of Dickson C.J. in Bronfman Trust, supra, regarding hypothetical transactions which may have been carried out in order to permit the deduction of interest and his reference to the simple reorganization of the taxpayer's affairs in Zwaig, supra, transactions and a reorganization which in his opinion represented “the epitome of formalism”.
16 It should first be reminded that in Bronfman Trust, supra, the Supreme Court of Canada reiterated the principle that the tax liability of a taxpayer must be determined based on what he did, and not on what he might have done. Secondly, for the purpose of the deduction provided for in paragraph 20(1) c) of the Act, it has also been established in that decision that what should be considered is not the purpose of the borrowing itself but rather the purpose for which the borrowed money was used. In fact, as Judge Bowman of this Court suggested in Mark Resources, supra, to the extent that, prima facie, the purpose of the borrowing and that for which the funds were used are identical, the distinction is not meaningful.However, as he pointed out, focus must be had not on the direct and immediate result of the use to which the funds were put but rather, in a real and practical manner, on the ultimate economic objectives sought by the transactions.Thus it seems clear that the analysis should not be restricted to the consideration of each of the transactions taken individually while ignoring the cause-effect relationship that may exist between them.
17 I think it is worth citing here at length the passage from the unanimous judgment of the Supreme Court of Canada per Dickson C.J. in Bronfman Trust, supra, relied on by counsel for the respondent. At the close of the judgment in that case, immediately preceding the disposition of the case, Dickson C.J. said the following:
Before concluding, I wish to address one final argument raised by counsel for the Trust. It was submitted - and the Crown generously conceded - that the Trust would have obtained an interest deduction if it had sold assets to make the capital allocation and borrowed to replace them. Accordingly it is argued, the Trust ought not to be precluded from an interest deduction merely because it achieved the same effect without the formalities of a sale and repurchase of assets. It would be a sufficient answer to this submission to point to the principle that the courts must deal with what the taxpayer actually did, and not what he might have done: Matheson v. The Queen, 74 D.T.C. 6179 (F.C.T.D.), per Mahoney J., at p. 6179. In any event, I admit to some doubt about the premise conceded by the Crown. If, for example, the Trust had sold a particular income-producing asset, made the capital allocation to the beneficiary and repurchased the same asset, all within a brief interval of time, the courts might well consider the sale and repurchase to constitute a formality or a sham designed to conceal the essence of the transaction, namely that money was borrowed and used to fund a capital allocation to the beneficiary. In this regard, see Zwaig v. Minister of National Revenue, [1974] C.T.C. 2172 (T.R.B.), in which the taxpayer sold securities and used the proceeds to buy a life insurance policy. He then borrowed on the policy to repurchase the securities. Under s. 20(1)(c)(i) the use of borrowed money to purchase a life insurance policy is not a use entitling the taxpayer to an interest deduction. The Tax Review Board rightly disallowed the deduction sought for interest payments, notwithstanding that the form of the taxpayer's transactions created an aura of compliance with the requirements of the interest deduction provision. The characterization of taxpayers' transactions according to their true commercial and practical nature does not always favour the taxpayer. The taxpayer Trust in this appeal asks the Court for the benefit of a characterization based on the alleged commercial and practical nature of its transactions. At the same time, however, it seeks to have the commercial and practical nature of its transactions determined by reference to a hypothetical characterization which reflects the epitome of formalism. I cannot accept that it should be allowed to succeed.
18 The hypothetical characterization put forward by counsel for the trust in Bronfman Trust, supra, and the circumstances in Zwaig, supra, are clearly comparable. In both cases, assets held to produce income were first sold and the proceeds used for another purpose within a short time. A loan was then obtained in order to repurchase the same assets so that interest could be deducted. The facts here not only follow the same pattern but reflect the same economic situation, except that there was no sale or repurchase of property here. The transactions engaged in by the appellant in 1985 amount to a temporary withdrawal of money allocated to a productive use for the purpose of acquiring property for personal use, and then to a borrowing secured on that property to return the borrowed money to its original productive use, all within the space of three days. As to the transactions carried out in 1988, the sequence was simply altered in that the appellant first obtained a loan and then, a few days later, withdrew an equivalent amount from his partnership capital account which was repaid the same day with the borrowed money.
19 I consider that essentially the facts in the instant case are sufficiently close to those described by Dickson C.J. to be bound by his remarks. In each case there was within a short period a reallocation of money originally used to produce income to a personal purpose and then a loan the proceeds of which were immediately returned to the original productive use.
20 While the binding effect of an obiter stated in the form of a simple observation made in passing may be open to question, it is not so when an opinion supported by reasons is given with respect to specifically described transactions. The binding effect of an obiter becomes clearly more so when such an unambiguous opinion is stated in a unanimous judgment of the Supreme Court of Canada.In this connection I take the liberty of adopting here the remark made by Associate Chief Judge Christie of this Court in Cutmore.Though he considered in that case that the observations referred to were not an obiter dictum of the Supreme Court, Associate Chief Judge Christie added:
Even if it were, this passage from the reasons for judgment delivered by Robertson C.J.O. on behalf of the Ontario Court of Appeal in City of Ottawa v. Township of Nepean et al., [1943] O.W.N. 352 at 353, applies equally to this court:
What was there said (in City of Ottawa v. Town of Eastview et al., [1941] S.C.R. 448 at 459) may be obiter, but it was the considered opinion of the Supreme Court of Canada and we should respect it and follow it, even if we are not strictly bound by it.
This was cited with approval by Mr. Justice Chouinard in delivering the judgment of the Supreme Court in Sellars v. The Queen, [1980] 1 S.C.R. 527 at 530.
21 Applying the reasoning of Dickson C.J. to the facts of the instant case, I consider that the analysis of the “true commercial and practical nature” of the transactions carried out by the appellant leads to the conclusion that their ultimate purpose was the purchase and renovation of his residence, not investment in the law firm in which he is one of the partners. Investment in the law firm already existed and the purpose of the loans was only to reimburse money withdrawn and used for personal purposes a few days earlier in 1985 and on the same day in 1988.
22 It is true that Singleton, supra, is to be distinguished from the instant case. However, the distinction does not reside so much in the fact that the appellant in that case had obtained the loan jointly with his wife whereas here the appellant engaged in the various transactions alone. Rather, the distinction lies in the fact that in Singleton, supra, there was no evidence that without the infusion of money borrowed from the bank by the appellant on the same day into his capital account the law firm would have had the liquidity necessary for his withdrawal. In the instant case, the withdrawal and the repayment both took place on the same day, in 1988. However, as to the transactions carried out in 1985 I must refer here to paragraph 22 of the agreement on the parties' admissions, in which it is stated:
[TRANSLATION]
Kronström had in its cash account in June 1985 the liquidity necessary to authorize the withdrawal of $100,000 from the capital account of Alain Robitaille.
23 Although it is not possible, as Judge Bowman did in Singleton, supra, to speak of the “brief detour” of the money into the accounts of the law firm for the transactions carried out in 1985, the fact remains that the simple reorganization of his affairs by the appellant is in my opinion of the same type as the hypothetical transaction referred to by Dickson C.J. in Bronfman Trust, supra, and carried out in Zwaig, supra, reorganizations of the kind which he disapproved as representing “the epitome of formalism”.
24 So far as the judgment in Trans-Prairie Pipelines, supra, is concerned, its application has been all but systematically limited and, as Judge Bowman notes in Singleton, supra, it has been limited to the facts of the case in many judgments, including that in Bronfman Trust, supra. In any event, I do not think that, considering the circumstances of the instant case, it can take precedence over the obiter of Dickson C.J. in Bronfman Trust, supra. There is no economic or practical necessity here to justify the borrowing of money for investment in the law firm in which the appellant was one of the partners. The money was borrowed simply to repay as soon as possible money used by the appellant to purchase and then renovate his residence, which he could not actually have withdrawn permanently from the partnership for such purposes.
25 As a consequence of the foregoing I consider that the assessments disallowing deduction of the interest in computing the appellant's income for the years at issue were correct.
26 The appeals are therefore dismissed.
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