Robert B Forward v. Minister of National Revenue, [1978] CTC 2604, [1978] DTC 1455

Delmer E. Taylor:—This is an appeal against an income tax assessment in which the Minister of National Revenue disallowed an amount of $1,854.07 claimed as interest expense in the year 1975. Both the appellant and the respondent relied, inter alia, upon paragraph 20(1 )(c) of the Income Tax Act, RSC 1952, c 148 as amended by section 1, SC 1970-71-72, c 63.

Facts

The appellant is a medical doctor, specializing in radiology, and resides in the City of Orillia, in the Province of Ontario. He practises his profession at 40 O’Brien Street in association with a Dr Small. The office is leased and maintained by The Small Company of Orillia Limited (hereinafter referred to as ‘‘Small Company” or the “Company”), which owns the equipment and furnishings used by both the appellant and Dr Small. Mrs Small, the wife of Dr Small, is the sole shareholder of the Company. In 1975, Dr Small proposed an arrangement with the appellant whereby Dr Small would subcontract a portion of his work to the appellant who would receive approximately one-half of the billings from their combined practice. Dr Small required that, in consideration for being permitted to enter into this arrangement, the appellant make an interest-free loan to Small Company. During the year in question the appellant paid $1,854.07 as interest on a personal bank loan, and that amount is the subject of this appeal.

Contentions

The appellant contended in the Notice of Appeal that:

—he borrowed some $40,000 to fulfill the conditions required for his business association with Dr Small:

—he paid $1,854.07 interest on the above amount;

—as a radiologist, it is of fundamental importance to him that he have access to patients and appropriate equipment;

—the borrowed money was used for the purpose of gaining access to such patients and equipment;

—the legal substance and the business reality of what happened was that the borrowed money was used to enable him to earn income from his business;

—the amount was paid during the year pursuant to a legal obligation to pay interest on borrowed money for the purpose of gaining or producing income from a business.

The respondent in the Reply to Notice of Appeal held that the deduction claimed was not interest on borrowed money used for the purpose of earning income.

Evidence

Two documents were submitted by the appellant, from which relevant portions are reproduced:

Exhibit A-1 :

A PROPOSAL FROM JAMES H SMALL (SMALL) AND THE SMALL COMPANY OF ORILLIA LIMITED (SCO) TO ROBERT B FORWARD (FORWARD) WITH RESPECT TO A JOINT VENTURE IN THE PRACTISE OF RADIOLOGY IN ORILLIA.

1. This proposed joint venture is in no way to be construed as a partnership. This proposal offers a way to share the financial risks of this venture for a limited time, five years.

2. Gross receipts of the practise will be deposited in a separate bank account. From this will be paid the direct expenses of the practise. These expenses will be billed monthly by SCO. The residual monies will be divided each month equally between Small and Forward. Projections of receipts and expenses for the time Autumn 1974 to Autumn 1979 are set forth in the accompanying pro forma statement of cash flow (schedule A).

3. Present and future financing will be provided by Small and Forward. The loans will be equal. They will be interest free loans to SCO for a term of five years. Repayments of loans will be made in equal amounts to Small and Forward. Anticipated maximums of proposed loans are set forth in schedule B.

4. Assets acquired by SCO will be owned by SCO. Neither Small nor Forward will have any direct interest in them. The direct expenses from SCO include depreciation of equipment on a straight line basis over five year periods that begin from the first use of each piece of equipment.

5. Schedule C delineates Small’s and Forward’s obligations as of 1 September 1974 reconciled to 1 July 1974.

(NOTE: Schedules A, B and C are not reproduced, but they did indicate projected increased earnings by the appellant over the anticipated period of the proposed agreement).

Exhibit A-2 (hereinafter referred to as the “Agreement”):

The Small Company of Orillia Limited

149 Peter Street North, Orillia, Ontario

Telephone (705) 325-6515

30 January 1975.

Today, The Small Company of Orillia Limited acknowledges receipt of $43,230.44 from Robert Bower Forward, MD, FRCP(C).

The Small Company undertakes to repay to Dr Forward $43,230.44 on the thirtieth day of January 1980.

No interest will be paid on this loan.

The Company has undertaken, today, an identical agreement with James Howard Small, MD, FRCP(C). Repayment of these two loans shall be in equal amounts, simultaneously, to these two creditors.

(Sgd) Diana L Small

Diana L Small

President.

(Sgd) James H Small

James H Small

Secretary.

The oral evidence of the appellant was that the actual banking accommodation required had been $38,500, and the balance of the funds provided to Small Company had been made up from private Savings.

Argument A

Counsel for the appellant referred the Board to the cases of The Queen v Balmoral Holdings Ltd, [1975] CTC 397; 75 DTC 5296; P W Lavack Co Ltd v MNR, [1975] CTC 2367; 75 DTC 283; Arthur J Thomas v MNR, [1977] CTC 2227; 77 DTC 171, and The Estate of W C Cochrane v MNR, [1976] CTC 2215; 76 DTC 1154. The basis of his position was that it was conditional upon the appellant loaning Small Company the funds involved, he was able to arrange his business affairs so advantageously with Dr Small.

Counsel for the respondent provided the Board with the following list of relevant cases:

Donald Preston McLaws v MNR, [1972] CTC 165; 72 DTC 6149;

Joel Sternthal v Her Majesty The Queen, [1974] CTC 851; 74 DTC 6646;

John A Matheson v Her Majesty The Queen, [1974] CTC 186; 74 DTC 6176;

DWS Corporation v MNR, [1968] CTC 65; 68 DTC 5045; affirmed by Supreme Court of Canada without written reasons 69 DTC 5203;

I Canada Safeway Limited v MNR, [1957] CTC 335: 57 DTC 1239;

C A Auld v MNR, 28 Tax ABC 236; 62 DTC 27.

His: basic argument was that the appellant had not used the funds in his own business, but had loaned them to an unrelated limited company.

Findings

It would be useful to quote the relevant portion of the particular section of the Income Tax Act, here involved, recognizing that. it provides a deduction from income, the conditions for which must be met specifically and in their entirety, if the appeal is to succeed:

20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) Interest.—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),

(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 property that is an interest in a life insurance policy), or . . .

The salient facts in this case are that:

—the funds in question, upon which the appellant paid interest, were not used in his own business;

—the appellant paid his proportion of the operating expenses of the Small Company;

—there was no provision for participation by the appellant in the earnings of Small Company; and

—he received a non-interest bearing note payable for the full amount of his loan to the Company.

Counsel contended that the appellant was entitled to the interest deduction as an expense of doing business. However, in my view the DWS decision (supra) supports the position of counsel for the respondent on this point—that since the funds were not used in the medical practice of the appellant, they are not deductible as a business expense.

Counsel for the respondent satisfactorily refuted any claim that the Balmoral, Lavack and Thomas decisions (supra) were of value to the appellant’s case, on the basis that these cases showed the acquisition of a “property” and had only limited application to a “business” perspective. However, by this argument counsel asserted that no “property” had been acquired in the instant case. With that I do not agree, since at least the note payable was acquired, a “property” appropriate to the income tax definition. However, the rationale for the dismissal of the appeal in Sternthal (supra), in my view, is eminently applicable for the same determination of this issue, based on the non-interest bearing characteristics of the note payable.

It might therefore be concluded without further examination that the proposition of counsel for the appellant, for the deductibility of the amount as a “business” expense fails because of the DWS decision (supra), and any proposition as a “property” expense also fails because of the Sternthal decision (supra). Yet it cannot be said that it was Only the fact that the borrowed funds had not been used in the appellant’s business, which defeated the appeal in DWS (supra). It was further realized that no apparent agreement or reasonable convention could be demonstrated between the funds loaned and any income to the appellant. Quoting one sentence from that judgment on pages 5051 and 74 respectively serves to emphasize this point: “Nor was interest or any other form of remuneration being received or claimed in the material period and this even though the effect of the loan on the company’s affairs was being felt.” (Italics mine).

It would appear to me that the learned Judge in dismissing the appeal in Sternthal (supra) followed this reasoning and distinguished the facts from those cited in the case of Trans-Prairie Pipelines Ltd v MNR, [1970] CTC 537; 70 DTC 6351. Counsel for the appellant in the instant case proposed that the loan to Small Company was a precondition for the appellant to enter into the working arrangements with that Company, and with Dr Small. He contended in the Notice of Appeal ‘‘the legal substance and business reality of what happened with that the borrowed money was used to enable him to earn income from his business”. It is evident that the borrowed money in itself did not produce such a result and counsel did not provide much enlightenment on the foundation for such a statement. However, it is from the generalities asserted in connection with the appellant’s medical practice that one could propose there was a second property acquired by the appellant, corollary to the note payable—the “right”, “advantage” or “benefit” of entering into the working arrangement with the Small Company and Dr Small. Such an opportunity apparently existed only for the appellant, not for other competing practising doctors in the area, and it flowed directly from the transaction involving the loan to Small Company.

To follow this, for any assertion of deductibility it would be necessary to read subparagraph 20(1)(c)(i) of the Act as follows: “borrowed money for acquiring a property, used for the purpose of earning income from a business”. It might be held that this would be within the intent of that subsection. However, it does not follow that any such deduction qualified by this rather circuitous route would be the interest on the money borrowed by the appellant. It was demonstrated earlier in this decision that the prime property acquired by the appellant was a note payable for the full amount of the loan to Small Company. While it might be contended that the very act of loaning the money to Small Company was responsible for the secondary property (the right to enter into a working arrangement), it would appear to me to be ultimately logical to conclude that it was the relinquishment of the interest from Small Company which produced that benefit. Axiomatically, it could then be concluded that the interest on the appellant’s bank loan, for which he was not recompensed, was the cost of acquiring that property—the right to enter into the working agreements. In that property he acquired a capital asset—certainly one of enduring value at least to the extent of five years under the working arrangement. Any such right or benefit thereby acquired, particularly as a result of the pre-condition asserted by counsel for the appellant, required in effect instalment payments to Small Company over five years equivalent to the interest charge abandoned on the loan. In effect, the first instalment on the payment for acquiring this secondary capital asset is the amount which this appellant seeks to deduct as an interest expense from his business income. Such an operating expense it is not.

The Board has attempted to explore the areas inherent in the proposition of the appellant by which he could claim this deduction. No basis for such deduction is apparent, even though it is recognized that there is probably considerable validity to the claim that the appellant’s income increased as a result of the loan and the working arrangements. This, however, is quite different from making a loan, the purpose of which was to earn income.

Decision

The appeal is dismissed.

Appeal dismissed.