Phyllis Barbara Bronfman Trust v. Minister of National Revenue, [1978] CTC 3088, [1978] DTC 1752

Guy Tremblay:—This case was heard at Montreal, Quebec, on February 21, 1978. The transcript was received by this Board on April 25, 1978.

1. The Point at Issue

The point at issue is whether interests paid in 1970 ($110,114), in 1971 ($9,802) and in 1972 ($1,432) are deductible by the appellant trust, on loans whose proceeds were used to pay parts of capital (capital accumulated after tax paid) to the beneficiary of the trust.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. The Facts

3.1 At the beginning of the hearing, the parties presented an Agreed Statement of Facts which reads as follows:

1. The Phyllis Barbara Bronfman Trust (the “Trust”) was established pursuant to a Deed of Trust between Samuel Bronfman as Donor and Allan Bronfman, Lazarus Phillips and Henry Gordon Norman as Trustees, which Deed of Trust was registered at Montreal on May 7, 1942 under No 523231.

2. Phyllis Barbara Bronfman is the institute of the Trust.

3. Pursuant to the Trust, the institute has the right to receive 50% of the revenues from. the Trust property and the Trustees have the discretion to make capital allocations of the Trust property in favour of the said institute.

4. The assets of the Trust consist of a portfolio of securities having a cost base of more than $15,000,000, the whole as set forth in the financial statements of the Trust as of December 31, 1969 and December 31, 1970.

5. All the said assets are of an income earning nature.

6. The earnings of the Trust amounted to $324,469 and $293,178 in 1969 and 1970, respectively.

3.2 The main witness for the appellant was Mr Arnold Martin Ludwick, CA. For ten years he has been executive vice-president of Cemp Investments (one of the companies in which the appellant trust has an investment) and of Claridge Investments (the managing company which manages the investments of the appellant trust and of Cemp).

3.3 The witness affirmed that every year 50% of the net revenues was distributed to Mrs Lambert (Phyllis Barbara Bronfman); the other half was retained by the trust for investment purposes after the taxes were paid.

3.4 Two types of investments were made:

(a) Marketable securities (Canadian stocks, US stocks, French stocks, bonds), and

(b) Holding companies (Cemp Investments, etc).

3.5 The investments are shown in the financial statements of 1969 (Exhibit A-1) at a total cost of $15,000,000 and have a fair market value of approximately $100,000,000.

3.6 On December 29, 1969, the appellant trust obtained a loan of $300,000 from the Bank of Montreal and used the proceeds of this loan to make a Capital allocation to Phyllis Barbara Bronfman Lam- bert. The payment followed a motion duly made at a meeting of the trustees on December 29, 1969 to resolve that a capital allocation in the amount of $500,000 (US) be made to the beneficiary (Exhibit A-3); the other $200,000 was paid with the funds of the trust.

3.7 On March 4, 1970, another motion was made at a meeting of the trustees (Exhibit A-4) to resolve that a capital allocation of $2,000,000 (Canadian) be made to Mrs Lambert. On March 6, 1970, the appellant trust obtained a loan of $1,900,000 from the Bank of Montreal (Exhibit A-6). On March 6, 1970, a cheque of $2,000,000 (Exhibit A-3) was made to Mrs Lambert. The other $100,000 was paid with the funds of the trust.

3.8 In its income tax returns the appellant trust claimed the deductibility of the following amounts of interest paid to the Bank of Montreal, with respect to the above-mentioned loans:

3.9 it was proven that the only loans made from 1968 to 1972 were those made at the Bank of Montreal and described in paragraphs 3.6 and 3.7. .,

3.10 According to Mr Ludwick (referring to the 1970 financial statement) later in 1970, probably in the fall, the trust had sold 128,675 shares of Gulf Oil Canada Limited for $1,966,255. The main part of that amount was used to pay a substantial part of the loans to the Bank of Montreal.

3.11- According to the witness, one way to pay the capital allocation to the beneficiary was by selling securities, but sometimes it is not the appropriate time to sell investments.

On page 17 of the transcript, counsel for appellant asked:

Why was it decided not to liquidate securities at that time?

While ! have been with Cemp and Claridge and the Trust, we have attempted to sell investments, or purchase investments when we think it is the best time to do so from an investment point of view. We are not always right, but try to be, and we try not to have to sell an investment at the time that we need funds for another purpose. We try to sell them when we think it is the right time to sell them. So, I guess you could say that rather than dispose of the investment at the time of making the capital allocation, we elected to use other funds for that purpose, the idea being that we would sell the investment perhaps at a later time to repay the bank borrowing.

explanation

On page 16 of the transcript, Mr Ludwick gives explanation concerning the reasons of the loan of $300,000:

,

. . IN 1969 there was a borrowing of three hundred thousand (300,000) US dollars, which amount was required to be borrowed by the Trust in order to add additional capital funds to finance the assets that the trustees were holding. In view of the depletion in invested, capital; and capital allocation to one of the, to the beneficiary, the only beneficiary, these invested funds had to be replaced by other funds in the Trust in order to finance the assets of the Trust, it being necessary to have enough capital of one form, either invested or borrowed capital in order to finance the assets of the Trust.

On page 32 of the transcript, the witness explains the policy of the Trust:

. . . we, aS a rule or as a policy, try to divorce our asset management, when to sell securities, from our liability management. What kinds of liabilities or what kinds of capital to have in the Trust, that is we must have total capital equal to total assets. So, if there is a need to deplete part of our capital, Say our invested capital, it is our policy now and always has been to manage the capital side, if we deplete invested capital, we have to use borrowed capital.

On page 35 of the transcript, Mr Ludwick explains again concerning policy:

. . we have tried to separate the investment decisions on the liability management decisions, so that the timing of the sale of investments and the purchase of other investments is done in accordance with our best guess as to when the right time is to make investments or sell investments, which is a business by itself, of course.

3.12 On November 12, 1974 the respondent by reassessment, disallowed the interest paid on the loans and claimed by the appellant in the following computation of the revenues.

3.13 Following the Notice of Objection dated December 18, 1974, the respondent by notification dated December 9, 1975, maintained the reassessment.

3.14 An appeal was lodged before the Tax Review Board on March 3, 1976.

4. Law—Jurisprudence—Comments

4.1 Law

The main section concerned in this case is paragraph 20(1 )(c) of the new Act (paragraph 11(1)(c) of the old Act). Paragraph 20(1)(c) reads as follows:

(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

(iii) an amount paid to the taxpayer under

(A) an Appropriation Act and on terms and conditions approved by the Treasury Board for the purpose of advancing or sustaining the technological capability of Canadian manufacturing or other industry, or

(B) the Northern Mineral Exploration Assistance Regulations made under an Appropriation Act that provides for payments in respect of the Northern Mineral Grants Program,

or a reasonable amount in respect thereof, whichever is the lesser.

4.2 Jurisprudence

4.2.1 The jurisprudence cited by the appellant is the following:

1. DWS Corporation v MNR, [1968] CTC 65; 68 DTC 5045;

2. Trans-Prairie Pipelines Ltd v MNR, [1970] CTC 537; 70 DTC 6351;

3. Tobin Tractor (1957) Ltd v MNR, [1971] Tax ABC 320; 71 DTC 250;

4. Lakeview Gardens Corporation v MNR, [1973] CTC 586; 73 DTC 5437;

5. Her Majesty the Queen v Balmoral Holdings Ltd, [1975] CTC 397; 75 DTC 5296;

6. P W Lavack Co Ltd v MNR, [1975] CTC 2367; 75 DTC 283;

7. Ernest F Neifer v MNR, [1976] CTC 2080; 76 DTC 1071 ;

8. The Estate of W C Cochrane v MNR, [1976] CTC 2215; 76 DTC 1154.

4.2.2 The jurisprudence cited by the respondent is the following:

1. Emelyn Jean Shields v MNR, [1968] Tax ABC 909; 68 DTC 668;

2. Flora Edina Carswell v MNR, 5 Tax ABC 194; 51 DTC 414;

3. Lyle A Meredith v The Queen, [1975] CTC 570; 75 DTC 5412;

4. Joel Sternthal v The Queen, [1974] CTC 851; 74 DTC 6646;

5. Andrew Kiss v MNR, [1976] CTC 2112; 76 DTC 1093;

6. Jack Verhoeven v MNR, [1975] CTC 2292; 75 DTC 230;

7. Melvin Zwaig, Trustee to the Bankruptcy of John Dunn v MNR, [1974] CTC 2172; 74 DTC 1121.

4.3 After studying all the cases cited by both parties, it is clear, on one hand, that the main case on which the appellant based his contention is Trans-Prairie Pipelines Ltd v MNR (supra) rendered in 1970. The facts in that case and the decision are summarized in the head- note as follows:

The appellant company was incorporated in 1954 to construct and operate a pipeline, its original issued capital being a number of common shares and 140,000 redeemable preferred shares, the latter having a total par value of $700,000. In 1956 the company issued $700,000 first mortgage bonds and used $400,000 of the amount so borrowed (with $300,000 obtained by issuing additional common shares) to redeem the preferred shares. In 1956 (and subsequent years) the company deducted the interest paid on its bonds; in 1956 it also deducted (under section 11(1)(cb)) legal expenses incurred in connection with the bond issue and the preferred share redemption. The Minister allowed the company to deduct only three-sevenths of the claimed expenses. The Minister took the position that four-sevenths, or $40,000, of the money borrowed through the issue of bonds was used by the company to redeem its preferred shares and not used for the purpose of earning income from its business; that interest on the $400,000 was therefore not deductible under section 11 (1 )(c) . . .

Held: The appeal was allowed. The appellant company was entitled to deduct all of the interest paid on its bonds during the years in question and all of the legal expenses claimed under section 11 (1)(cb). The whole of the $700,000 borrowed on the bonds was, during those years, borrowed money used for the purpose of earning income from the company’s business within the meaning of section 11(1)(c). Prior to the transactions in question, the Capital being used for the purpose of earning income from the company’s business was the $700,000 subscribed by the preferred shareholders and the amount subscribed by the original common shareholders. After those transactions, the money subscribed by the preferred shareholders had been withdrawn and what the company was using in its business to earn income was the amount subscribed by common shareholders (original and additional) and the $700,000 of borrowed money. As a practical matter of business common sense, the $700,000 of borrowed money went to fill the hole left by the redemption of the $700,000 preferred shares. 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 money 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 for the purpose of earning income from the business.

On the other hand, the main case on which the respondent based his contention to rebut Trans-Prairie Pipelines Ltd, is Joel Sternthal v The Queen, supra rendered in 1974 by Kerr, J of the Federal Court of Canada. The facts in that case and the decision are summarized in the headnote as follows:

The taxpayer who had a large excess of assets over liabilities borrowed a sum of $246,800 on December 22, 1966 from three private companies in which he had investments. On the same day he gave interest-free loans to his four children totalling some $280,000. For each of the taxation years 1967 to 1970 the taxpayer claimed a deduction on account of interest on the sum of $246,800 which was borrowed. The Minister disallowed the deduction contending that the interest was not interest on borrowed money used for the purpose of earning income. The Tax Review Board having dismissed his appeal (judgment unreported), the taxpayer took a further appeal. His contention was that if he had sold his excess assets and lent the proceeds to his children and then borrowed to replace those assets, the interest on the borrowed money would have been deductible. He argued that he was entitled to use his assets to make loans to his children and to borrow for the purpose of filling the gap left by the making of such loans. Therefore, as long as the assets which made the loan possible were used to produce income, interest on the borrowing was deductible.

Held: The appeal was dismissed. The Minister had properly disallowed the interest. The taxpayer had chosen to find the money for the loans by borrowing, and the fundamental purpose of the borrowing was to make the loans to his children, not to earn income. The Court distinguished the TransPrairie Pipelines Ltd case on the facts.

The learned judge, Kerr, J, commenting on the Trans-Prairie Pipelines Ltd case, said at page 856 [6649]:

As I understand the learned President’s decision in the Trans-Prairie case he rejected, as a test of deductiblity of interest under section 11(1)(c), whether the first expenditure of the money after it was borrowed was an expenditure for the purpose of the business, for although the use of that test might produce the right result in most cases it might produce a wrong result in other cases, and he reasoned that what must have been intended by the section 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. 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 TransPrairie 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. On the contrary, my appreciation of the facts is that the money was borrowed and used by the plaintiff for the purpose of making non-interest bearing loans to his children, not for the purpose of earning income. He chose to find the money for the loans by borrowing, and the fundamental purpose of the borrowing was to make the loans.

The appeal is therefore dismissed, with costs to be taxed.

In the case at bar, the Board is of the opinion that the facts are quite similar as those of Joel Sternthal rather than the Trans-Prairie case. The Board concurs with the reasoning of Judge Kerr.

According to the Board however, the appellant tried to prove another step in his evidence. He tried to prove that he would have lost revenues if he had sold in December 1969 and in February 1970 the shares of Gulf Oil Canada Limited to pay the beneficiary.

On this point, the facts are quite similar to those of the case of The Estate of W C Cochrane v MNR. Those facts and the decision of the late Mr Prociuk of the Tax Review Board are summarized in the head- note as follows:

The only asset of the estate of the deceased readily available for the payment of estate tax and succession duties was a term-deposit, the redemption of which, before the maturity date, would have resulted in a substantial reduction of the interest income of the estate. The executors avoided this. by borrowing money to pay the taxes and sought to deduct the interest, thereon, amounting to $14,663, in computing the income of the estate. The Minister disallowed the deduction contending that the money was. borrowed neither for the purpose of producing income nor for the acquisition-of property for the purpose of producing income within the meaning of paragraphs 18(1)(a) and 20(1)(c) of the Act and, therefore, the interest, thereon, was not deductible. The executors appealed.

Held: The appeal was allowed. The reason for paying the taxes with borrowed money was to preserve and gain income from the term deposit for the benefit of the estate. The interest on the. borrowed money was, there- fore, deductible.

The learned member, in rendering his decision, made the following reasoning at page 2219 [1156]:

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 Chief Justice Noël, 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 Hallstroms Pty Ltd v FTC (8 ATD 190), however, that the Court held, at 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.

The Board concurs with the reasoning of the late Mr Prociuk. However, the facts in the Cochrane case were well proven. In the case at bar the evidence given is not clear concerning the loss of revenue. No proof was made on the value of the shares of Gulf Oil. Moreover, the evidence given by Mr Ludwick concerning the policy of the separation of “the asset management” and “the liability management” may be a good administrative explanation but this is not sufficient to base a policy to allow deduction on interest paid on all loans made by the trust for paying capital allocation to the beneficiary. Each loan must be judged with its particular facts. In the case at bar, according to the Board, the evidence given was not complete.

5. Conclusion

The appeal is dismissed in accordance with the Reasons for Judgment stated above.

Appeal dismissed.