Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether amount of interest on an obligation arising from a settlement of separation agreement falling under the jurisdiction of the Family Law Act of Ontario is deductible under paragraph 20(1)(c).
Position TAKEN:
The amount of interest paid to the other spouse is not an amount described in paragraph 20(1)(c).
Reasons FOR POSITION TAKEN:
Under the Family Law Act of Ontario, a spouse does not have an undivided interest in the other spouse's net family assets. Rather, a spouse holding family properties with the lower aggregate FMV is entitled to an amount equal to one-half the difference between the values of properties held by each spouse. Therefore, a spouse cannot claim to have paid the interest on an obligation incurred to acquire an interest in a property, whether income producing or not, held by the other spouse. Interest is simply payable in respect of an amount and the amount is neither "borrowed money" for the purposes of subparagraph 20(1)(c)(i) nor an amount payable for property acquired for the purposes of subparagraph 20(1)(c)(ii).
August 22, 2001
HAMILTON TSO HEADQUARTERS
Phil Beaverstone Yves Leclerc
Estate and Trust Section (613) 957-2744
Audit Directorate
2001-008042
XXXXXXXXXX
We are writing in response to your e-mail request for our views with respect to the deductibility of interest paid by an estate as part of a separation settlement. You have provided a copy of the stated separation agreement and correspondence between your TSO and the representative of the estate on this matter.
Our understanding of the facts in this case is as follows:
XXXXXXXXXX entered into a separation agreement (the "Agreement") that was dated XXXXXXXXXX. The Agreement is entered into under the Section 54 of the Family Law Act of Ontario and is a domestic contract which prevails over matters provided for in the Family Law Act.
Within the Agreement, under the heading "XXXXXXXXXX", XXXXXXXXXX agreed:
1. that he would pay to the wife, in full satisfaction of all his obligations to her with respect to property rights, equalization under the Family Law Act, and support, an Equalization Payment of $XXXXXXXXXX as follows:
XXXXXXXXXX.
2. such payments will be in after tax dollars and without interest unless there is default in payment, in which case interest will be at prime plus XXXXXXXXXX% until payment.
Under the heading "XXXXXXXXXX", it is mentioned in the Agreement that upon the payment of the $XXXXXXXXXX, interim spousal support will come to an end. As well it is stated that neither party will have the right to claim support from the other. Under the heading "XXXXXXXXXX", it is stated that:
"XXXXXXXXXX".
Lastly, in the last will of XXXXXXXXXX, under clause XXXXXXXXXX, it is stated that:
"XXXXXXXXXX".
XXXXXXXXXX
Representations
Representations from the estate's representative are that the interest paid out by the estate to XXXXXXXXXX are deductible against the estate income in the year incurred. The rationale for the deduction is that the interest was incurred to permit the acquisition from XXXXXXXXXX of income producing assets (i.e. "on an amount payable for property acquired for the purpose of gaining or producing income" for the purposes of subparagraph 20(1)(c)(ii)), being her interest in a substantial investment in certain shares and other investments. The XXXXXXXXXX shares were the principal property forming the family assets. To support their argument, the representative referred to the Tax Court of Canada cases of Robert Wilson (90 DTC 1744) and of Charles N. Erskine (99 DTC 1182).
Following our review of the documents forwarded to our office and the court cases referred to by the representative, we consulted the Family Law Act of Province of Ontario (the "OFLA") as well as the Family Relations Act of the Province of British Columbia (the "BCFRA"). Since the cases cited by the representative both involve the BCFRA while the present case is confined to Ontario, we had to compare the BCFRA and the OFLA to determine whether the same result would be produced under each piece of legislation. Our analysis below assumes that the XXXXXXXXXX shares and the other investments were owned at all times by XXXXXXXXXX or his estate before taking into account the effect of the OFLA.
Family Relations Act of British Columbia:
Subsection 56(1) states that each spouse is entitled to an interest in each family asset on or after March 31, 1979 when a separation agreement respecting the marriage is first made. In subsection (2), it states that the interest under subsection (1) is an undivided half interest in the family asset as a tenant in common. And in subsection (3), an interest under subsection (1) is subject to (b) a marriage agreement or a separation agreement.
The definition of family asset is found in section 58. In subsection 58(2), property owned by one or both spouses and ordinarily used by a spouse or a minor child of either spouse for a family purpose is a family asset. Also in subsection 58(3), it states that the definition of family asset includes the following: a) if a corporation or trust owns property that would be a family asset if owned by a spouse, (i) a share in the corporation, or (ii) an interest in the trust, owned by the spouse.
Lastly, in subsection 64(1), it states that "interest of a spouse" means the interest of a spouse arising under section 56, a marriage agreement or a separation agreement.
The court cases referred to by the representative generally concluded that the obligations were undertaken by the taxpayers in those cases in order to acquire their spouse's interest in income producing assets, thereby placing the interest paid on the obligation within paragraph 20(1)(c) of the Act. This is consistent with the fact that, immediately before the time the separation agreement is made, under the BCFRA each spouse has an undivided interest in each family asset. In those cases, the conclusion that can be drawn is that one of the spouses was acquiring the other's interest in certain assets. Hence, as long as those assets were income earning assets, the interest paid on the amount owed was deductible. In essence, one spouse was buying the other's interest in an income earning asset.
Family Law Act of Ontario:
Subsection 5(1) of the OFLA states that when a divorce is granted or a marriage is declared a nullity, or when the spouses are separated and there is no reasonable prospect that they will resume cohabitation, the spouse whose net family property is the lesser of the two net family properties is entitled to one-half the difference between them.
Considering the above excerpt from the OFLA, a spouse would be entitled to an amount equal to one-half of the difference between the aggregate values of each spouse's net family properties. There is no outright entitlement to the other spouse's property itself. A calculation has to be made as stated under subsection 5(1). Therefore, the spouse who would have the highest net family properties would have the obligation to make a payment to the other spouse to fulfill his or her obligations to the other spouse. In the present case, the interest deduction would not be available to the estate of XXXXXXXXXX because XXXXXXXXXX did not have an undivided interest in any of XXXXXXXXXX assets. As a result, the interest on XXXXXXXXXX obligation under the Agreement was not paid "on an amount payable for property acquired" for the purpose of subparagraph 20(1)(c)(ii) of the Act.
It is observed that clause XXXXXXXXXX of the Agreement states that the Agreement is a domestic contract, which should prevail over matters provided for in the Family Law Act. Nevertheless, clause XXXXXXXXXX of the Agreement states that payments made thereunder will be made in full satisfaction of all his obligations to his spouse with respect to property rights, equalization under the Family Law Act, and support. Accordingly, notwithstanding clause XXXXXXXXXX of the Agreement, it is clear that nothing in the Agreement gave XXXXXXXXXX any entitlement to any property, whether income earning or non-income earning of the estate in this case, other than the payment provided for under the provisions of the Agreement.
Conclusion
In conclusion, from the review of the BCFRA, OFLA, Agreement and the court cases cited by the representative, the interest paid by the estate does not qualify for a deduction under subparagraph 20(1)(c)(ii) of the Act. Unless the shares of XXXXXXXXXX were jointly owned by XXXXXXXXXX to begin with, XXXXXXXXXX will not be considered to have acquired any interest in them as a result of the application of the OFLA or the Agreement.
Under the OFLA, a spouse does not have an undivided interest in any property of the other spouse and can only claim an equalization payment. The payer may have to liquidate personally owned income-producing assets to fulfill his or her obligation but this does qualify a payment of interest accruing on the obligation prior to that time as being in respect of an amount payable for property acquired for the purposes of subparagraph 20(1)(c)(ii). Moreover, as the obligation under the arrangement does not involve "borrowed money" for the purposes of subparagraph 20(1)(c)(i) of the Act, no deduction in respect of such interest is available under that paragraph.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy & Legislation Branch
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