27 October 1998 Internal T.I. 9823830 - INTEREST DEDUCTION

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: What is the Department’s position?

Position: Decision limited to identical situations

Reasons: Decision based on the special circumstances of the facts.

CANADIAN TAX FOUNDATION 1998
ROUND TABLE

SUBJECT: Pierre Grenier
Decision of the Federal Court - Trial Decision

Issue:

Whether interest on a mortgage loan to acquire a personal residence is deductible.

Law:

The Income Tax Act provides that interest expense is deductible on money borrowed for the purpose of earning income from a business or property (Par. 20(1)(C) of the Act).

Interest is also deductible on borrowed money used to repay a loan that was used to earn income. Subsection 20(3) of the Act deems that the replacement loan is used for the same purpose as the original loan.

Jurisprudence:

In the case of Her Majesty The Queen v. Phyllis Barbara Bronfman, the Supreme Court of Canada ruled that an interest deduction is only available where the loan is used directly to produce income. However, the Court stated that in exceptional circumstances, it might be appropriate to allow the deduction of interest on funds borrowed for an ineligible use because of an indirect effect on the taxpayer’s income-earning capacity. (Exhibit I)

Facts:

• In 1985, Mr grenier mortgaged his house in Rosemère for $65,626 and invested the money in his new automobile company in Gatineau Quebec.
• He subsequently sold his Rosemère residence and reimbursed the mortgage with the funds received from the sale.
• He then acquired a residence in Gatineau which was financed with a mortgage loan in the amount of $151,700..
• Mr Grenier then claimed a deduction for interest on the Gatineau mortgage.
• Tax Court of Canada allowed a deduction for interest on $65,625 on the Gatineau mortgage.

Decision

Judge Pinard allowed a deduction for interest on $65,625 of the Gatineau mortgage based on the Court findings in the Bronfman case.

Judge Pinard found that it was appropriate to allow the interest deduction given the exceptional circumstances found in the taxpayer’s case. In finding so, the Court considered:

• the true commercial character of the transaction;
• the economic context of the transaction; and
• the indirect effect of the loan on the taxpayer’s income-earning capacity.

The Court also relied on the case and Her Majesty The Queen v. John Shore in which the Federal Court - Trial Division allowed an interest deduction on a loan obtained in similar circumstances.

Comments

• The special circumstances indicate that Mr Grenier did not act in bad faith or attempt to manipulate his affairs. Mr Grenier already had a tax deductible mortgage loan which had to be reimbursed upon the sale of the Rosemère house and which in fact indirectly was replaced by the new mortgage loan on the Gatineau house. Indeed, had the automobile company reimbursed $65,625 to Mr Grenier before he bought his Gatineau house, he would have had to arrange for a mortgage loan of only $86,075. Since his investmentof $65,625 was not reimbursed, he had to replace the first mortgage loan with a higher second mortgage loan.
• The commercial character of the transaction was to "fill a hole" left by the reimbursement of the first mortgage loan. This situation reflects the economic reality and the final result is that the funds were used to earn income.
• It is Revenue Canada’s view that the Court’s decision would be limited to identical situations.

Ghislain Martineau
982382
October 28, 1998