Citation: 2008TCC434
Date: 20080806
Docket: 2007-4776(IT)I
BETWEEN:
ESTATE OF MARY RIZAK C/O GEORGE JEHN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan, J.
[1] The Minister of National Revenue disallowed
the deduction of interest charges claimed by the Appellant as “interest
payable” on money borrowed to acquire shares under a deferred purchase plan
fund. The Minister’s determination was based on the following assumptions of
fact:
a)
on July 18, 2003, the
Appellant entered into an Investor Subscription Agreement – Deferred Purchase
Plan Fund (“DPP”) called Horizon DPP Fund which name was later changed to
Olympus United Invest II DPP DSC (“Olympus”);
b)
the Appellant subscribed for
$600,000 of Olympus DPP (3 x the normal purchase of $200,000), with $150,000
paid in cash and the $450,000 balance in the DPP of Olympus;
c)
the DPP accrued interest
rate is the greater of 8% and 1% above prime Canadian dollar lending rate of
the Royal Bank of Canada;
d)
the Appellant was not
required to pay any accrued interest until the subscription was completed – the
closing date for the subscription was December 31, 2010;
e)
the Appellant had no income
earning ability until the shares were acquired and the shares could not be
acquired until the subscription was completed;
f)
under the Investor
Subscription Agreement, there was no purchase until the full amount was paid
and no shares issued until the closing date of the subscription;
g)
under the subscription
agreement, the initial payment made by the Appellant did not constitute her as
a holder of any Class Shares;
h)
the Appellant was not
entitled to any dividends until the Class Shares subscribed for had been fully
paid and issued;
i)
the Appellant had no income
earning purpose until the subscription was completed on December 31, 2010;
j)
the Appellant did not incur
any interest expenses on borrowed money;
k)
the Appellant provided no
documentation to support any loan was made, including date of loan, amount of
loan, interest rate, terms of loan repayment and the repayments that have been
made against the principle amount owed.
[2] Mr. Miklos Nagy, who described himself as a
financial advisor, acted as the Appellant’s agent and testified at the hearing.
It was apparently upon his advice that in 2003, the late Mary Rizak entered
into the Investor Subscription Agreement – Deferred Purchase Plan Fund
(“Subscription Agreement”) called Horizon DPP, later known as Olympus United Univest II DPP DSC (“Olympus DPP”). Also present on behalf of the Appellant
was a Mr. George Jehn, who identified himself as the Appellant’s executor. Although Mr.
Jehn testified, his evidence established only that he had had no involvement
with the events leading to Ms. Rizak’s subscription of the Olympus DPP.
[3] Mr. Nagy submitted
that on a proper
interpretation of the terms of the Subscription Agreement, the Appellant was entitled to deduct the interest
charges claimed in its 2004 taxation year. For reasons never explained, the
actual subscription agreement(s) purportedly executed by the late Mary Rizak in
2003 were not before the Court. Instead, Mr. Nagy tendered a blank version of
the standard form Olympus DPP subscription agreement which was entered (without
objection from the Respondent) as Exhibit A-1. Mr. Nagy also put in evidence
three identical documents, each entitled “Statement of Accrued Interest
Payable”
which, he said, Olympus DPP had issued to Ms. Rizak in 2004 for each of her
three $200,000 subscriptions. Under the heading “Accrued Interest and Paid up
Capital” for Olympus DPP appears the following chart:
|
Paid up Capital
|
Outstanding
Balance
|
Initial
payment
|
Accrued
Interest since Inception
|
2004 Accrued
Interest
|
|
$200,000
|
$150,000
|
$50,000
|
$17,490.41
|
$12,032.88
|
[4] Mr. Nagy relied on Exhibits A-1 and A-2 to
support the Appellant’s position that interest charges of $36,099.64
($12,032.88 times 3) ought to be deductible in 2004 as that was the amount
payable on the total outstanding balance of $450,000. Mr. Nagy admitted on
cross-examination that, under the Subscription Agreement, no shares were
to be issued until the “Closing Date”, defined therein as the date specified by
the subscriber for payment of the outstanding balance and accrued interest, on
a day not later than December 31, 2010. He further admitted that the late Ms.
Rizak never paid the outstanding balance and accrued interest and somewhat
reluctantly, conceded that no share certificates had ever been issued to her.
[5] All of this notwithstanding, Mr. Nagy
contended that even without the issuance of shares, “her investment could have
been sold at any time”. In support of this proposition, he said he had heard of
“others” who had thought of doing this. This possibility, coupled with his
assertion that the late Ms. Rizak’s only intention in subscribing for the
shares was to earn income, was sufficient to show the income-generating ability
of the Olympus DPP. He argued that because a subscriber was obligated by the
Subscription Agreement
to pay the outstanding balance and accrued interest by, at the latest, December
31, 2010, the Appellant could be taken to have “borrowed” that amount from Olympus
DPP to acquire the shares. Finally, he relied on the bare declaration contained
in the documents entitled “Statement of Accrued Interest Payable” as proof that
interest was payable on the outstanding balance in 2004. For these
reasons, he urged the Court to conclude that the Appellant was entitled to
claim a deduction of interest charges under paragraph 20(1)(c) of the Income
Tax Act.
[6] The Respondent’s position was that the
Appellant was not eligible for such a deduction because it had not satisfied
the criteria of either subparagraph 20(1)(c)(i) or (ii) of the Act :
20. (1) Deductions permitted in computing income from
business or property -- 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 the taxpayer's 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 from the property 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),
…
[7] Counsel for the Respondent cited the words
of Dickson, C.J. in Bronfman Trust v. Canada to explain how
paragraph 20(1)(c) permits the deduction from income of interest payments that
would otherwise be non-deductible under paragraph 18(1)(b) of the Act:
20 I
agree with Marceau J. as to the purpose of the interest deduction provision. Parliament
created s. 20(1)(c)(i), and made it operate notwithstanding s. 18(1)(b), in
order to encourage the accumulation of capital which would produce taxable
income. Not all borrowing expenses are deductible. Interest on borrowed money
used to produce tax exempt income is not deductible. Interest on borrowed money
used to buy life insurance policies is not deductible. Interest on borrowings
used for non-income earning purposes, such as personal consumption or the
making of capital gains is similarly not deductible. The statutory deduction
thus requires a characterization of the use of borrowed money as between the
eligible use of earning non-exempt income from a business or property and a
variety of possible ineligible uses. The onus is on the taxpayer to trace the
borrowed funds to an identifiable use which triggers the deduction. Therefore,
if the taxpayer commingles [page46] funds used for a variety of purposes only
some of which are eligible he or she may be unable to claim the deduction: see,
for example, Mills v. Minister of National Revenue, 85 D.T.C. 632
(T.C.C.); No. 616 v. Minister of National Revenue, 59 D.T.C. 247
(T.A.B.).
[8] Referring to the principle established by
the case law that interest is deductible only when it is payable, counsel for the
Respondent submitted that notwithstanding the description used in each
“Statement of Accrued Interest Payable”, no interest was in fact or in law “payable”
in 2004. In addition, the Respondent argued that no money had been borrowed to
acquire the shares described in the Subscription Agreement; nor had interest
been payable on money borrowed to acquire income-generating property since the
conditions for the issuance of the shares subscribed for under the
Subscription Agreement had never been fulfilled. Finally, Mr. Nagy’s testimony notwithstanding,
there was no evidence that the late Ms. Rizak could have sold her unissued shares.
[9] In my view, the Respondent’s position is
the correct one. It is common ground that no interest was actually paid in
2004. Thus, to succeed in its claim for a deduction of interest charges under
subparagraph 20(1)(c)(i) or (ii), the Appellant has the onus of proving that an
amount was “payable” in 2004 “pursuant to a legal obligation to pay interest on
borrowed money”. The only evidence of any such legal obligation was the blank
Subscription Agreement tendered by the Appellant in support of its position.
Even under the more relaxed requirements of the Informal Procedure, such
documentation falls far short of establishing any legal obligation imposed on
the late Ms. Rizak in 2004. However, assuming for the sake of argument that the
Subscription Agreement did give rise to “a legal obligation to pay interest on
borrowed money”, it is clear from paragraph 1 of that document that no interest
was payable until the Closing Date; that is to say, the day on or before
December 31, 2010 when the subscriber actually paid the outstanding balance.
The Appellant admitted that the late Ms. Rizak never paid the outstanding
balance of $450,000 in 2004 or at any other time before the authorities finally
shut down the Olympus DPP. Pursuant to the terms of the Subscription Agreement,
no interest became payable in 2004, a state of affairs that is in no way transformed
merely by Olympus DPP issuing a “Statement of Accrued Interest Payable” for
that year. Having failed to show that any
amount was paid or payable for interest on borrowed money in 2004, the
Appellant cannot succeed. The appeal is accordingly dismissed.
Signed at Ottawa, Canada,
this 6th day of August, 2008.
"G. A. Sheridan"
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