The Queen v. Epstein, 84 DTC 6259, [1984] CTC 270 (FCTD)

Strayer, J:—It was agreed at the outset of the trial that this case and that of Her Majesty the Queen v Florence Epstein (T-4336-82) would be heard together and that the evidence and argument would be applied to both cases.

The salient facts are simple and not in dispute. They are set out in several paragraphs of the statement of claim which were admitted in the statement of defence. These paragraphs are as follows:

4. In reassessing the Defendant for the 1975 taxation year, the Minister of National Revenue included the amount referred to in paragraph 2 in computing his income. In so doing, he assumed, among others, the facts referred to in paragraphs 5 to 12.

5. On 15 May 1964, David and Diane Opie sold a motel property at 8700 Yonge Street, Richmond Hill, Ontario (the “property”) to Emerald Isle Motel Limited (“Emerald Isle”).

6. On 6 May 1965, Emerald Isle granted a first mortgage in the amount of $132,000 (the “mortgage”) on the property to Credit Foncier Franco-Canadien (“Credit Foncier”).

7. On 14th July 1970, Emerald Isle sold the property to Black Prince Holdings Limited (“Black Prince”). The purchase price was $410,000, which was satisfied by $126,000 cash, by a second mortgage from Black Prince to Emerald Isle in the amount of $182,000, and by Black Prince assuming the mortgage with Credit Foncier. The outstanding balance of the mortgage was $102,000.

9. On 5 September 1975, Credit assigned the mortgage to Guaranty Trust Company of Canada (“Guaranty Trust”), which acquired it as trustee for the RRSP of which the Defendant was the annuitant. The outstanding balance of the mortgage was $63,220.98.

10. The fair market value of the interest in the mortgage acquired by the trust governed by Alexander Epstein’s RRSP was $51,650. The fair market value of the interest in the mortgage acquired by the trust governed by Florence Epstein’s RRSP was $11,200.

11. On 15 March 1976, an agreement was entered into between Guaranty Trust and Black Prince extending the time for Black Prince to pay the mortgage until 5 September 1980. This agreement provides in part “. . . that the mortgagor shall have the privilege of paying the whole or any part of the principal sum hereby secured at any time or times without notice or bonus.”

12. At all material times: Alexander Epstein and Florence Epstein were husband and wife; Black Prince was controlled by Alexander Epstein; and neither Alexander Epstein nor Florence Epstein dealt with Black Prince at arm’s length.

Mr. and Mrs. Epstein did not include, in computing their respective incomes for the 1975 taxation year, the amounts of $51,650 and $11,200 respectively representing the fair market value of the investments acquired by their Registered Retirement Savings Plans as noted in paragraphs 9 and 10 of the statement of claim, (supra).

The Department of National Revenue issued a notice of reassessment on June 3, 1980 in respect of Alexander Epstein and on August 26, 1980 in respect of Florence Epstein, including in their respective incomes for 1975 the amounts of $51,650 and $11,200 respectively representing the fair market value of the investment by their RRSPs in the mortgage on 8700 Yonge Street as assigned by Credit Foncier to the Guaranty Trust Company. The Minister of National Revenue takes the position that the acquisition of this mortgage by their RRSPs was a non-eligible investment. He relies on Income Tax Regulations, paragraph 4900(1)(g), which in 1975 provided that a qualified investment for a Registered Retirement Savings Plan would include:

(g) a mortgage, or interest therein, secured by real property situated in Canada and acquired by the savings plan trusts, other than a mortgage in respect of which the mortgagor is the annuitant under the plan governing the savings plan trust or a person with whom the annuitant does not deal at arm’s length.

By virtue of subsection 146(10) of the Income Tax Act where a Registered Retirement Savings Plan acquires a non-qualified investment, the cost of the investment is to be included in computing the income for the year of the taxpayer who is the annuitant under the plan. Section 251 of the Act, in particular for these purposes subsection 251(2), defines relationships which are not deemed at arm’s length. In this case, however, it is agreed that Alexander Epstein and Florence Epstein were not dealing with Black Prince Holdings Limited at arm’s length.

The issue for determination, then, is as to whether Black Prince became a “mortgagor” within the meaning of paragraph 4900(1 )(g) of the Income Tax Regulations as quoted above. It is clear that Black Prince was not the mortgagor in 1965 when the mortgage was first granted by Emerald Isle Motel Limited to Credit Foncier Franco-Canadien. The question is whether, by buying the mortgaged property from Emerald Isle in 1970, partly for cash, partly by assuming Emerald Isle’s obligations under the mortgage granted to Credit Foncier, and partly by giving a second mortgage back to Emerald Isle, Black Prince became a “mortgagor” with respect to the mortgage to Credit Foncier. If so, then when Credit Foncier in 1975 assigned its interests as mortgagee to the Epsteins’ Registered Retirement Savings Plans, the mortgagor (Black Prince) would be a legal person with whom the annuitants (the Epsteins) would not be dealing at arm’s length. It was common ground that the meaning of the term “mortgagor” was not defined in the Income Tax Act or in the federal Interpretation Act.

Briefly put, the position of the plaintiff is that the word “mortgagor” should be given the meaning it has in the law of Ontario in this case because the mortgage is one governed by the laws of Ontario. Counsel referred to various authorities and statutes to demonstrate that in Ontario a person who derives title under a mortgagor is for all practical purposes in the same position as the original mortgagor with respect to his entitlement to the equity of redemption and his obligation to make the payments under the mortgage. In particular, he cited The Mortgages Act RSO 1970, c 279, paragraph 1(d) which provides that in that Act “‘mortgagor’ includes any person deriving title under the original mortgagor or entitled to redeem a mortgage, according to his estate, interest or right in the mortgaged property”.

The defendant on the other hand argues in effect that by its dictionary meaning, “mortgagor” means the person who “gives a mortgage as security for a loan” or “pledges that property for some particular purpose such as security for a debt”. The emphasis here is on the person who initially grants the mortgage and that is of course the most common way in which the word is used. The defendant Alexander Epstein on behalf of himself and his wife argued that this is the common law meaning of “mortgagor” and that the common law interpretation should govern. He contended that there is no justification for using a provincial statute to interpret a federal law.

I have no doubt that in many circumstances involving the application of the Income Tax Act it is necessary to look to provincial law to ascertain the legal relationships between individuals or the legal consequences of certain actions or transactions. Clearly the Income Tax Act assumes a whole network of legal relationships, a majority of them under provincial law, governing property and commercial transactions. The Income Tax Act imposes certain fiscal consequences on these relationships and to apply the Income Tax Act it is often necessary to resort to provincial law to determine the nature of these relationships. But it must be remembered that the purposes of the Income Tax Act are not necessarily those of provincial law and expressions in the Income Tax Act must be given an interpretation which is consistent with the purposes of that Act. Perhaps there is some ambiguity in the word “mortgagor” as it is used in paragraph 4900(1)(g) of the Income Tax Regulations applicable in 1975. Arguably, it might be taken in its literal sense to refer only to the person who first grants the mortgage, or it conceivably could be taken to refer more broadly to the assignee of a mortgagor who becomes the owner of the equity of redemption and assumes the obligations of the original mortgagor. Faced with this ambiguity, it is my view that the interpretation which is most consistent with the purposes of the Income Tax Act is the more narrow, literal, interpretation which would confine the word “mortgagor” as it appears in paragraph 4900(1)(g) of the Regulations to mean the person originally granting the mortgage.

I believe this to be the interpretation most consistent with the purpose of the Income Tax Act, because I can see no reason for this Regulation except as a means to prevent an original mortgagor who is not dealing with the mortgagee at arm’s length from granting an improvident mortgage on business or investment property at an excessive rate of interest above what the market would require, thus putting himself in the position of paying large amounts of unnecessary interest (tax deductible as a business or investment expense) into an RRSP where the proceeds would be tax sheltered and of which he is the beneficiary or “annuitant”. In other words, it is the opportunity which the original mortgagor would have, where the mortgagee is not dealing with him at arm’s length, to set the terms of the mortgage in such a way as to avoid legitimate taxation, which is the “mischief’ which is to be prevented by the Regulation. In the present case, or in other similar cases, where the person not at arm’s length to the Registered Retirement Savings Plan annuitant takes over the rights and obligations of a mortgagor under an existing mortgage, it is not in a position to distort the terms of the mortgage in a manner to avoid taxation. Therefore in terms of what I conceive to be the purpose of the Regulation, there is no justification for giving an extended meaning to the word “mortgagor” to include the person who has acquired the equity of redemption from the mortgagor.

It is, of course, conceivable that a mortgage could be “rigged” at an earlier stage by the original mortgagor in anticipation of transfers of the interests of the mortgagor and/or of the mortgagees with the result that the party with the equity of redemption, and the annuitants of the RRSP that ultimately acquired the rights of the mortgagee, would be parties not dealing with each other at arm’s length. But presumably this would only happen if the original mortgagor was itself not acting at arm’s length from the annuitants in which case the ultimate investment by the RRSP in that mortgage would be disqualified under paragraph 4900(1 )(g). In the present case the defendants denied any relationship with Emerald Isle Motel Limited, the original mortgagor, or its owners, and the Minister did not allege any such relationship.

It is also possible that once an RRSP takes over a mortgage where the mortgagor is not at arm’s length to the annuitant, the terms might be substantially revised by mutual consent so as to make it essentially a new mortgage. In such case there might be reason for treating the revised mortgage as a non-eligible investment. But that position has not been argued here with respect to the extension of this mortgage, and the agreed facts do not suggest that the terms of the mortgage have been substantially revised. The mortgage has only been extended, presumably on the same terms.

I therefore conclude that Black Prince Holdings Limited is not a mortgagor within the meaning of paragraph 4900(1 )(g) of the Income Tax Regulations and as a result this appeal should be dismissed.