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Citation: 2004TCC419
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Date: 20040629
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Docket: 2001-3709(IT)G
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BETWEEN:
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IRVIN KEW,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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____________________________________________________________________
Counsel for the Appellant:
Kim E. Johnson
Counsel for the Respondent: Victor Caux
____________________________________________________________________
REASONS FOR JUDGMENT
(Delivered
orally from the Bench at
Vancouver,
British Columbia, on April 8, 2004)
McArthur J.
[1] This
is an appeal from an assessment of tax for the Appellant's 1995 taxation year
whereby the Minister of National Revenue disallowed alimony or maintenance
deductions of $31,233 and investment interest charges of $16,736. The Appellant
transferred his 50% interest in a matrimonial home to his former spouse in
consideration of a variety of concessions including arrears of alimony and
maintenance. He wishes to deduct the entire amount.
[2] He
is a professional architect carrying on business through a corporation, Irvin
Kew Architecture Incorporated. The second issue is whether he can deduct
$16,736 in interest on operating capital borrowed from the Royal Bank of Canada
(RBC), the Hong Kong Bank (HKB) and the Canadian Imperial Bank of Commerce
(CIBC).
[3] I
will first deal with the child support amount. By written separation agreement
dated May 5, 1988, the Appellant and his former spouse Nicola agreed to live
separately and apart. They had three children, twin boys born October 1, 1972
and a daughter born February 14, 1979. Nicola had exclusive use of the
matrimonial home. The Appellant agreed to pay: (i) $150 monthly per child; (ii)
one-half of the private school fees for the two boys; (iii) one-half of the
property tax for the matrimonial home; (iv) the mortgage payments on the
matrimonial home; and (v) insurance premiums for the children's benefit.
[4] The
Appellant's business suffered financially and he fell into arrears of his
support obligations almost from the outset. Nicola did not attend the hearing,
but her presence was felt from several of her carefully drafted letters to the
Appellant and her accounting records of payments made by him. In 1995, RBC
called in a substantial loan which eventually resulted in a separation
agreement modification which was dated and signed in August 1995 (Exhibits A-5
and R-1, Tab 1) and included the following covenants:
2. As of the date of payment to the
Husband of the sum of FIFTY ONE THOUSAND DOLLARS ($51,000.00) his obligation to
continue with child maintenance is thereby terminated and the payment of
FIFTY-ONE THOUSAND DOLLARS ($51,000.00) represents a full and final
satisfaction of child maintenance.
.
. .
4. The Husband and the Wife agree
further that the sum of FIFTY-ONE THOUSAND DOLLARS ($51,000.00) in addition to
representing full satisfaction of child maintenance obligations shall also
represent full satisfaction of the Husband's interest in the property at 1657
Fell Street.
[5] The
above terms evolved from an offer made by Nicola to the Appellant in a letter
dated July 21, 1995 (Exhibit A-3), which included the following:
As part of this
offer, I will agree to relinquish my legal right to free residence here until
Henrietta is 19 years old, which is two and a half years from now. This will
save you the sum of $20,085 in mortgage payments over this period of time. I
will arrange for my lawyer to draw up a legal revision to the Separation
Agreement and Court Order to this effect.
I enclose account
sheets setting out the amount of unpaid maintenance and other amounts over the
past few years, which total $31,233.17 (interest excluded). . .
Nicola's
offer was made after the Appellant requested that he be permitted to mortgage
his equity in the matrimonial home to pay creditors. The Appellant accepted
Nicola's offer on August 1, 1995 with the following notation set out in a
letter from Nicola to him on the same date (Exhibit A-4):
This is to confirm
our telephone conversation and my acceptance of your offer to pay me the total
sum of $51,000.00 (net) for my interest on 1657 Fell Street, including the
relinquish of all your rights for further claims as itemized in your letter
above; it is also agreed that you will confirm receipt of the 1993 and 1994
maintenance arrears the sums of $5,400.00 and $3,600.00 respectively as part of
the terms of this agreement.
The
Appellant now seeks to deduct, as support payments, the amount of $31,233 which
he states was in satisfaction of maintenance arrears.
[6] The
Respondent's position is that the amount is not deductible because (i) the
second agreement of August 1, 1995 did not provide for satisfaction of
maintenance arrears; (ii) the Appellant had been in arrears of child support,
private school fees, insurance and property tax for some time; (iii) the
portion of the $31,233 which may have been unpaid child maintenance was capital
in nature. Counsel refers to the M.N.R. v. J.J. Armstrong, (1956) C.T.C.
93 (S.C.C.); and (iv) the Appellant did not actually pay Nicola and she had no
discretion over the use of the amount.
[7] For
the reasons that follow, I find that the entire amount is not deductible as
unpaid child maintenance. The Appellant relies in part on obiter dicta
of O'Conner J. of this Court in White v. The Queen, 97 DTC 1108 at page
1115 where he states:
With respect to alimony, the amounts
paid were not pursuant to a judgment or an order but were rather paid pursuant
to a settlement and release agreement which released the Appellant from all
obligations past and present. It is true that in certain circumstances a lump
sum payment representing payment of alimony arrears may qualify but in this
appeal there is absolutely no proof as to whether any portion of the amount
paid to the former wife relates to payment of arrears of periodic alimony.
Moreover, in my opinion, the $25,000 lump sum payment provided for in the Decree
Nisi cannot be considered as alimony paid on a periodic basis.
The words from this quotation:
"It is true that in certain circumstances a lump sum payment representing
payment of alimony arrears may qualify … " are emphasized by counsel for
the Appellant. Unfortunately, those certain circumstances have not been set
out, and this comment is of no assistance to the Appellant. The transfer by the
Appellant to Nicola of his equity in the home was to satisfy a variety of debts
owed by the Appellant to Nicola only part of which may have been maintenance
arrears. The Appellant's evidence falls short of establishing that the home
equity was transferred: (i) for the maintenance of Nicola or the children; (ii)
because it represented unpaid child support; (iii) giving Nicola
discretion over the use of the amount.
[8] In
addition, I find that the amount was a capital payment. The Respondent's
counsel referred to Armstrong, where Kellock J. of the Supreme Court of
Canada at page 95 stated:
KELLOCK,
J.: - In this case the sum of $4,000 was paid by the respondent "in full
settlement" of all payments due or to become due under a decree nisi which
obligated him to pay to his former wife the sum of $100 a month for maintenance
of the infant child of the parties until the latter should attain the age of
sixteen years. In consideration of this payment the respondent was released by
the wife "from any further liability" under the said judgment.
. . .
If, for
example, the respondent had agreed with his wife that he should purchase for
her a house in return for a release of all further liability under the decree,
the purchase price could not, by any stretch of language, be brought within the
section. The same principle must equally apply to a lump sum paid directly to
the wife to purchase the release. Such an outlay made in commutation of the
periodic sums payable under the decree is in the nature of a capital payment to
which the statute does not extend.
[9] The
relevant sections of the Income Tax Act have been amended many times
since this was written but the basic principle is relevant today. The only
breakdown of the lump sum amount is provided by Nicola's July 21, 1995 letter.
It includes savings by the Appellant of $16,500 for future child support
payments and two $10,000 amounts, which are clearly not maintenance support. I
agree with the Minister's position that any outlay made in the computation of
periodic sums is a capital payment. The character of the amount changed. In our
instance, it is impossible to discern how much of the payment if any, was a
computation of periodic sums.
[10] I
will briefly deal with the Appellant's remaining submissions. The relevant
legislation includes subsection 56(12) of the Act, which reads in part:
56(12) Subject to
subsections 56.1(2) and 60.1(2), for the purposes of paragraphs (1)(b),
(c) and (c.1) (in this subsection referred to as the "former
paragraphs") and 60(b), (c) and (c.1) (in this
subsection referred to as the "latter paragraphs"), "allowance"
does not include any amount that is received by a person, referred to in the
former paragraphs as "the taxpayer" and in the latter paragraphs as
"the recipient", unless that person has discretion as to the use of
the amount.
To be an allowance, the
recipient must have the discretion as to the use of the amount. Nicola did not
have a discretion as to the use of the amount because it was equity in real
estate. The Appellant's counsel refers to the words in paragraph 60.1(1)(b)
which read in part:
60.1(1) Where a decree, order, judgment or written agreement
described in paragraph 60(b) or (c), or any variation thereof,
provides for the periodic payment of an amount by a taxpayer
. . .
(b) for the
benefit of the person, children in the custody of the person or both the person
and those children,
the amount or any part thereof, when paid, shall
be deemed for the purposes of paragraphs 60(b) and (c) to have
been paid to and received by that person.
The
payment was not a periodic payment as required. The equity transferred by the
Appellant cannot be considered for the purpose of paragraphs 60(b) and (c)
to be alimony or another allowance payable on a periodic basis. As stated by
application of subsection 56(12), it cannot be considered alimony since Nicola
had no discretion as to the use of the equity transferred to her.
[11] The
Appellant submits that she had discretion in that she became the sole owner of
the matrimonial home and had the absolute discretion to deal with the home.
This was not the freedom to act as she wished with the $31,000 which is
envisaged in the Act. She was granted equity in real property. This is
not an amount paid for the purposes of paragraphs 56(1)(b) and (c)
or 60(b) and (c) of the Act.
[12] An
historical review of the background leading up to the second separation
agreement is important. The original separation agreement of 1988 provided for
payments as set out earlier. The Appellant made partial payments over the years
to Nicola without any allocation of the amount paid. He was almost always in
arrears. She kept careful records; he kept none.
[13] In
1995, his business was in serious financial difficulties and he asked Nicola
for permission to mortgage his 50% equity which was agreed to be a net of
$83,000 after deducting arrears set out by Nicola in her July 21, 1995 letter,
which are not nebulous claims. She offered to pay the Appellant $31,600 for his
equity. Finally, they agreed at an amount of $51,000. Nicola had to arrange
financing and legal documents. The equity she received was not a discretionary
one. It appears to be a hard-fought compromise and commingling of amounts of
various natures.
[14] I
find that paragraph 60.1(1)(b) does not assist the Appellant. Again,
Nicola did not have a discretion as to the use of the equity conveyed to her.
She did not receive a payment; she received an interest in real estate, not a
payment of money that she could use freely. Even accepting the Appellant's
argument, only part of the amount is for arrears paid for the maintenance of
both Nicola and the children, and no pro rated accounting was, or could be
provided with any accuracy.
[15] I
now turn to the claimed interest expense in the 1995 taxation year. The issue
is whether the Appellant may deduct interest in the amount of $16,736. The
question narrows down to whether the interest was on loans between the
corporation to various banks or between the Appellant personally and the banks.
Who borrowed the money? I have no doubt that the corporation actually made the
interest payments in 1995 and expensed it. The Appellant counters this fact by
submitting that the payments of interest made by the corporation were in fact
his personal drawings which he directed the corporation to be paid directly to
the banks. There is no paper trail such as corporate resolutions or directions
or other evidence to support this, and I do not accept it.
[16] Carolla
Williams, auditor, testified on the Minister's behalf. Her credibility is not
in question. She meticulously reviewed both the corporation's and the
Appellant's records, including the corporation's contract to borrow the money
for its business. The Appellant was the controlling mind of the corporation.
The business was substantial, having some 15 employees and monthly carrying
costs of $35,000 during the early 1990s. In 1995, the RBC demanded repayment of
its loans in excess of $170,000. HKB granted the corporation a line of credit
in excess of $200,000. The Appellant personally guaranteed this debt and
granted the bank a collateral mortgage on his home. (This is not the same real
estate as the matrimonial home that we have referred to above.) The Appellant
owed RBC $44,000 personally in 1995 which he paid off with a personal loan from
HKB.
[17] In
1994, the Appellant signed a loan agreement with CIBC to purchase a van. The
corporation paid the interest and the corporation claimed capital cost
allowance in 1995. The van loan and trade-in allowance were credited to the
Appellant's shareholder loan in the corporations 1995 fiscal year. The Appellant
submits that the $16,700 was interest paid by him on money he borrowed and
re-loaned to his corporation for the purposes of producing income. The amount
is made up of: (i) RBC - $13,100; (ii) HKB - $2,300; and (iii) car loan -
$1,200.
[18] The
Appellant had the burden of proving that he borrowed the money and paid the
claimed interest for the purposes of earning income. On balance, the
documentary evidence does not support the Appellant's position. The greatest
portion of the interest was paid to RBC by the corporation. Tab 18 of Exhibit
R-1 is a letter dated July 10, 1995 from the RBC to the corporation and the
Appellant, clearly identifying the two outstanding loans to the corporation
totaling $191,036 and various debts of the Appellant in the amount of $44,642.
The bank wrote that it was not prepared to renew the company or personal credit
facilities outstanding and demanded payment.
[19] Exhibit
A-7 is evidence of a mortgage registered August 1993 against the Appellant's
property to RBC for $175,000. This is the best evidence the Appellant produces
that it was a personal loan, but given contrary evidence and contradictory
evidence, I find this mortgage was collateral security to the corporate loan.
Exhibit A-8 is a RBC fax cover sheet addressed to HKB indicating the
corporation's $195,000 outstanding debt. In a letter dated July 9, 1999 to
Revenue Canada (Exhibit R-1, Tab 3), the Appellant's accountant stated in
paragraph 2 on page 2 that the corporation negotiated a line of credit in the
amount of $200,000 with HKB to pay out the RBC. I cannot simply ignore this
statement as an accountant's error when it is coupled with the evidence: (i)
RBC confirmed its $175,000 loan was to the corporation; (ii) the corporation
paid the interest and expensed it (about $13,000); and (iii) there is no
written evidence that the corporation paid the Appellant a dividend or salary,
and he, in turn, had the corporation pay the interest with his money. This is
wishful thinking to take tax advantage of transactions between a taxpayer and
his corporation. Form matters, and I refer to The Queen v. Friedberg,
92 DTC 6031 at page 6032. It has to be documented.
[20] Exhibit
R-1, Tab 15 is a receipt for the payment of $13,000 interest by Irvin Kew
Architecture to RBC. Tab 16 is a letter from the HKB to the corporation dated
September 5, 1995 stating it is pleased to offer the corporation a $200,000
plus loan with an unlimited personal guarantee from the Appellant supported by
a $341,000 collateral mortgage on his residence. If RBC and HKB loans were
personal and not corporate, I would expect to see a file of documentation
including corporate resolutions. The Appellant's evidence falls far short of
what is required to meet his burden of proof. With respect to the personal
loans with RBC and HKB, there is insufficient evidence to conclude that this
money, about $47,000, was used for business purposes.
[21] With
respect to the 1994 van loan, the Appellant signed the loan agreement with CIBC
and the corporation paid the interest and claimed capital cost allowance. While
the trade-in allowance and van loan were credited to the Appellant's
shareholder loan, I do not accept the Appellant's evidence that the van was
used exclusively for business purposes. It was his only vehicle.
[22] For
these reasons the appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 29th day of
June 2004.
McArthur,
J.
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