Date: 20000905
Docket: 1999-1766(IT)I
BETWEEN:
DARLENE A. BALDNER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
O'Connor, J.T.C.C.
[1] This appeal was heard at Winnipeg,
Manitoba on June 19, 2000. The Appellant was represented by her
agent and husband David Baldner ("spouse") who also
testified for the Appellant.
FACTS:
[2] On February 16, 1987 the Appellant
purchased 63,000 common shares ("Shares") of
Greenstreet Holdings Ltd. ("Greenstreet") from her
spouse for $125,000.
[3] Greenstreet owned 100% of Baldner
Holdings Ltd., which in turn owned 100% of R. W. Packaging
Ltd.
[4] The Appellant financed the Shares
purchase by means of a loan from the Canadian Imperial Bank of
Commerce ("CIBC") in the amount of $125,000 (the
"Share Loan"). The Share Loan was secured by a second
mortgage on the home of the Appellant and her spouse.
[5] Originally the home had a first
mortgage loan of $250,000 with the CIBC.
[6] The spouse used the $125,000
received by him for the Shares and applied these to reduce the
mortgage loan to approximately $125,000. Actually a new mortgage
("Mortgage Loan #1") was executed in 1990 for
approximately $125,000 and presumably the original mortgage was
discharged.
[7] In 1992 the CIBC called
certain personal and business loans as well as the Share Loan.
The spouse on January 1, 1993 caused R. W. Packaging Ltd. to sell
its assets. The cash proceeds from the sale ($185,000) were used
to pay off the loans the CIBC had called, including the Share
Loan. The Share Loan was paid partly in 1993 and completely in
1994.
[8] The Appellant and the spouse did
not pay off Mortgage Loan #1 as CIBC was not demanding
payment of that mortgage.
[9] The Appellant and her spouse were
displeased with the CIBC and consequently they arranged for CIBC
to assign the balance Mortgage Loan #1 to the Toronto-Dominion
Bank ("TD Bank"). The Appellant thus become indebted to
the TD Bank in an amount of approximately $125,000
("Mortgage Loan #2").
[10] In the years in question the Appellant
sought to deduct the interest charges on Mortgage Loan #1 and on
Mortgage Loan #2.
[11] Although the assets of Greenstreet have
changed to cash and to a lesser extent, some investments, the
Shares the Appellant acquired continue to be owned by her.
[12] The interest expense on the Share Loan
was $7,534 for 1993 and its deduction was allowed.
[13] Interest expense on Mortgage Loan #1
was $5,760 in 1993. The interest expense on Mortgage Loan #1 was
$8,106 in 1994. In 1995 the total interest expense on Mortgage
Loan #1 and Mortgage Loan #2 was $8,398. The year 1994 was not
reassessed for the Appellant and no Notice of Objection by the
Appellant was filed with respect to the 1994 year. The $8,106
interest expense for 1994 had been erroneously claimed on the
spouse's return and was disallowed.
[14] By Reassessment dated November 19, 1996
the Minister of National Revenue ("Minister") denied
the Appellant's claim for deduction of interest by the amount
of $7,534 in 1993 and $8,398 in 1995.
[15] The Appellant filed Notices of
Objection to these reassessments.
[16] Subsequently the Minister reassessed
the 1993 taxation year on February 9, 1999 to allow
the deduction in 1993 of $7,534. Further, the Minister confirmed
the 1995 reassessment by Notice of Confirmation dated February 9,
1999.
SUBMISSIONS:
[17] The submissions of the Respondent and
of the Appellant read in part as follows:
MS.
HARWOOD-JONES "(Counsel for the Respondent):
Despite some lengthy and sometimes confusing evidence, I think
that the facts in this case are not all that complex.
What we have is a situation where Mrs. Baldner had two
loans that we are talking about, and one was in respect of shares
that she purchased in Greenstreet, and ...she was legitimately
entitled ... to an interest deduction, and that was given by the
Minister.
The other loan was a mortgage loan or a personal loan for the
purchase of her personal residence. That is not an issue. I think
everybody agrees on those facts.
Ultimately the loan with respect to the shares was called by
the CIBC. In other words, the CIBC demanded that she pay back
that loan. And Mr. Baldner ... sold the assets of the business
and received I think it was $185,000.00 or something along those
lines as proceeds of that sale, and used a part of the proceeds
to pay off the share loan that had been called by the CIBC for
Mrs. Baldner.
The mortgage loan, the loan that was taken out to purchase the
house still continued to exist. That loan wasn't paid out
...
The share loan, was also secured by the house, but that one
was paid out. The mortgage loan still continued to exist and
didn't change in nature or in character in any sense.
But because the business loan was called and Mrs. Baldner had
been obtaining the interest deduction with respect of the
business loan, but because that loan wasn't there anymore,
because it had been paid out by Mr. Baldner, now Mrs. Baldner
wants to claim an interest deduction for the mortgage.
The Minister's position is, of course, that that mortgage
loan has never been used for the purpose of earning income. It
was used to acquire the personal residence. And that, of course,
is the issue in this case.
In the absence of section 20(1)(c) of the Act, ...
there is no deduction allowed in respect of interest without that
section, but 20(1) entitles the taxpayer to a deduction in
respect of interest, or, pardon me, in respect of an amount that
is wholly attributable to, and then we skip down to ... paragraph
(c),
"...an amount paid in the year or payable in respect of
the year pursuant to a legal obligation to pay interest on
borrowed money used for the purpose of earning income from
business or property".
That section has been the subject of commentary in the Supreme
Court of Canada . ...
[Bronfman Trust v. Canada [1987] 1 S.C.R. 32] is a
situation where the trust borrowed funds in order to make a
capital allocation to the beneficiary of the trust. The borrowing
of the funds was - the allocation was not for the purpose of
producing income. It was for the purpose of giving the
beneficiary some money.
The trust claimed an interest deduction on the basis that
borrowing those funds allowed the trust to retain income
producing assets in the trust portfolio. ...
The Supreme Court disallowed the deduction because the
borrowed funds were not used for the purpose of producing income,
but were rather to make the payment to the beneficiary.
And there are a number of comments by Chief Justice Dixon, as
he was at that time, which are germane to the case, and I have
highlighted them and noted them.
Paragraph 20, and I have provided the quick law version to
Your Honour and to Mr. Baldner, and that is at page 8 of the
decision, makes a number of comments that are, in the
Minister's submission, important in this case.
"It is important to recall that the purpose of an
interest deduction is to encourage the accumulation of capital
which would then produce taxable income."
The Supreme Court also reminds us that,
"Not all borrowing expenses are deductible",
and the interest on borrowing as used for non-income earning
purposes, for example personal consumption, that is not
deductible interest.
The court states that,
"The statutory deduction requires a characterization of
the use of the borrowed money as between the eligible use of
earning nonexempt income from the business or property and a
variety of possible ineligible uses."
And as the court states,
"The onus is on the taxpayer to trace the borrowed funds
to an identifiable use which triggers the deduction."
In other words, the taxpayer has to demonstrate that the
funds, and it can be through a tracing mechanism, but that these
funds are used for an eligible use, in other words, an income
producing use.
...
Paragraph 28 of the decision, which is on page 9 of the copy I
have provided, is also, in the Minister's submission, very
important in this case. As you will see highlighted there, the
court says,
"Neither the Income Tax Act nor the weight of
judicial authority permits the court to ignore the direct use to
which the taxpayer puts borrowed money."
That is very important in this case because the direct use to
which the money, the mortgage loan, was put was to purchase the
personal residence of the taxpayer. ...
To continue going through this case though, at paragraph 31,
which is on page 10, the court indicates that,
"It has been held repeatedly that an individual cannot
deduct interest paid on the mortgage of a personal residence even
though he or she claims that the borrowing avoided the need to
sell income producing assets",
which is not that far away from what we have here.
In this case, the issue is, of course, that the proceeds of the
sale of the assets were used to pay out the share loan, as
opposed to the mortgage loan.
Finally at paragraph 40 at page 12 of this decision, the court
indicates that,
"The taxpayer must satisfy the court that his or her bona
fide purpose in using the funds was to earn income."
The Bronfman case was reaffirmed, so to speak, by the
Supreme Court in Tennant v. Canada (Minister of National
Revenue - M.N.R.) [1996] 1 S.C.R. 305, which I have provided
as well.
The facts in that case are essentially that a taxpayer used a
loan of a million dollars to purchase shares and then effected a
section 85 rollover and obtained shares in a different company,
which only had a value of $1,000.00. And the Minister allowed the
deduction only to the extent of the value of the replacement
shares.
That appeal was allowed as the replacement shares were
sufficiently linked to the initial loan ...
The Supreme Court tells us that we need to, in order to have an
interest deduction, we need to establish a link between the
current eligible use of the property, proceeds of disposition of
an original eligible use property if that is the path that is
being followed, and the money that was borrowed to acquire the
original eligible use property.
In that case, the taxpayer could trace those initial funds, which
were used for the purpose of producing income. There was a path
that we could follow.
The problem fundamentally in the present case ... is that those
funds on the mortgage loan were never, and this was admitted by
Mr. Baldner in his testimony, were never borrowed for the purpose
of earning income. They were borrowed for the purpose of
purchasing a principal residence, which is not an income
producing activity.
It is not, this isn't a situation where the funds were then
used to repay the business loan or anything like that. In fact,
that mortgage, the character of the mortgage never changed and
that, I think, is the problem that Mrs. Baldner faces today.
When the business loan was called, Mr. Baldner paid it off, but
the mortgage funds were still used for the residence. They
weren't converted to any other use.
And effectively, what we have here is a situation where the
taxpayer is saying that since she can't have the interest
deduction for the business loan, because it was paid off, she
would like the interest deduction on a different loan, but the
problem that she faces is that that loan has never been used for
the purpose of producing income and that is a fundamental
requirement, ...
Now Mrs. Baldner wants the interest deduction because if the
business loan had not been called then, assuming that
Mr. Baldner sold the assets of the company, and we heard
testimony that he sold the assets of the company because the
loans had been called, but I take the suggestion to be that if
the business loans had not been called and the sale had
proceeded, then those funds would have been used to pay down the
mortgage loan, but he simply didn't have that
opportunity.
But again ... we need to look at what was done. In fact, the
business loan was paid off. The mortgage remained intact and was
never used for business purposes.
And there is no link between the mortgage proceeds or the
mortgage loan and an income producing activity. It is not a
deductible form of interest. It is a personal loan that was used,
and continued to be used at all times, simply for the purpose of
obtaining the residence.
Mr. Baldner testified that he paid off the share loan to protect
the interest in the house, because the share loan was also
secured by a mortgage on the house, a second mortgage, but just
because the share loan was a second mortgage doesn't
mean that the first mortgage was for business purposes. It still
remained a separate type of loan for separate purpose.
I'm speculating at this point, but it may have been that if
there was a differently structured transaction, whereby the
proceeds from the sale of the business were used to pay off the
mortgage loan and then another loan was taken out to pay off the
share loan or something like that, then we might be in a
situation where there might be a link to be established, but
there is simply no link. They are two very separate loan
situations here.
Those are my comments on the substantive question of whether the
interest deduction is allowed, but I do have a couple of comments
on the issue of whether the 1994 appeal is valid.
Now as I understand from the documents that I have filed and from
Mr. Baldner's testimony, the 1994 taxation year was initially
assessed and allowed as reported on May 26, 1995, and that is
evident from the notice of assessment, which is R-4.
The notice of objection for 1994, the official notice of
objection, was filed on March 20, 1997, and that is in the bundle
of notices of objection, which is R-3.
Mr. Baldner testified that on January 30th of 1997, he wrote a
letter to Revenue Canada discussing this notion of transferring
the deduction from him to his wife, and the letter from Scarrow
and Donald, which is A-9, indicates that. It says,
"Our client had written to Revenue Canada in January 1997
and understood that you would accept that letter as his notice of
objection."
That is a letter dated February 28, 1997.
So what we have is a notice of assessment in 1995, in May of
1995, no reassessment, but a request in early 1997, and then a
notice of objection subsequent to that request.
It was after that that the Minister made an indication that it
was not going to allow that to happen, ...
...
Now section 165 of the Income Tax Act requires a notice of
objection to be filed within 90 days after the mailing of the
notice of assessment. Of course, a taxpayer can get an extension
of time. ...
The application for an extension of time can be made under
subsection 166.1(7), that is 1(7), but that section precludes,
pardon me, that is the section that precludes the granting of an
application unless it is made within one year of the expiration
of time otherwise allowing for the filing of the objection, and
that is where, of course, we get our one year and 90 days.
In this case, that is on or about August 26, 1996. So it is
before there was any indication to Revenue Canada that
Mr. Baldner was seeking this transfer of the deduction from
himself to Mrs. Baldner, which ultimately was disallowed, would
be disallowed in any event, for the same reasons that 1993 and
1995 were disallowed, because the Minister's position is that
that is a mortgage loan with no business purpose and, therefore,
doesn't meet the requirements of 20(1)(c).
The Minister, of course, would be precluded from granting an
extension of time by 166.1(7) and, from my understanding
and from the evidence that we have seen, there has not been an
application for an extension of time to the Minister.
In any event, the Minister wouldn't be able to allow it and
this Court, of course, is bound by the same time constraints,
although by a different section.
But in any event, we are past the one year and 90 days for the
1994 and so there simply can be no appeal, because, of course, in
order to have an appeal, there must be a valid notice of
objection filed.
...
HIS HONOUR: Well, just one question. What do you think of
the substance over form advice apparently given by Revenue
Canada?
MS. HARWOOD-JONES: Well, of course, that is a legal issue,
as to whether a loan is going to meet the requirements of
20(1)(c) and Revenue Canada, of course, can't be held to any
legal opinion that it has provided.
Now the evidence on it is relatively sketchy. We have the notes
which indicate, in fact, that Revenue, or rather that the
accountant appeared to recognize that, normally speaking, this
mortgage loan wouldn't fit into the requirements of
20(1)(c).
If indeed Revenue Canada said go ahead and do it, then that is
regrettable, but cannot form estoppel. Of course, there cannot be
estoppel against the Crown. ...
MR. BALDNER: I would just like to make some comments with respect
to the closing.
If I could start by saying that, you know, you said you might
hear from Mr. Baldner something different, and when you say, you
know, "It seems like they want to get a deduction anyway
when the mortgage wasn't for business purposes", I think
the -- originally we don't argue that the original mortgage
had anything to do with the share loan. It didn't.
We put a mortgage that -- we had a mortgage on our home to
finance our home. We had a mortgage, a second mortgage to finance
the purchase of the shares of Green Street Holdings, and that we
are not arguing with because those are the facts.
However, if I could have changed the events in any way, I would
have. If I would have been allowed to pay the mortgage and leave
the share loan existing, I would have. I didn't have those
choices. ...
The mortgage, the comment was made the mortgage was never used
for investment income. Not originally, but it was, because after,
after the loan was called by the CIBC, the share loan, our
position is that, at that point, since we had the money to pay
out the mortgage but weren't allowed to, that we are asking
the Court to allow us to deduct the mortgage interest on mortgage
one and two, which were the CIBC and TD mortgages on the
house.
We're asking that because although the mortgage loan
wasn't originally taken out for that purpose, we still had
the shares. We still had the investment security. We just
didn't have the loan from the bank because they required us
to pay it back, but we still had the mortgage.
And so although we don't disagree that it wasn't
originally taken out, certainly when the CIBC called the share
loan, that is when we checked with Revenue Canada and Revenue
Canada advised us that we should, or at last that it was
reasonable to take a position of substance over form, ...
As far as tracing the funds and their eligibility back and the
fact there should be a direct connection, I would suggest that
there is a direct connection and that the direct connection is
that, in the beginning, we had a share loan which was called by
the CIBC. So we transferred the deduction to a loan which had
identical security, both secured by our home, and pretty much
identical amounts.
And again that is a substance over form, because it's not as
though my wife sold her shares. She didn't sell her shares.
She still had the original investment, the original assets or
shares that were purchased with the proceeds from the original
share loan.
That there should be a bona fide purpose to earn income, well,
certainly after the share loan was called, in our mind it was a
bona fide purpose for the mortgage, because again it goes back to
the fact that we had no choice. We had to pay out the share loan.
We would have paid out the mortgage because it was nondeductible.
...
I believe these carrying charges should be allowed for the
following reasons.
The taxpayer had no control over the CIBC calling her share loan.
The CIBC forced the repayment of her share loan in conjunction
with a line of credit to RW Packaging Ltd.
The share loan could not be refinanced because RW was the primary
asset held by Baldner Holdings, which was 100 percent owned by
Green Street Holdings Inc.
The share loan was 7 percent of the outstanding shares of Green
Street Inc., and Darlene still owns those shares today.
Out of a concern for being forced to pay off a deductible share
loan, David Baldner asked Doug Smith, of Scarrow and Donald
Group, to check with Revenue Canada to see if they would allow
the taxpayer to substitute the interest for mortgage one for the
share loan.
As Doug attested to today, the share loan and mortgage loan were
approximately the same amounts and he explained that to Revenue
Canada, and that both loans were secured by a mortgage charged on
the home of the taxpayer and her spouse.
Revenue indicated to Doug Smith that it was reasonable with a
substance over legal form argument. Based on that discussion,
based, pardon me, based on that discussion, the deductions were
taken until Revenue ruled to disallow the carrying charges.
And it is our position that the use of the mortgage number one,
and later number two, the Toronto Dominion Bank, are reasonable,
and I qualify, under the circumstances, because I understand
where Revenue is coming from, but I think that under the
circumstances, my wife and I feel that it is reasonable to allow
the mortgage loan to stand in the place of the share loan, given
the circumstances that the taxpayer was faced with.
And I think that that is the essence of what substance over legal
form is about. ...
Anyway, I think just in concluding, I think from our
standpoint, really it is a matter of substance over legal form.
We don't dispute the fact the mortgage -- in fact, we agree
that the mortgage originally wasn't taken out for the
purchase of shares, but under the circumstances with what took
place, we think it is reasonable that if we were forced by the
CIBC to pay off the share loan, but not forced to pay off the
mortgage loan, and they are the same amounts and secured by the
same things, and my wife still carries the shares today, that it
should be allowed that we deduct the mortgage loan.
I would also point out to the court that the mortgage loan has
been paid off, subsequent to that. So had this not occurred, had
the CIBC not come along and called our loan, we would still have
that loan today. We would have been deducting the interest and we
would probably have it for numerous years to come.
And we aren't -- you know, Revenue Canada then would have --
it would have cost Revenue Canada money, or at least they
wouldn't have -- I mean we are arguing about what is, you
know, 1993, 1994, 1995, but the fact of the matter is it would
have gone on a long time.
We don't have a mortgage anymore. It's all paid off.
We're not claiming the mortgage.
So actually Revenue Canada is winning because the CIBC came along
and called that loan, because everything is paid off right
now.
So we are just asking that it be recognized under the
circumstances that because we had no control over CIBC and
because they called that loan, the share loan, that you recognize
the validity of the mortgage, which originally wasn't taken
out for that purpose, but would have been paid away, paid off,
and, you know, let us go on for the period in question."
ANALYSIS AND DECISION:
[18] In my opinion the position of the
Minister is correct. The interest on the Mortgage Loans is not
deductible, as the monies were not borrowed for the purposes of
producing income from a business or property as required by
paragraph 20(1)(c) of the Income Tax Act. The fact
that the Appellant and the spouse would prefer to have paid off
the Mortgage Loans with no deductible interest as opposed to
paying off the Share Loan resulted from the call of the Share
Loan and personal and business loans by CIBC. This in effect is
not sufficient to allow for tracing and to consider the interest
on the Mortgage Loans as really interest on the Share Loan. The
fact the amounts of the Mortgage Loan and the Share Loan were
each approximately $125,000 and the fact that the Share Loan was
secured on the home just as the Mortgage Loans, again, is not
sufficient to qualify for deduction of interest on the Mortgage
Loans. With respect to the submission of the Appellant and the
"substance over form" argument there can be no estoppel
against the Crown with respect to legal advice given by persons
in Revenue Canada. This principle is well-established.
[19] Considering that the interest on the
Mortgage Loans has not been allowed I need not attempt to clear
up the 1994 year as to who was entitled to deduct that interest
nor need I deal with the fact that since no Notice of Objection
was filed by the Appellant for 1994, or whether any of the
correspondence could be considered as a Notice of Objection but,
in any event, I believe once again that submissions of Counsel
for the Respondent are correct. Since no Notice of
Objection was filed for 1994 there can be no valid appeal before
this Court for that year.
[20] Consequently the appeals are
dismissed.
Signed at Ottawa, Canada, this 5th day of September, 2000.
J.T.C.C.
Email this Content